Monthly Archives: March 2012

Conrad Industries (CNRD.PK)

Conrad Industries designs, builds and overhauls tugboats, ferries, liftboats, barges, offshore supply vessels and other steel and aluminum products for both the commercial and government markets. The company provides both repair and new construction services at its four shipyards located in southern Louisiana and Texas. It’s a cyclical business that has shown impressive growth and earnings the past five years, but despite this the company is currently trading at a ~5.3x P/E-ratio including cash and just a 3.2x P/E-ratio excluding cash. Some quick stats based on the numbers that the company reported last Thursday. These are different than reported by for example Yahoo Finance because they haven’t yet updated for the new results and share count:

Last price: 16.80
Shares outstanding: 6,088,287
Market cap: 102.3M
Cash and Equivalents (mrq): 43.7M
Enterprise Value: 58.6M
P/E (ttm): 5.3x
EV/EBITDA (ttm): 1.6x
P/B (mrq): 1.09x

With numbers like this you would expect that Conrad Industries is a business like some of my other holdings: one with a mediocre past and future. I don’t think this is the case at all, the company compounded book value per share at a 13.5% rate the past 10 years and at 21.0% the past 5 years. There is also reason to believe that the company is not operating at peak earnings at the moment since historically a large amount of business was related to oil drilling in the Golf of Mexico, and after the Deepwater Horizon accident this dried up. With the current high oil price drilling activities will probably pick up again, and that should be good news for the company. The best part of course is that at current prices you aren’t really paying anything for this potential.

Historical results

I have created a spreadsheet that includes key statistics for the company for the past 10 years, and made some tweaks compared to the Solitron spreadsheet. The diluted shares outstanding used in the per share calculations are the amount of shares outstanding plus options at the end of the year. All companies report EPS numbers based on average weighted shares outstanding during the period, but I think that’s stupid and not reflecting economic reality. If you own 50% of a business and decide to buy the remaining 50% in the second quarter you would say that you own 100% of the business and profits at the end of the year, not a weighted 75%. I’d guess it would make some sense if earnings would be distributed to shareholders during the year.

The reason I ran into this issue was because Conrad Industries is buying back shares, and it bought this year a lot back in the last quarter. So the share count is down nicely, but the weighted average share count is not.

A last tweak I made is to base the average earnings and cash flow per share numbers on the reported shares outstanding in the most recent quarter. What matters is how big of a piece of the business you are buying right now, not how big it was in the past. If I would also make this adjustment for Solitron those numbers would be looking a bit worse since it has a slow but steadily rising share count. Anyway, enough about the accounting, the financial overview (click to enlarge):

The historical results show some positive and negative things. The company was facing troubles in the years leading up to 2005, and that was also the year when the company decided to delist from the Nasdaq to save costs, and since then Conrad Industries has been trading on the pink sheets. The company has not gone dark, and is still publishing quarterly and annual reports that provide an excellent amount of information. Besides audited financial statements the company breaks down revenues by segment and provides information about the order backlog, among other things. Small positive note: the CFO managed to reply within an hour when I emailed a question about the latest annual report.

If we would know nothing about Conrad industries a conservative valuation would probably be to assume that the average earnings for the past 10 years is a safe estimate for the normalized earning power of the company. Throw a conservative multiple on that, add back the cash and you can be fairly sure that you are not paying too much. Average EPS for the past 10 years has been 1.17, combine that with a 8.5 no-growth multiple and add back the $7.07/share in cash and you would end up with a $17/share price target: basically today’s price.

I would say that the 17$/share price target is ridiculously negative since the company has shown a good growth rate and healthy margins even when we include some of the worst years in it’s history, and the company managed to achieve this growth in book value while carrying a large non productive cash position. The company has also become more diversified. Historically most of it’s revenue was Golf of Mexico related, and that this has been successful is shown by the fact that the Deepwater Horizon accident is barely visible in the results. If you would take a more normal multiple for the business (let’s say 10~12.5x) and take the average of the past five years as a guess of normalized earnings power you would get a price target between $34 and 41$/share.

And I don’t think that’s overly optimistic since we are talking about a period that includes a recession and the Deepwater Horizon accident. It should be noted that the backlog is down this year, it was $47.1 million at December 31, 2011 compared to $89.5 million at December 31, 2010. The estimated backlog at March 31, 2012 is $68.7 million.

