Clumsy Rick's  Instablog

Genuine Parts is a few weeks away from finishing its third quarter and will be reporting those results shortly after. I believe the stock looks very attractive, particulary if you are looking out to fourth quarter, for the following reasons:

As a follow up to my last post on Rex on September 4, the company reported second quarter results this morning that were quite positive. EPS were $0.09 (about $0.03 excluding an accrual benefit), reversing the trend of losses from the last three quarters.

The ethanol division would have been break even except for the start up costs at the last plant it opened. More importantly, ethanol margins have improved in third quarter so far and all plants are operating profitably. 

Another positive update was on the real estate front where the company is making progress leasing out vacant properties, including part of its largest distribution center for which a lease was signed after the close of the quarter. In addition to property it is already landlord on, the company can either sell or lease out 23 former stores and 2 distribution centers.

Estimated Asset Valuation Update:

Corporate Cash and +$7 million Tax Refund= $9.50/shareReal Estate: 43 stores and 2 warehouses, net $3 millon mortgage=$5.00-$5.50/share
General Tax Credits: $3.40/share
Ethanol Interests (138 million gallons per year at name plate capacity): ?????

In summary, Rex has substantial assets, including cash and tax credits that exceed the current share price.  The bleeding has stopped and there is the potential for a significant increase in earnings and cash flow in coming quarters as the company leases or sells vacant properties and as ethanol turns profitable, as it has done so far in third quarter.

Disclosure: Long RSC

Rex will report its 2Q ending July 31 results next Wednesday, Sept 9th. While this quarter will still have a drag from its legacy retail business including potential store closure costs, the operating results in its core ethanol and real estate business should show improved results relative to 1Q.

Excluding exit costs from retail, Rex could post its first positive EPS in a year, reversing the trend in losses seen since the beginning of the consumer spending downturn late last summer. Given Rex's substantial asset base (book value $25/share, net corporate level cash of $8.50-$9.50/share), a positive earnings result could help boost the stock modestly as it would help alleviate concerns of erroding value.

2Q results should benefit from modestly higher ethanol prices (estimating blended price of $1.64/gallon) and relatively flat variable input prices relative to 1Q. Additionally, with interest rates now rising, the company should not see a drag from interest rate hedges as it has for the last several quarters. Hedges could boost earnings this quarter.

Looking ahead to 3Q, the company should see a more robust earnings increase versus last year's poor results. Retail will be completely closed down. Corn and natural gas prices have fallen more than declines in the price of ethanol leading to improved (albeit still weak) spreads currently. The last of the ethanol plants being built by companies Rex has invested in should be up and running for the full quarter.

It would be encouraging to see improved financial results, but in the end Rex is still an asset/value play. The stock is trading just above its corporate level cash balance at $8.50-$9.50. Real estate and other assets could be worth an additional $7.00 per share. Valuing ethanol assets is perilous, but given the price of the stock and value of real estate, you are essentially getting the interest in various ethanol assets of approximately 139 million gallons per year (mgpy) production at name plate capacity for free.

Disclosure: Long RSC.

Many retail stocks are off their recent 2009 highs after weak June sales were reported and some economic data has suggested we are in for a slow economic recovery.  However, even assuming only a modest recovery in the economy into 2010, the outlook for retail earnings is better than it has been for several quarters. Sales declines appear to be bottoming just as cost cuts are starting to show up in full. Additionally, many retailers have the potential for significant upside to gross margins this year.

Sales appear to be bottoming: Per US Advanced Retail Sales data, seasonally adjusted retail sales appear to have bottomed in March with a 12.1% year-over-year decline. June’s 10.0% decline was the best showing since last November as the declines started to accelerate into this recession. Last year’s fiscal stimulus remains as a near term challenge for retail comparisons. However, as we enter the fall, easing comparisons should start to improve reported sales. This, of course, assumes no significant drop off in demand from the current sales trend. Admittedly, this is the biggest risk to retail, but one that appears at least partially discounted already in analyst earnings estimates and the valuation of retail stocks.

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Rex Stores (RSC), the ethanol producer, should see a significant acceleration in free cash flow starting in the second half of this year.  Assuming the price of corn and ethanol (or the ratio of the prices) remains relatively stable, Rex's free cash flow could reach an annualized rate of $20-25 million ($2-2.50/share).  If correct, this means the market is valuing RSC shares at an inexpensive 4x-5x free cash flow.  

There are several positive events for Rex coming up in the 2H09. First, Rex will have completed its exit from its legacy retail business in 2Q09, freeing up capital and management while putting end to its financial drag.  Second, the One Earth Energy ethanol plant Rex is a majority investor in should be up and running by the end of the 2Q09. I believe this plant will add to profits and operating cash flow modestly based on current ethanol and corn prices.  Additionally, the completion of this project will mean the end of substantial capital expenditures flowing through the company's financials (even if it was funded by non-recourse debt of the partnership, consolidated on Rex's balance sheet). Finally, Rex revealed on its 1Q conference call that the Levelland-Hockley plant it is a majority investor in was not operating at capacity for part of 1Q09 because of maintenance. After the maintenance, however, production at that facilty apparently improved. Thus, the financial results from this plant should look better in 2Q09 and beyond.

My estimate for $20-$25 million in free cash flow comes from a runrate of $6-$7 million in operating cash flow per quarter and about $1 million in maintenance capital expenditures per quarter.  This estimate does not include cash flow from the potential sale of any of its former retail stores or its distribution centers.

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The release of the US Advanced Montly Sales Report once again showed worsening trends for Electronics and Appliance Stores. Seasonally adjusted sales were down 13% in May, which was worse than last month's 11% and significantly below a temporary peak in January with a 0.6% decline. While I do believe industry sales have slowed this Spring due to the highly discretionary nature of purchases this time of year, I also believe this report is overstating the decline for the consumer electronics (CE) industry as a whole, and especially individual retailers, due to the impact of the Circuit City bankruptcy and sales absorption by chains outside the Electronics and Appliance Stores' division.

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