Core Investment Idea
This is a simple case of a firm in a poor industry, but has a big investment portfolio that takes up most of the market cap (Think Sanborn Maps). It is not a great company, so I don't think the firm's business model needs deep analysis, but due to its valuation I think it can be a great investment as more of an asset play if the firm keeps paying dividends.
George Risk Industries (OTCQB:RSKIA) is a tiny manufacturer of burglar alarms based in Kimball, Nebraska. The firm also manufactures computer keyboards, pool alarms, thermostats, duct wire covers, and water sensors. The firm's market capitalization is 34M, however being a very illiquid microcap that trades OTC, it rapidly fluctuates. The firm is headed by Mr. Ken Risk, who owns a substantial percentage of the shares outstanding. Essentially it can be thought of a private firm that is public for no real reason. Subsequently it is plain to see why the firm is undervalued; it is an obscure tiny firm, in a very "unsexy" industry that does not even trade on an exchange.
Financial Statement Analysis
The firm despite its size has been very stable in terms of generating cash flow. In the last four years, income has grown from 0.52M to 2.65M, however, Operating Cash Flow has been above 2M in that period, ranging from 2.06 to 2.45. The firm makes no acquisitions, and capital expenditures have been small, ranging from 0.06M to 0.30M. Effectively, FCFE has been above 2M over the past four years.
The balance sheet shows 26 M in cash and investments. 20.2M of that is invested in a fixed income fund managed by a mysterious third party which GRI refuses to name, creating one potential risk factor for the firm. 5.8 M of it is held in cash and cash equivalents. So given a market capitalization of 34M, and portfolio of cash and investments of 26M, the business itself is selling for 8M. Keep in mind though, that even though the market cap is 34M, due to the high volatility, it can trade for far less than 34M as well, and moves of 5% on any given day are not uncommon. However, if we take the 34M figure, then essentially we can buy annual cash flow of 2M for only 8M. That is basically the value proposition of this particular investment.
This is a critical question as tiny microcaps can very easily stay in microcap purgatory if no catalyst appears and trade below liquidation for years on years. However I do believe there are two catalysts: buybacks and dividends. Over the past few years GRI has been buying back small amounts of stock, in addition it has started paying a dividend and increased it over the last few years. The current dividend yield on the stock is 4%, which is strong, and the dividend has been rising the last few years, as the firm continues to drain its cash. Last year's dividend was $0.23, and this year I was expecting an increased dividend of approximately $0.25, and instead it was $0.28, which would make it a more than 50% payout rate on FCFE, which I believe is justified and sustainable as rather than grow, we want them to liquidate.
As a corollary to the above point, the position should be sold if these specific catalysts do not occur. We want to see the dividend at least maintained if not raised next year, and if there is a cut, it indicates a divergence of opinion between management and the investment view, as a result then it would be a candidate for selling.
The aforementioned fixed income portfolio is a risk as we do not know who is managing it or as to what their skill set is, so having that much of the firm's value locked up in a fund is certainly a concern. The other risk is that being a private firm, entrenched management can use the firm as their own personal account, to some extent it is happening already as the firm leases a plane from Mr Risk. This much inside ownership also restricts the possibility of an acquisition.
The other primary risk is liquidity. This is a serious concern as the stock does not trade everyday. It has a total float of about 5 million shares, and many of them are not on the market, as a result movements of +/- 4-5% are very common and can even be as extreme as ~10% movements, which may not reflect any changes in fundamentals, a drastically different situation from larger caps. The other consequence is that you will not be able to exit your position quickly if a change in fundamentals were to happen, and if you use market orders, chances are you will not get a good price. To trade this stock, limit orders are a must, I believe this stock can be a good investment at approximately $6 or lower, so I would recommend buying using a limit order set slightly below this price, and same goes for sell, use a limit order slightly above your target exit price.
I estimate the IV to be approximately $10, compared to a last price of $6.80. But given the stock's liquidity, I think it can be had lower, at say $6 or lower.