Another important thing to note is that the company has changed between now and 2002. The company expanded into the aluminum marine fabrication and repair business in 2003 and in 2005 the development of a new construction area was competed that enables Conrad to efficiently construct larger vessels than before. In the past years they also seem to have replaced a lot of rented equipment with company owned equipment, so the capex in the past years wasn’t just maintenance capex. This supports the notion that the financial results after 2005 should be weighted more heavily.

Capital Allocation

The company has shown some good capital allocation decisions in the past: it bought back ~11% of outstanding stock in 2008, and reducing the share count by another 6% since. The trading volume in the stock is limited, so this is a decent result, and the board of directors have approved a new share repurchase program for 2012. Can’t say the repurchase program was executed genially: they stopped it at the end of 2008 only to resume end 2010 because of concerns about the economy, and obviously that would have been the best time to buy with the lowest prices. But hindsight is of course 20/20.

A bigger development is a new capital expenditure program for 2012 for $20.8 million, a very significant increase compared to previous years (Conrad spend approximately $40 million on capex the past 10 years). It’s of course always a bit uncertain how this is going to work out, but in this case it could be a positive development. The company has been compounding book value at a nice rate the past years, and it’s only better if the company can reinvest a big part of the cash balance in the business:

Our Board of Directors has approved a $20.8 million capital expenditure program for 2012 which includes a contract we entered into July 2011 to purchase 50 acres of property adjoining our Conrad Deepwater facility for approximately $5.5 million which is subject to customary closing conditions.

And another quote from the latest annual report (emphasis mine):

Other significant approved capital expenditures include bulkheading, upgrade to launch system and purchase of various cranes. The remaining capital expenditures are for the repair and upgrade of existing facilities and purchase of machinery and equipment that will allow us to improve production efficiencies. The board has indicated to management their desire to be prudent and if conditions are not favorable to postpone the less important expenditures.


Insiders own 51.2% of all outstanding shares so while they should have the incentive to operate the business in a prudent manner, other shareholders have a weaker position as minority shareholders. I’m not worried about this since management seems to have a solid track record, is not excessively paid, and there are no ugly related party transactions. The CEO, John P. Conrad, Jr., gets a base salary of $330,000 and a bonus that varied between $330,725 and $549,300 the past three years. The company stopped using an option based compensation plan after delisting from the Nasdaq (this is by the way driving the decreasing diluted share count from 2002 till 2007, basic outstanding shares has remained constant in that period).

The founder of the company J. Parker Conrad is 96 years old and owns 18.7% of the outstanding stock while his son, the current CEO, is 69 years old and owns 17.8%. His daughter owns 12.1%. John P. Conrad, Jr. assumed the role of CEO in 2004 and has been in charge turning the company around in 2005/6. Conrad was written up earlier this year on VIC and the author included a nice quote about the operational abilities of the management:

During the second quarter of 2011 we were affected by rising water levels along the Mississippi and Atchafalaya Rivers. The primary adverse impact was the temporary suspension of operations at our Morgan City shipyard which is located on the Atchafalaya River outside the protection of the levee system. In order to minimize the impact of the imminent flooding and decrease the amount of down time, we constructed our own levee system to protect our Morgan City shipyard. This resulted in no property and equipment damage and also allowed us to return to full operation with minimal clean-up, months sooner than otherwise. We relocated all of our production and support personnel and many of our projects to our other shipyards and continued operations at a minimally reduced level for approximately forty-five days. We resumed limited operations at our Morgan City shipyard during middle of June and were fully operational at this yard by July. All of our other yards remained fully operational. Due to the efforts of our people to plan for protection and move projects to other facilities, there was only a minimal impact on our profitability and no material adverse effect on our Company. Additionally, we were able to keep our people working and we were able to meet the delivery deadlines committed to customers.

