Farmer Bros. Is A (Speculative) Buy

Summary

• I continue to think this company is troubled, as evidenced by the ongoing losses.
• That said, I think a troubled company can be a good investment at the right price, and I think the shares have reached "right" territory.
• In addition, I think investors would be wise to follow the lead of insiders, the people who know this business better than anyone.

Since writing my bearish piece on Farmer Bros. Co. (FARM), the shares are down about 41% against a gain of about 3.25% for the S&P 500. I have a few reasons for revisiting the name. First, the company has obviously published new financial statements, so they deserve comment. Second, a stock that’s trading at $9.50 is by definition a less risky investment than the same stock when it’s trading at $16.30, so it may be worth buying at current levels. Finally, the company took a number of steps to help lessen the impact of the Covid pandemic on operations, including drastically reducing the workforce, furloughing many others, reducing executive compensation by 15%, and cutting board compensation for the quarter. This holds out the possibility that the company may actually turn a profit in the near future.

Financial Snapshot

In my previous article on Farmer Bros., I characterized their financial history as “troubled” because there seemed to be a disconnect between revenue and net income. Revenue has grown slowly over time (up at a CAGR of about 1.7% over the past several years, while loss from operations and net losses have exploded. I also noted that the business seems to be highly cyclical.

It seems that little has changed since I last wrote about the business. In spite of the fact that revenue in the most recent period was down “only” 7.4% relative to the year ago period, net loss from operations rose by nearly 300%. Net loss was “only” $27.3 million in the most recent period relative to a $64.5 million loss last year. This improvement was impacted by a few factors. First, during the most recent period, the company suffered a goodwill impairment charge of $42 million. Offsetting that somewhat, the company realised a gain on the sale of assets to the tune of ~$23.375 million. Additionally, the company enjoyed a $1.222 million income tax benefit in the most recent period against a $39.15 million tax expense in the previous year. So losses were reduced because of the sale of some assets, and a helping hand from the IRS.

It’s not all bad over at Farmer Brothers, though. The capital structure is much stronger at the moment, which will help the company weather the current crisis. In particular, over the past year, the company has managed to reduce long term borrowings by just under 35%, while cash and equivalents are about 116% higher now than they were the same period a year ago. . In my view the combination of balance sheet improvement and responses to Covid will help the company weather the current crisis.

More broadly, though, I remain troubled by the fact that a company can not generate consistent profit in spite of $600 million in annualized revenues. This problem obviously doesn’t disqualify the company, because a troubled business can be a great investment at the right price. Thus, I need to examine what investors are being asked to pay for these shares at the moment.

Source: Company filings

The Stock

I think a great business can be a terrible investment, and I think a challenged business can be a great investment. It’s all about the price paid. If an investor overpays for quality, they’ll have a poor showing in my view. If they underpay for any asset, I think they’ll do well. For that reason, I need to spend some time writing about the stock as a thing distinct from the underlying business.

When considering any stock, I want to make sure that it’s inexpensively priced. I want to make sure that it’s trading at a discount relative to its own history and to the overall market. I judge whether a stock is cheap or not in a few ways, ranging from the more simple to the more complex. On the simple side, I look at a ratio of price to some measure of economic value, like earnings, free cash flow, and the like. On that basis, I’d say that Famer Bros. is actually trading at a fairly significant discount to the overall market and to its own history, per the following.

Data by YCharts

Note, when I last looked at the company, I threw a bit of a virtual hissy fit over the fact that it was trading at a price to free cash flow over 350. It's a much more attractively priced stock at the moment.

In addition to the simple ratio between price and some economic value, I want to try to understand that the market is assuming about the future based on price. In order to do that, I turn to the methodology described by Professor Stephen Penman in his book “Accounting for Value.” In a nutshell, Penman describes how an investor can isolate the “g” (growth) variable in a standard finance formula to work out what the market must be thinking about the future. At the moment, the market seems to be forecasting a growth rate of about 9% for this business, which I consider to be a very optimistic assessment. I’m on the fence about Famer Bros.. According to some measures, the shares are extremely inexpensive. Some other measures suggest that these shares remain overpriced. If only there were some people who could break the tie.

Insider Activity

Thankfully there are some people who can break this tie by their actions. The people are insiders and the actions they’re taking to break the tie is buying this stock aggressively. In my view, when the people who know this business better than any Wall Street analyst ever will put their own capital to work in the name, it would be silly to not take notice.

Specifically, since November of last year, three insiders have made significant purchases of shares. President and CEO Deverel Maserang purchased 13,000 shares in mid-November 2019. Between mid-February and mid-March of this year, Director Christopher Mottern purchased 5,000 shares. Finally, Director Stacy Loretz purchased 2,500 shares in mid-March.

I think it’s very reasonable to assume that these people know this business much better than I, and if they’re buying that’s a very positive sign in my view.

Conclusion

I think Farmer Bros. remains a relatively troubled business. In spite of reasonably consistent revenue, the company has failed to turn a profit for years. That said, I think there are some bright spots, particularly on the balance sheet. Additionally, I think the company took some shareholder friendly moves recently. I think a troubled business can be a great investment at the right price, though, and I think there’s some compelling reasons to think we’re quite near the “right” price. For my part, I’ll be taking a small speculative position in this stock, and I would recommend other investors do the same. I wouldn’t recommend putting too much capital to work here, but I think the insider buys are compelling enough to warrant a small long position. Please also note that I think any money put into this stock should be considered “gone”, as there’s a reasonably large chance that the shares will continue to fall in price. You have been warned, dear reader. Only invest in this stock with money that you can afford to lose.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FARM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Mark Krieger]

great article...thank you

[haydendalia]

And.. It's gone.

[Derek Capo]

Lol