Price Target: $1.75
A string of negative news and potential market over-reaction has punished Exide (XIDE) shares for the past 2 months. Exide's business is a highly competitive and commoditized business where it sells batteries to car manufacturers, auto parts retailers such as Pep Boys, and a wide spectrum of industrial batteries around the world.
Exide has been on my investment radar since the stock nosedived a couple of years back and traded between $2.00 - $4.00. The business economics did not attract me and it was not trading below BV to merit a closer look or investment.
With the stock trading below $1.00, I thought it was time to take a closer look and see if the market was right or if there was value here.
|Current Price||Book Value TTM||P/BV||Revenue||P/S||Mkt Cap||Enterprise Value|
|$0.52||$3.36||.24||$2.92 Bil||0.02||$41 mil||$792 Mil|
In the article I will discuss a couple of major points to rectify my investment thesis.
- Exide's Bankruptcy Risk
- Regulatory shut down of the Vernon, CA Lead Recycling Plant
- Shareholder Lawsuits
1. Bankruptcy Risk
Exide is no stranger to bankruptcy, after over-leveraging itself in the early 2000s, they went Chapter 11, re-emerging in 2005. This type of event is normally burned into every investors memory. To be clear, Exide's current numbers are no where near the pre-bankruptcy numbers of 2001.
What the numbers tell us:
Liquidity: (Exb. 1)
Currently Exide stands at no immediate or short term danger. It's current Defensive Interval Ratio is 79 days. Meaning if they would stop all operations completely, they would have close to 3 months of money to pay bills. A distressed company with under 30 days would be a red flag.
Exide's April 4th announcement of better than expected free cash flow of $50 and total liquidity of $230+ million is very positive material information. (click here to read release)
Solvency: (Exb. 2)
The solvency ratios do not paint a rosy picture for Exide. Their financial leverage has grown to 6.5, 20% above their historical DFL. The Fixed Charge Ratio dropped below 1. Late in 2012, Exide purchased over $5 million worth of their Sept 18, 2013 convertible debt which could have negatively contributed to the lower Fixed Charge Ratio. These are key numbers to watch but do not conclude an imminent demise of Exide.
On April 3, 2013, a Debtwire.com reported Exide consulting with Lazard sent Exide shares tumbling over 50%. This information was translated by the market as a potential bankruptcy chapter 11 reorganization by Exide.
After the Exide news release, the stock did not rebound back to previous pricing. It was enough to scare away a lot of investors and speculators.
If not bankruptcy, then what could this mean?
My best guess, to restructure debt agreements and negative covenants. Why? The Frisco, TX property sale and recycling plant closure. Management has declared a $37 million dollar profit from this sale to be recognized in the FY 2014. Unfortunately due to debt covenants, this money will be put in escrow and Exide will not have any access to it. This is a major reason why I believe Exide is consulting with Lazard.
2. Regulatory Shutdown of Vernon, CA Lead Recycling Plant
The major point I would like to make here is, in my opinion, Exide no longer wants to be in the lead recycling business. It wants to concentrate on making the best batteries in the market. If I'm right, Exide will no longer spend precious investment dollars into these facilities.
Not too long ago, recycling lead was a profitable 3rd party sales business and gave Exide a competitive advantage on gross margin. This no longer exists and is the reason why Exide has shut down two recycling facilities in the last year. (Frisco, TX & Reading, PA)
The shutdown of these two facilities has left a lead raw material supply gap of ~25%. They are now buying 25% of their lead needs through contracted suppliers. With the shutdown of their Vernon,CA plant, they will have to outsource more lead. This should not be a material operational problem.
I believe that Exide knew without spending a lot of money, there was a high probability of being shutdown by the CA EPA, and decided against investing into a unprofitable business. This is the same reason why they idled the Reading, PA plant.
What happened to the lead recycling business in the USA?
Increased environmental regulations under the Obama administration have harmed this once profitable enterprise. Johnson Controls (NYSE:JCI), Exide's main competitor, and largest battery producer in the world has moved the majority of it's recycling operations to Mexico. The environmental regulations are not a quarter as stringent compared to the USA.
These developments have negatively effected Exide in two ways. (1) by increasing the operational cost to recycle in the USA. (2) Increasing the cost of spent batteries where Mexican recyclers can pay more for spent batteries because it costs less to recycle. This has resulted in downward pressure on Exide gross margins for years now.
Health & Environmental Liabilities?
The Vernon, CA plant was shut down for 2 reasons. Arsenic emissions exceeded maximum accepted levels and a damaged water drainage pipe. Based on historical environmental cleanups and penalties, Exide could be on the hook for $8 - $10 million. (Most recently, Exide has an environmental cleanup liability for $6-8 million on the 1999 Tampa, FL closure)
Currently, health risk liabilities caused by Exide's air pollution and water contamination does not look probable and non-material. The factory is in a highly industrialized zone and ground contamination has been prevalent for years. Sole responsibility falling on Exide would be highly improbable. Based on regulations, cancer-risk has exceeded the maximum allowed by CA EPA, 1 in 1 million (.0001% chance of cancer). Exide's air emission Hazard index is 156 in 1 million. The effected population is 110,000. Which implies a .0015% chance of chronic cancer or approximately 17 individuals adversely effected after long term exposure. To be conservative and account for any uncertainty this health liability may produce, $10 million should suffice.
Overall, an investor can conservatively price a $20 million liability for any unknowns on the Vernon, CA facility.
From 6/3/13 to 6/5/13, the California EPA will be holding a hearing on behalf of Exide and the plant suspension.
3. Recent Shareholder Lawsuits
The complaint filed:
"The Complaint alleges that defendants failed to disclose that: (NYSE:A) Exide was polluting the environment with potentially fatal levels of arsenic, and exposing almost 110,000 residents near its Vernon, California battery recycling facility to dangerously high levels of pollutants; (NYSE:B) based on actual and projected revenues and expenses Exide would not be able to meet its debt repayment obligations and other pledges and promises under its debt agreements and indentures. The lawsuit claims that when the market learned of this information the value of Exide securities dropped damaging investors."
- Rosen Law Firm
Interesting enough, approximately four other law firms followed suit and filed the same class action for shareholders who lost more than $100,000.
These lawsuits will most likely NOT hold up in court, shareholders were disclosed and notified in last year's Aug 10-Q of potential regulatory problems at the Vernon, CA and fines paid. This complaint dangerously implies imminent doom for Exide and this flooded stock ticker news feeds.
Sept 18, 2013 Convertible Debt
If I am correct about Exide's current health and liquidity position, this has given Exide management a rare opportunity to buy back it's debt on the open market very cheap. ~$55 million of the 9/18 Convertible Debt was left outstanding and it was trading at a 70% discount.
If management was savvy, they could have saved the companies millions by buying it up. Only time will tell.
Exide is a struggling company with poor business economics. This does not mean it is worthless. One can buy a great company at a terrible price or buy a bad company for a great price. In this case, I believe the latter is true for Exide.
After all the hysteria passed and the "electronic herd" trampled this stock. Exide presents itself as a classic Benjamin Graham "cigar butt". According to the most current data and my interpretation, I believe Exide's problems are manageable with healthy economic conditions and cyclicals rebounding.
My price target is $1.75 in the next 6 months.
Disclosure: I am long XIDE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.