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N.H. Snyder
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Research Partner at Incline Global, a global long/short hedge fund. Graduated from Columbia MBA in the Value Investing Program, President of Investment Ideas Club within Columbia’s Investment Management Association (CIMA). Several years of fundamental equity analysis experience including two... More
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  • Conrad Industries (CNRD) - A Benjamin Graham Sweetheart
    Conrad Industries (OTCPK:CNRD) Target Price: $~26.75, +120% upside
    May 24, 2011

    Company Background:
    Conrad Industries, Inc. (“CNRD” or “The Company”) is a micro cap., with a market cap. of ~$82mn and an enterprise value of $50.6mn, which provides new construction (66.5% of revenues) and repair services (33.5%) for tugboats, ferries, lifeboats, barges, offshore supply vessels and other specialty vessels for commercial and government markets at its four shipyards and its six drydocks located in S. Louisiana and Texas. J. Parker Conrad, Co-Chairman, founded the Company in 1948. All revenues occur in U.S. and Puerto Rico.

    CNRD went public in June 1998, and on March 30, 2005, voluntarily delisted stock due to the high costs of public listing, a limited shareholder base, and other distractions associated with being a publicly listed company. It began trading on the Pink Sheets, and subsequently institutional coverage went away as did most liquidity for shares of the Company.

    Search Process:
    I originally identified CNRD while performing an EV/EBITDA multiple and other FCF yield screens for companies in December 2009 when I was seeking cheap stocks that had flown under the radar. Conrad’s market cap. was ~$40mn and shares  traded at ~1.3x 2009 EV/EBITDA. Since then share price +83%, going from $7 per share to $12.80 per share. Earnings power, backlog and book value have continued to build. With each passing quarter has retained its huge discount to its intrinsic value.

    Target Price & Valuation

    Asset Value Based Valuation: At $12.80, Conrad’s enterprise value is $50.6mn (market cap $82mn, cash $34.0mn, debt $2.6mn). Current assets less current liabilities is $56.9mn and a book value is $83.6mn. CNRD is trading at slight discount to its current account liquidation value and its enterprise value is priced well below its book value. In other words, this is a classic net-net.

    As Conrad’s liquidation value is $12.51 per share and its current enterprise value is $7.90, or a huge discount to liquidation value the street is probably assessing some unwarranted discount due to illiquidity and family control. However, by any traditional investment  valuation method Conrad is remarkably cheap and would truly be a Benjamin Graham sweetheart.

    To find Conrad’s liquidation value use a 50% recovery on inventory and other current assets as goods have little value to non shipbuilders. Haircut land value and buildings, office value by 25% for transaction fees and taxes in the event of an asset sale. Net PPE after adjustments close to reproduction value as a competitor can reproduce this current infrastructure at a comparable reproduction cost. Off-balance sheet adjustments include 20% of Conrad’s profits ($3.9mn) based on recurring relationships and another $4.8mn, or a 5 year average of SG&A, to account for R&D, expertise and employee training.

    Conrad Adjusted Asset Valuation (As of3/31/2011)
    Cash & ST Investments: $34.0 mn
    Receivables: $49.0 mn
    Inventory: $1.1 mn (50.0%) $0.5 mn
    Other Current Assets: $3.7 mn (50.0%) $1.8 mn
    Total Current Assets: $87.7 mn Adjusted: $85.4 mn

    Land: $5.2 mn (25.0%) $3.9 mn (shipyards, 97 acres)
    Buildings: $34.2 mn (25.0%) $25.7 mn (230k Sq. Ft. Book value at $149/sq. foot)
    Equipment: $20.1 mn (30 Overhead cranes, 7 rolling cranes)
    Drydocks: $11.5 mn (5,050 ft.of steel bulk head,5 slips)
    Barges & Boats: $1.7 mn
    Gross PPE: $72.7 mn, Adjusted PPE $62.9 mn
    Accum. Depreciation: ($35.5 mn)
    Total Net PPE: $37.3 mn Adjusted: $27.4 mn