Competitive advantage

When buying a company because you think it’s potentially a good business you have to ask yourself what kind of advantage the company has that is protecting profits and margins, and I’d say that this is a bit of a weak point in the thesis. The company is protected from international competition by the Jones Act:

Section 27 of the Merchant Marine Act of 1920 (the “Jones Act”) requires that all vessels transporting products between U.S. ports must be constructed in U.S. shipyards, owned and crewed by U.S. citizens and registered under U.S. law, thereby eliminating competition from foreign shipbuilders with respect to vessels to be constructed for the U.S. coastwise trade. Many customers elect to have vessels constructed at U.S. shipyards, even if such vessels are intended for international use, in order to maintain flexibility to use such vessels in the U.S. coastwise trade in the future.

While the Jones Act has been in existence for a long time I see it more as a risk than a competitive advantage, since protectionism is being reduced worldwide. The geographical location of the company, near the Golf of Mexico, is a bit of an advantage because it’s making the company attractive for the oil and gas industry in that part of the world, but I don’t think there is a real big competitive advantage at Conrad Industries compared too other shipyards. They are simply well managed and able to serve a diversified customer base thanks to the different facilities they operate.


The case for Conrad Industries is quite simple. If you are very pessimistic about the growth and future earnings of the company you are not paying too much at today’s prices. If the company manages to maintain the average performance of the past 5 years it’s already significantly undervalued, and if it can continue to grow at current rates the sky is the limit. I wouldn’t bet on a lot of growth though since I can’t find a compelling reason why the company has a big competitive advantage.

I have been on a buying spree the past month and Conrad Industries is the latest addition to my portfolio. It’s a bit of a different idea than most of my other idea’s that are asset based. I’am not saying that Conrad Industries doesn’t have a strong balance sheet (it does), but the great thing is that it’s a healthy business that should be growing intrinsic value yearly. With an asset based play you are more betting on someone unlocking the value contained in those assets, and the longer that’s taking, the lower your returns will be. With Conrad I’m actually hoping that time is going to be my friend.

On a scale from 1 to 10 I give the stock a 9: It’s a nicely growing company with a strong balance sheet that seems to be well managed, and most importantly: you’re not paying anything for the upside potential.


Author is long CNRD.PK

More reading

The company has been written up three times on VIC (one, two & three) and while finishing this write-up I noticed that the author of Portfolio14 also published some thoughts about the growth potential of Conrad Industries.

Solitron Devices (SODI.OB)

Solitron Devices is a tiny semiconductor company with a 7M market cap that manufactures components such as transistors and voltage regulators. Most components are custom made and sold to companies related to the US defense and aerospace industries. The company has been posting reasonable solid results the past 10 years: the last loss was in 2002, and margins have been improving gradually ever since. Even though Solitron is profitable, it’s currently trading for less than the cash on it’s balance sheet. Some quick stats from Yahoo Finance:

Last Price: 3.00
Shares outstanding: 2.27M
Market Cap: 6.80M
Enterprise Value: -467K
Trailing P/E (ttm): 6.67
Price/Book (mrq): 0.68
EV/EBITDA (ttm): -0.34

Just looking at the above key ratios it’s obvious that Solitron is cheap. It’s PE ratio is low even if we ignore all the cash on the balance sheet, and if we include the cash you have a profitable company that you get for less than free (ok, almost: outstanding options are not included in the stats above, diluted you get $2.98/share in cash). Everything is cheap for a reason though, and Solitron has some ugly things in it’s past while the future for a company that’s tied to the defense industry is probably also not too bright.

Liabilities (and assets) from the past

Solitron entered bankruptcy in 1992 because a factory of the company burned down, and that was enough to push the, at that moment, debt loaded company in bankruptcy. The current company was a part of the old Solitron that emerged from bankruptcy, but not without liabilities. The company has a settlement agreement with the USEPA that requires the following payments for environmental liabilities:

The Settlement Agreement required the Company to pay to USEPA the sum of $74,000 by February 24, 2008; the Company paid the entire sum of $74,000 to USEPA on February 27, 2006. In addition, the Company is required to pay to USEPA the sum of $10,000 or 5% of Solitron’s net after-tax income over the first $500,000, if any, whichever is greater, for each year from fiscal years 2009-2013. For payment to USEPA to be above $10,000 for any of these five years, the Company’s net income must exceed $700,000 for such year, which has happened in fiscal year 2001, fiscal year 2006, fiscal year 2008, fiscal year 2009, fiscal year 2010, and the current fiscal year.

