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AWX- value trap or value investment?

|Includes: Avalon Holdings Corporation (AWX)

With a market cap between $10-11m, Avalon Holdings is a potentially substantially undervalued microcap with a lot of potential for value creation. AWX currently trades for under 0.3x BV. The company has 5.7m in cash and practically no debt (230k in capital leases), so half of the company’s market cap is just the cash on the balance sheet. However, the company has been extremely cheap for almost a decade, and could very well represent a value trap. Investors will have to dig into the company to decide for themselves.


AWX was spun out of American Waste Services on June 17, 1998. It consisted of an 18 hole golf course, Avalon Lakes in Warren Ohio, and a waste disposal / landfill management business. In 2003, the company entered into a lease to manage another golf course, Squaw Creek, and in 2006 the company purchased another golf course, Sharon Country Club. Waste disposal accounts for 75-80% of the company’s revenue and golf 25-30%.


There is the potential for a lot of value in the golf segment. They own 5.6 acres in their Warren property (plus clubhouse, restaurant, pro shop, etc.) and 130 acres at their Sharon property. While I have no particular insights into the value of the land, the fact that they own that much land, plus their cash holdings, gives the stock some downside protection in the form of hard assets.


In fiscal 2005-2009, the company earned 0.1, 0.35, 0.38, 0.19, and -0.2 per share. This year, results will come in slightly ahead of last year’s loss. So this is a company that can be profitable. However, what I really like about the idea is the profitability of the waste management division is being hidden by the red ink generated by the golf courses and corporate overhead. The waste mgmt division earned $2.2m before taxes in 2009 and 3.6m before taxes in 2008, and has earned just under $2mm in the first nine months of 2010 (vs just under 1600m in the first nine months of 2009). Assuming the WM division can earn $2.5m pretax this year, the company as a whole would trade at 4 times pre tax WM earnings and, on an EV basis, under 3 times WM pretax earnings. Note that, at the time of the spinoff in 1998, the value of the WM division was estimated at at least $15mm.


However, the profitability of the waste management division is offset by the golf courses and huge corporate overhead. The golf courses pre tax loss ran 0.8m in 2009 and 0.4m in 2008, and have lost $435k in the first nine months this year (vs 500k in the same period last year). Corporate expenses ran 2.3m in 2009 and 2.5m in 2008, and have run 2.1m in the first nine months of this year (versus 1.75m in the same period last year). So the profitability of the core WM division is more than overrun by losses from the corporate and golf courses.


I find this often happens with small caps, where the whole company appears to be trading on a slightly cheap valuation to earnings, but a deeper look reveals one profitable division and one losing money division (for example, see GAXC, one of my favorite ideas right now)


Here's where my two questions about the company come up- where can value be created in this situation? and is the WM business profitable, or would corporate overhead eat all of the profits up if it was a single division? I suspect WM business would be very profitable on its own, as I suspect the golf business is the vast majority of corporate costs. Here is a breakdown of the company's assets by division – WM = 10.7m, golf = 31m, corp = 39.6m. Total = 81.2m intersegment assets = -34.2m net assets = 47.1m To me, it seems clear that almost all of the corporate assets are golf assets, which likely makes most of the corporate expense golf expenses.


It’s my believe that the golf course segment will never be able to earn a decent ROIC. Personally, I'd like to see the chairman buy the golf assets from the company (I think they are his baby and he'll never be rid of them... as such, he should take them on as personal investments), and then use the proceeds from the golf sale to fund growth / acquisitions for the WM division.


There are, however, plenty of negatives to this name. The company’s CEO suddenly resigned and was replaced by the chairman (the market actually liked this move, sending the shares a couple of percent higher). This same chairman has owns 66% of the voting control of the stock through a dual class agreement, and under his watch (he has been chairman since the spinoff, and CEO for most of the company’s history) the company has undergone significant value destruction. The company is also still on the prowl for acquisitions, despite their horrendous acquisition record. Specifically, the company is considering acquiring another golf course in Northest Ohio, where several clubs are experiencing difficulties. When your own golf courses are experiencing difficulties, have always experienced difficults, and are sucking up capital from a profitable and successful WM business, maybe it's not the best idea to go looking for more of them. I like this name, and I think there could be a ton of assets that, if managed properly, could send this name higher. However, I really think this is the dreaded "value trap". Mgmt has had over a decade to shut down the golf assets or sell them off and focus on the Waste Mgmt division, but they keep investing in them and buying new courses. I'd like to recommend this name, but I'm forced to stay away.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Long GAXC