    Customer Relationships: $3.9 mn
    Cost to Create Workforce, Build Expertise $4.8 mn (1x5 year average SG&A)
    Total Off Balance Sheet: $8.7 mn
    Total Assets: $125.0 mn  Adjusted: $121.4 mn

    Total Debt: $2.6 mn
    Other Liabilities: $38.8 m
    Total Liabilities: $41.4 mn

    Total Adjusted Net Asset Value (NYSE:NAV): $80.1 mn,  $12.51 Per Share

    Earnings Power/Cash Flow Valuation: Built detailed propriety earnings model to find Conrad’s earnings power based on the  Company’s historical operating margins and management guidance. I believe 7.0x 2011 P/E is justifiable given Conrad’s historical average P/E multiple of around 7.0x, the barriers to entry of U.S. Jones Act shipbuilding, and conservative estimates of internal U.S. trade demand growth. Accordingly, 5.0x forward EV/EBITDA justifiable given Conrad’s historical forward multiple of 5.0x EBITDA and strong backlog visibility. Below market average forward multiples makes sense to me as this is a competitive business with  undifferentiated products. Despite these competitive dynamics, Conrad’s ROIC(1) over the past three year has been 14.3%.

    By using 7.0x 2011 earnings of $19.4 million and 5.0x 2011 EBITDA of $33.4 million, Conrad’s earnings power offers a blended (50/50)  earnings power target price of $26.75, or a >120% margin of safety. Furthermore, due to strong transparency and a large backlog this  earnings power is highly predictable.

    Footnotes: (1) ROIC = Tax Effected EBIT / Total Capital – Non-interest paying liabilities.

    Comparables: No pure comparables as most U.S. Jones Act shipbuilder competitors, remain privately held, and/or are part of larger ship operators such as Kirby Corporation (NYSE:KEX). Other publicly traded U.S. shipbuilders such as Gunderson, is part of The Greenbrier Companies and Trinity U.S. Inland Barge, is part of Trinity Industries, two larger publicly traded transportation conglomerates.
    However, In January 2011, Todd Shipyards Corporation (TOD), a clean comparable acquired by Vigor Industrial for $98.1 million. Valued TOD at 3.8x LTM EV/EBITDA and 9.3x LTM EPS. Using average of multiples on 2011 results leads to $23.18 target price.

    Investment Merits:

    Building Backlog/Long Term Visibility:
    Backlog declined from $80.9mn in 2007 to $38.3mn in 2009. As of 3/31/11, backlog was $112.3mn. On 3/29/11, released 2010 annual report disclosing additional $75.2 million of NEW BUSINESS subsequent to 2010.  Since reporting surprise robust Q1 2011 orders, CNRD’s market cap. has declined by $5mn. Using Conrad’s 5 year historical net income margin of 8.9%, the $75mn revenue surprise will lead to an additional $6.7mn of earnings, meaning “Mr. Market” is  attributing less than 0x this new earnings surprise. At Conrad’s 2008 EBITDA margin, 2011 EBITDA would hit nearly $50mn.

    Industry Wide Inflection Point: In February 2011 tonnage of all commodities moved on internal U.S. Waterways, was the highest in  five years. However, tank barges that operate on the inland waterways of the U.S. declined from 4,200 in 1982 to 2,900 in 2002. Levels increased from 2002 to 3,100 by 2011. Risk of oversupply is mitigated by mature fleet with approx. 850 tank barges over 30 years old. Average age of a tank barge is 20 years old, with only 28% built in the last ten years. The economic collapse also helped consolidate excess supply with bankruptcies at Bender Shipbuilding and Trico Marine Services, Inc.

    Diversified Strategy: Transitioned away from cyclical oil/gas industry into more diversified product and customer mix. Decline in new construction for Gulf of Mexico oil/gas, offset by securing work from other commercial customers and government sources. In terms of business mix in 2010, 75.5% of revenues came from commercial, 14.1% of revenues came from government, and only 10.4%
    revenues came from energy. Strong support for long term viability with or without Gulf of Mexico oil drilling.