The company is also required to make quarterly payments to holders of unsecured claims on the old Solitron with the following terms:

At February 28, 2011, the Company is scheduled to pay approximately $1,030,000 to holders of allowed unsecured claims in quarterly installments of approximately $7,000. As of February 28, 2011, the amount due to holders of allowed unsecured claims is accrued as a current pre-petition liability.

This debt is carried on the balance sheet at face value, but it is obviously worth a lot less: it’s basically an interest free obligation that requires minimal principal payments. It would take the company 36 years to pay down the debt, and if you would for example assume a 5% discount rate the NPV of the debt would be around $450K. So the balance sheet of the company is actually a bit better than visible at first sight.

Because of it’s history the company also has a big tax asset that is carried at zero on the companies book, but it’s big enough to avoid paying any significant amount of taxes from now till 2029:

At February 28, 2011, the Company has net operating loss carryforwards of approximately $14,267,000 that expire through 2029. Such net operating losses are available to offset future taxable income, if any. As the utilization of such net operating losses for tax purposes is not assured, the deferred tax asset has been mostly reserved through the recording of a 100% valuation allowance.

The past also explains why Solitron has been building up cash on the balance sheet. As part of the settlement with the USEPA the company agreed to not pay out any dividends. The last required payment to the USEPA is at the end of fiscal year 2013, so this could act as a potential catalyst in the not so far away future.

The Company has not paid any dividends since emerging from bankruptcy and the Company does not contemplate declaring dividends in the foreseeable future. Pursuant to the Company’s ability to pay its settlement proposal with USEPA, the Company agreed not to pay dividends on any shares of capital stock until the settlement amount for environmental liabilities is agreed upon and paid in full.


For valuation purposes most of the points above are not very relevant. The company has been paying low taxes for years, and the money that is spent on the bankruptcy and environment liabilities are also already part of the historical results, and not that big to begin with anyway. So simply throwing a multiple on average historical earnings or cash flow should work fine to get an estimate for the intrinsic value of the operating business. If everything else would remain the same you would expect that future performance should be slightly better than past performance because the amount of money that the company needs to spend on environmental liabilities is decreasing. I have put some key financial statistics in the spreadsheet below:

Average EPS (diluted) for the past 10 years has been 0.30 while it has been 0.46 for the past year. If you would use a 8.5x no-growth multiplier you get a business value between $2.55/share and $3.91/share. Add the $2.97/share in cash and you get a value between $5.52 and $6.88/share, comfortably above today’s $3.00 price.

Whether or not a no-growth assumption is the right one is of course a good question. If you look at historical results you would say that it’s pessimistic, but if you take in account that defense spending is going down in the US it could also be optimistic. In it’s latest quarterly report the company for example writes that the backlog of orders decreased with 20% compared to the same period previous year while the level of new bookings decreased with 48%. So no reason for optimism.

The part about the competition in the latest 10K is also worth reading. The company manufactures custom made components that adhere to military specifications, and because of this it does have a bit of a niche market with less competition. At the same time the Defense Department is pushing the use of cheaper commercial off the shelf components that will reduce the potential market. A silver lining is that major competitors have elected to withdraw from the military market, and it would be my guess that this is one factor that is driving the increase in margins. With big players such as Motorola and Fairchild Semiconductor leaving Solitron should be gaining some pricing power.


The CEO owns 28.7% of the company while other insiders own an insignificant amount of shares. There has been no buying or selling by insiders, something that’s in my mind always a bit worrying. Because if the company is really cheap you would expect that the people that have the most inside business knowledge to be the first to buy. The company does employ a stock option plan (in general not a big fan of this, I don’t like to get diluted, and as visible in the spreadsheet above the share count is on the rise). The bonus that the CEO gets when pre-tax income exceeds $250,000 is in my mind a more sensible incentive. As a percentage of revenues the company spends a relative high amount on CEO pay, and while I would prefer to see something else, I think it’s also almost unavoidable with a company this size.


As is the case with most, if not all, companies on this blog Solitron Devices is not the greatest business in the world. But adjusting for the cash balance the business is basically free, and since there is no sign of value destruction at the company it has at least to be worth something. While the history farther back in the past is ugly, the remaining liabilities and risks related to the bankruptcy and the environmental damages are small and not a big reason to discount the business value.