    Expanding Margins: Main cost is steel and CNRD is building steel escalation clauses into contracts. Vessel construction gross margins hit peak in 2008 at 20.1%. Since 2008, experienced pricing pressure and gross margins declined to 11.6%. Expects margins to be similar to 2010 levels. Even if gross margins flat vs. 2010, Conrad will make significant gains from strong volumes booked. Conrad’s labor costs are 20-30% lower than unionized competition as most of its employees are hourly labor and non-unionized.

    Owner Operator Mentality:
    J. Parker Conrad, age 95, founded Conrad Industries and served as Chairmen since inception in 1948. Since March, 1998, J. Parker has been Co-Chairmen of the Board with son John P. Conrad Jr., age 68, whom has been at the Conrad since 1962. Conrad’s own 49.1% of outstanding common stock. Shareholders are partnering with Conrad family and the Conrad’s continue to make prudent long term investment decisions in the best interests of its shareholder’s over the past seven decades.

    Shareholder Friendly: In 2008, Conrad bought $9.4mn shares back. August 2010, approved $5mn share buyback, representing ~15%  of CNRD’s total market cap. at the time. Conrad building earnings power which will be distributed over a diminishing share base.

    Pristine Balance Sheet:
    Conrad’s debt totaled $2.6mn, with cash of $34.0mn on March 31, 2011. Untapped $10mn revolver with JPMorgan expires April 2012 at interest rate of ~2.2%.

    Barriers to Entry: Jones Act (1920) requires all goods transported by water between U.S. ports be carried on ships constructed in the U.S., and owned and crewed by U.S. citizens. Barrier eliminates foreign competition whom can build ships at nearly ½ the price. Protectionist legislation in place ~100 years and not likely to change. The U.S. shipbuilding industry will probably not draw new entrants as the current industry enjoys measly margins, unexciting growth, and an ugly, boring business model.

    Investment Risks:

    Competitive Market Lacking a Moat: Shipbuilding and repair is extremely competitive on price.
    Small size and limited liquidity: Avg. volume of 5,237 shares or ~$73,000 per day. Only 3 – 3.5mn shares freely tradable.
    Shareholder Restrictions: Company bylaws limit outside influence and make a potential buy-out more challenging. The stockholder’s rights plan will expire on May 13, 2012, unless redeemed or exchanged at an earlier date.
    Mississippi River Floods: Rising water levels may impair business this spring, took precautions to safeguard.
    Exposed to Gulf of Mexico: The Department of Interior lifted a moratorium on deepwater drilling on October 12, 2010. Lifting the ban on drilling, however, really did not take away the long-term uncertainty.

    May 24 5:05 PM | Link | 1 Comment
  • Bling is Back - Buy Harry Winston

    Company Background- Harry Winston Diamond Corporation (HWD), engages in mining and retailing of diamonds in the U.S., Canada, and internationally. The Company, through its subsidiaries, holds a 40% ownership interest (60% owned by Rio Tinto) in the Diavik Diamond Mine which supplies rough diamonds; and engages in the retailing of fine jewelry and watches under the Harry Winston brand. The Company currently operates 19 retail locations with 8 in the US, 5 in Japan, 2 in Europe, and 4 in Asia ex-Japan. HWD was founded in 1980 and is based in Toronto, Canada.

    Investment Thesis- Buy Harry Winston (HWD) as the vertically integrated diamond miner/retailer will benefit from strong diamond prices, improving mining recoveries, rebounding luxury spending, and reinvigorated retail unit growth in Asia. The Company is uniquely positioned to leverage mine ownership and proprietary diamond pricing information flow and HWD has already witnessed surging revenues over the last two quarters with mining revenues rising 121% y/y (70.1% price, 51.1% volume). Nevertheless, short term production issues such as a thick top soil have led to lower recoveries and higher costs in the near term. As HWD finishes its transition to underground mining the Company is positioned to surprise the investment community with lower than expected costs and more sustainable pricing.

    HWD will continue to experience robust diamond prices, which have risen past pre-recession highs, which will in turn flow through to the bottom-line as mining efficiencies reduce operating costs and HWD has minimal additional variable costs. All of which have set the stage for earnings to surge past lagging sell-side estimates.

    Target Price- Harry Winston’s base case intrinsic value is $16.29 implying a >40% return over the next twelve months. Valuation is based on a sum-of-parts valuation using a 7x EV/EBITDA multiple for the mining assets and 10x EV/EBITDA multiple for retail assets. Commodity companies typically trade at 6-8x normalized EBITDA. However, Diavik represents a compelling asset as it was the last substantial high grade diamond discovery in nearly a decade and long term diamond supply is dwindling. For retail, we use 10x EV/EBITDA as Harry Winston’s closest comparable, Tiffany’s (NYSE:TIF) is trading at 10x Jan. 2012 EBITDA.

    Operating assumptions for FY Jan. 2012 mining include: 3.1 mm carats (guidance), $105/carat ($99.34/carat in FY ’11E), and 3.5 grade (3.4 in ’11E).

    Operating assumptions for FY Jan 2012 retail include: revenue growth +15% (10% unit growth, 5% comps), 2 new stores (guidance), 51% gross margin (51.4% in FY ‘11E) due higher gold/silver, and 6.1% EBIT margin (5.5% FY ‘11E). Based on these assumptions and my multiples each $10/carat = $1.00 of implied share value.

    HWD’s valuation is also compelling by looking at the Diavik diamond mine as a standalone asset. In August 2010, HWD repurchased a 9% stake in Diavik for $220 million, implying HWD’s 40% Diavik stake was valued at $980 million - even before the continued rise in polished diamond prices over the past four months. Additionally, it has been rumored that Anglo American will offer to buy the Oppenheimer’s 40% stake in DeBeers for at least $3.1 billion. Using available data this would imply that Diavik is worth ~$1.1 billion. Harry Winston’s current enterprise value is ~$1.1 billion, allowing for tremendous downside protection as investors are essentially getting 19 high end jewelry stores for FREE.

    Harry Winston Thesis

    Strong Branded Business- Harry Winston is possibly the strongest jewelry brand in the higher end diamond market allowing the Company to earn robust EBITDA margins in good times (~44% EBITDA margins) vs. an LTM EBITDA margin of 22.2%. This very discretionary and cyclical business has passed its inflection point and explosive earnings potential lie ahead. Downside protected by HARD ASSET ownership of diamond mine asset.

    Back From the Brink- In March 19, 2009, HWD suspended its dividend and raised $150 million by selling a 9% stake in Diavik to Kinross Gold Corp (NYSE:KGC). Additionally, the Company enacted two six-week shutdown periods in mid-summer and at year end. HWD’s share of carat production in FYE Jan. 2010 dropped ~40% to 2.23 million carats from 3.69 million carats the previous year. On the retail side, HWD took over $12 million out of discretionary SG&A between 2009 and 2010 to right size its cost structure. As a rebound has commenced HWD has reacquired this 9% stake and has initiated new hiring and compensation increases on the retail side.

    Mining Segment, formerly Aber Diamond Corporation, (LTM: 48% of revenues, 89% of EBIT)

    Diavik Mine is located in Canada’s Northwest Territories. The Diavik deposit comprises three diamond bearing pipes that are being mined using open pit and underground mining methods, with a fourth pipe being reviewed to determine the viability of mining. Production commenced in 2003 making it the most recent large scale diamond discovery in the world. At 7.8 million carats per annum, Diavik controls ~5% of global diamond production and Diavik remains the highest grade diamond mine in the world. Diavik now maintains nearly 60 million carats of reserves and resources which will take production beyond 2022. The mine’s life, from the start of production in 2003, and including the underground mining operation is estimated to be 16 to 22 years.

    Over the last two years production has been changing from open pit to underground and HWD is assessing cheaper mining methods, which would lead to higher velocity and lower mining costs. Underground production should accelerate as the year progresses and by 2012, Diavik is expected to be a 100% underground mine. In the short term costs have been higher than expected forcing short term speculators out of the name and clearing the way for an attractive investment opportunity for the more patient investor once operating margins rise again.