There is also a catalyst on the horizon since the company should manage to fulfill it’s obligations towards the USEPA in 2013, making it possible to do something productive with the cash on the balance sheet.

On a scale from 1 to 10 I give the stock an 8: Solitron’s future is uncertain, but at current prices the company is trading as if it’s worthless and there is even a potential catalyst.


Author is long SODI.OB

More reading

Oddball Stocks has an excellent three part (part onetwothree) series on Solitron written nine months ago when the company was trading at a slightly higher price with less cash on the balance sheet.

Ben Bernanke lecture series

I just watched the first two parts of a four-part lecture series about the Federal Reserve and the financial crisis that Ben Bernanke is giving to students of the George Washington University. While I usually try to stay away from macro-economics in my investing process it’s certainly interesting to watch and listen to a key player in the financial crisis. Guess we will figure out in a few years time how successful the current monetary policies have been. Part one of the lectures:

Deswell Industries (DSWL)

Deswell Industries (DSWL) is a Chinese company that manufactures plastic parts, printed circuit boards and other components. Last year most Chinese companies that came public through a reverse takeover proved to be frauds, making it clear that there are big risks involved in investing in foreign countries where it is not easy to check if a company is telling the truth, and there is no system in place to prosecute fraudsters. So there are good reasons why people are staying away.

I have looked at several Chinese companies in the past year, initially trying to figure out if there could be value. Those RTO-companies became very cheap on every imaginable financial metric after the fraud allegations came out. Initially, being way too naive, you see a lot of arguments for the short case that make sense, but also a lot of arguments for the long case (you would for example expect that big hedge funds do actually do some due diligence when they decide to invest), and you figure if it would be 50/50 fraud/real it would still be an insane opportunity. With a bit of luck I managed to avoid disaster because the companies SEC filings (In this case talking about CCME) made no sense at all if you dug in some of the agreements the company made.

But if I’am honest: I only managed to avoid CCME because of the stupidity of the management, and not a lot later Sino-Forest showed just how elaborate, long running and large scale fraud could be. So with that in mind: how could you ever become comfortable with any Chinese company?

When is fraud not possible?

To answer the fraud question you have to ask: what is the goal of fraud? That’s easy, it’s stealing money, and money has to come from somewhere and someone. For a company there are basically three ways to attract money and defraud investors:

  • IPO the company: making it possible for insiders to cash out from a non-existing or materially misstated business.
  • Issue new shares: it’s not a lot different from the first option, but the great thing is you can just keep issuing new shares if you can find buyers.
  • Issue debt: see above

By definition every publicly traded company has to come public at some point in time, so there is always a mechanism available that makes fraud a possibility. If a company went public a long time ago, and didn’t issue any debt or equity since it would be unlikely to be a fraud, but you can’t be sure. Maybe they are just too busy spending money, and want to leave the option open to get a refill if needed.

So what you also want to see is that the company is returning cash to share holders. Just returning a little bit of money is not enough. Paying a few million in dividends, or having some insider buys, and then trying to raise hundreds of millions in debt or equity would be a wonderful model that Bernie Madoff would approve. But if a company would raise for example a total of 10 million dollar, and then return 20 million dollar in dividends, you can be sure. It would be the worst fraud ever.

So the idea is really simple, and my excuses for wasting so many words on it, without even having started to talk about DSWL, but I have good reasons. The idea was posted on Whopper Investments a few days ago, and you see that no-one is willing to buy the company, including the author of the article, because it’s supposedly too hard to evaluate if the company is a fraud. And that’s exactly why it could be an opportunity: no-one is willing to buy some unknown Chinese company. I guess there is a thin line between being contrarian and not being open to other people’s opinions, but when everbody is staying away it might be a good time to go against the crowd.

How does Deswell do on these criteria?

Based on the previous discussion you can probably guess where this is headed, so here are some of the facts:

  • The company came public in 1995 through an IPO (not through a RTO)
  • The company issued a mix of shares and warrants, raising approximately 20.5 million dollars between 1995 and 1998. No equity has been raised since (if you look at share count numbers from old filings note that it has executed a three-for-two stock split in 2002 and also 2005).
  • The company started paying a dividend in 1996, and has been paying out money every year since, for a total sum of approximately 90 million dollar.

Of course not all that money has been returned to outside investors since insiders own part of the outstanding shares as well (and still do), and it’s a bit harder to track how much insiders have exactly made by selling shares on the open market. The filing history only goes back to the year 2000, and while the company does offer some information on 1998 and 1999 it’s not enough to figure it out exactly. Insiders owned 64% of the company in 1999, and sold a lot of shares in 2007, keeping an interest of ~20% since. With the stock around 10$ that year this would probably have resulted in a gain of ~60M dollar.

So if we add this up it’s hard to believe in the fraud case: the company is simply returning way to much money to share holders compared with how much is coming in. You don’t have to have special insight or skills to evaluate this case, a little bit of common sense is in my opinion really more than enough!

How cheap is it?

Cheap. The cheaper something is, the less time I spend on trying to value the business as accurate as possible, figuring that can wait until the stock price rises significantly. But just to get a ballpark figure: the company has a 35M market cap while holding 36.7M in cash and equivalents. And then of course we do have more assets such as accounts receivable, inventories and PP&E, and there is a business that is actually generating positive cash flows as well (total book value is 122M). Just to give a rough idea some historical key statistics from Morningstar (does not include the results of the latest quarter that were, at the time of writing, just released):

As is visible the business is in a decline: margins have been dropping because inflation in China is high and labour costs are rising (in the last few years the minimum wage was raised with 20%, twice!). DSWL produces commodity products: it does not have a real competitive advantage. The company used to be way more profitable, but just being in China is not as big of an advantage anymore, and maybe the future for commodity producers are even cheaper countries such as Thailand or the Philippines.

But I don’t think you should be overly pessimistic on China, Apple for example believes that it wouldn’t even be possible to move their production back to the USA, not because labour costs are higher in the USA, but the required workforce is not there. A quote from a NY Times article titled “How the U.S. Lost Out on iPhone Work”:

Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.

A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.

“The speed and flexibility is breathtaking,” the executive said. “There’s no American plant that can match that.”

Assuming that the company is worth book value ($6.6/share) is probably a bit optimistic, but lets say the company is able to do 80M in revenue with a 15% gross margin. Deduct ~4M in maintenance capex, take a 30% tax rate and multiple that with a 8.5 no-growth ratio and you will get a business value around 50M which would imply a share price of $5.3 after added back the cash balance. It’s rough, but with the shares trading at $2.14 you don’t have to be overly precise.


The thesis for Deswell Industries is beautifully simple, but you have to be comfortable with the logic behind it, because buying a company that looks cheap but isn’t real is probably not going to end very well.

While finishing this write-up the company gave another hint that it is undervalued and not a fraud. DSWL announced today that it has authorized a share repurchase program for $4M over the next two years. The program could create significant shareholder value and it also shows the willingness of Deswell to return money to shareholders.

On a scale from 1 to 10 I give the stock a 8.5: I’m confident that the company is not a fraud, and that it’s cheap. It’s not a great business.

A final note about portfolio diversification: I also have a position in 0684.HK (Allan International Holdings), and this company also is very exposed to the risk of rising labour costs in China. While I’m not particularly worried about this risk, I certainly don’t want to have a lot of exposure, so I have decided to reduce my stake in Allan International (have to figure out how to track this nicely on the portfolio page).


Author is long DSWL, 0684.HK

Quick ASFI update

As can be seen on the portfolio page of this blog ASFI is my highest conviction pick, but since buying it half a year ago my conviction level has been dropping because of the lack of share buybacks. A cash rich and undervalued company is great, especially if that cash is used to buy back undervalued shares. ASFI announced in June 2011 a share buy back for $20M worth of shares (significant for a ~120M market cap company), but totally failed executing it (buying back less than $0.5M worth of shares).

Last Friday ASFI announced a new share repurchase program, again for $20M, but this time under Rule 10b5-1 of the Securities Exchange Act of 1934. According to the company this should make it easier to repurchase shares:

A plan under Rule 10b5-1 allows a company to repurchase its shares at times when it otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods.

Hopefully the company will be able to deliver on the repurchases this time.


Author is long ASFI