    Retail (LTM: 52% of revenues, 11% EBIT)- Harry Winston salons, which are located in 19 prime markets around the world represent the most luxurious diamond retail franchise in the world. The brand has proven its resilence with sales rising 48.3% y/y in the last quarter.

    In Spring 2010, HWD hired Frederic de Narp to build the Harry Winston Brand watches and accessories after he successfully built the Cartier brand. HWD also announced a long term retail growth strategy including 26 salons by 2013 and 35 salons by 2016. Plans also include the introduction of partnered stores (±20 stores) in riskier markets in which Harry Winston would retain control of the brand image but share the operating costs with a business partner. Also, HWD will be expanding its wholesale watch network from 188 locations at the end of FY10 to ±300 by 2016. Lastly, Harry Winston will develop its bridal business in every salon, which HWD doesn’t currently have.

    With a balanced geographical sales footprint HWD isn’t overly exposed to the indebted consumers of the developed market and Asia has now passed Europe and North America as HWD’s biggest sales generator. No other luxury diamond retailer is better positioned to meet the need for high end diamond clientele quiet like Harry Winston, which is the go to diamond retailer for the world’s rich and famous.

    Risks Diamond demand collapse, lower recoveries at Diavik, synthetic diamonds have been manufactured since the 1950s and have yet to make a major impact on the market. Russia flooding the market with stockpiles (Russia showed discipline with palladium). Inventory turns only ~1.0x per year.

    Other Potential Catalysts-

    * Rumors surfaced in Sept. 2010 that Rio and BHP Billiton Ltd., may combine Canadian diamond operations. The two parties have had long talks about this potential multi-billion merger of their Canadian diamond operations.

    * On HWD’s last call Mgmt claimed they would love to buy some more rough diamond production because they have a very good marketing platform for it.

    Diamond Industry Primer- Rough diamond prices have rebounded after falling as much as 65% from September 2008 through March 2009. Diamond prices are now well above pre-recession highs and represent the top performing commodity worldwide after palladium and copper. Large volumes of production from Zimbabwe have probably depressed prices somewhat in smaller, cheaper, off-color goods. Nevertheless, quality diamond prices continue to strengthen as long term supply declines and demand builds.

    Diamond Supply Diamonds weren’t discovered until 140 years ago. Since then over 5,000 mines have been explored with only 50 found to be economical. Despite a boom in exploration in the last decade, there have been no new discoveries of any significance since the early 1990s. The industry is consolidated with 90% of all rough diamond production coming from De Beers, Rio Tinto, Alrosa and BHP Billiton. In 1902, De Beers controlled 90% of the world's diamond production. Nevertheless, De Beers, now with 40% market share is more profitable today as the Company has created tremendous brand value associated with top notch diamond retailers.

    In total, due to a consolidated and disciplined production base global diamond supply was cut by as much as 90% in Q1 2009. Producers realize that scarcity drive price and value. Inventories are now very low at retailer levels and any uptick in demand would lead to a rise in retail diamond prices. Furthermore, existing mines are beyond peak production levels and no new major mines are in the pipeline. Even new discoveries would take 7-10 years from discovery to production.

    Diamond Demand- The diamond jewelry market is valued at over $58 billion. With 35% of global sales, the United State is the biggest consumer of diamonds. China, at around 10%, is now the world’s second largest diamond market, surpassing Japan in 2009. China consumption is still growing strongly and is expected to roughly double its share by 2015. The Indian and Chinese markets view diamonds with more of an eye to investment, much as they do gold.

    A large part of the diamond market still grows no matter what the economic environment — bridal jewelry - which is as much as 50% of the diamond market. In 2011, as consumers recover from the “Great Recession” global luxury spending is forecasted to increase 5-10% with the following composition: China +15%, Rest of Asia +10%. North America +5%, Europe +5%, Japan 5%. Demand for luxury brands continue to strengthen globally, especially by consumers in China supported by the rapidly expanding wealth of its consumers and in the Middle East as a result of higher energy prices. The supply chain is now de-stocked and retailers are seeing pull-through in demand for diamonds.

    Disclosure: I am long HWD.
    Jan 09 9:30 PM | Link | 1 Comment
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