Emeco Group (EHL.AX)
I exited a couple of positions the past few days for various reasons. Today I sold my stake in Emeco Group because I think that my initial thesis is broken. I bought the company because I believed that the assets would be worth more than the current enterprise value of the business, and that the company would earn enough to manage their debt load.
Based on the latest trading update both now appear to be false. The company announced one week ago that it would close the Indonesian business segment and that they would incur a A$38.5 million impairment charge on their equipment. They have also relocated approximately A$10 million of their Indonesian fleet to Australia. Given the fact that their Indonesian fleet was just A$81 million at the end of this year this means that the impairment was approximately 54% of original book value. If you would apply the same discount to the remainder of their fleet it would completely wipe out equity.
So I think the margin of safety that I thought was there simply isn’t there. I also didn’t like that they had to refinance their debt at a high interest rate to get rid of some covenants. I originally thought they would be able to meet them by simply selling equipment.
Suntech Power Holdings (STPFQ)
I also exited my short in Suntech, and this is something I should have done a few months earlier because at the current low price of the stock the carrying costs of the position are a bit too much (despite the fact that I was synthetically short using a structured product instead of having to borrow shares). The short position returned 56.4% in a bit more than a year time, a result I’m happy with since the leverage of the position was less than one.
Prisa capital structure arbitrage (Class A/B shares)
When I wrote about the irrational pricing of the Class B shares compared to the Class A shares the B shares were cheaper than the A shares despite the fact that they were superior in almost every way. We are now nearing the automatic conversion of the Class B shares in the Class A shares, and I managed to exit most of my position at a fair premium. The automatic conversion will be at 1.33x A shares for every B shares, and there will be a 24.8% dividend on the B shares as well (payable in A shares).
Calculating the performance of a long/short trade isn’t easy, especially when you have traded a bit and when one leg is traded in euro’s and the other leg is traded in dollars. So the results below aren’t totally accurate. I have measured the gains and losses in the table below compared to the initial value of the short leg (the Class A shares):
| Gross total return | 130.5% |
| Borrow fees | -12.0% |
| Trading costs | -3.1% |
| Net return | 115.5% |
| Return attributable to dividend payments | 14.3% |
| Return attributable to premium increase | 55.6% |
| Return attributable to residual long exposure | 33.0% |
| Return attributable to trading profits | 12.5% |
I think this might be one of my best trades ever. That the outcome would be this favorable was certainly not a given: if Prisa would have entered bankruptcy I would probably have made just a little, or lost a little. But being able to double your money without significant market exposure is obviously pretty awesome :).
Disclosure
Still long some Prisa Class B shares, and short a few Prisa Class A shares. No position in STPFQ or EHL.AX anymore.
Do you not think the Emeco Indonesia situation was more an anomaly than what can be expected from the rest of the business? At the half year update their utilisation rate was almost 0% in the region! The country was swimming in spare capacity after the government banned exports of raw ores. But elsewhere utilisation was more like 40-80% so not as desperate. The fact they got 50 cents on the dollar was pretty good considering.
How much do you think it costs to ship equipment from Indonesia to Australia or Canada? I don’t think it’s more than a couple percentage points (and the fact that Emeco did transfer $10 million in assets from Indonesia to Australia seems to support that point). So I’m thinking that the value of their equipment – or resale value – isn’t a whole lot higher in the rest of the world.
I have a call scheduled with EHL for next Thursday. Any questions you would like me to ask?
If you could ask some questions about the points I’ve been speculating about that would be nice. e.g. How comparable was the Indonesian equipment with the rest of their fleet? (perhaps old units? specialized equipment? spare parts?) How much does it cost to ship it/How easy is it to sell worldwide? Basically: what does the recent write-down imply about the value of the rest of the fleet?
Also a good one: how representative was 1H’14 sustaining capex for the average capex required to maintain the current fleet?
Good point. I have contacted IR at Emeco about this and they say that the equipment WAS shipped and sold internationally, and that the 50% discount is a reflection of a global slump in values.
So it does appear the downside risk here is not limited, liquidation value is a lot lower than I previously thought.
It’s a pity because this share will rocket if the mining market improves but without downside protection is too risky.
Thanks for the insight.
If the equipment is selling for 50% in the aftermarket (primarily CAT and Komatsu equipment) why is CAT hitting all-time high and Komatsu flat? Can you ask if Emeco has bid on any non-mining work in any countries and the prospects there? A major US renter (United Rentals) appears to be doing much better but I think they lease to a more diverse customer base.
Packer
I am still surprised Joy Global is near new highs too and it is primarily mining related. Either the market will be OK reflecting CAT and Joy or on its back reflecting Emeco. I still think the votes via JOY, CAT and even URI are stronger than the smaller votes of Emeco.
Packer
It’s indeed difficult to reconcile those datapoints, and I have to admit that I haven’t looked at JOY, CAT or URI in-depth enough to understand their valuation. But my decision to sell isn’t based on market perception of the company: but the transaction results of the underlying assets. Haven’t seen a compelling argument so far on why this data point isn’t accurate. Actual market transactions beat speculation on what the assets should be worth imo.
The CAT mining segment isn’t doing great. Revenue down 50% YoY or so and gross margins also contracting significantly. CAT is doing alright because the other segments are doing great.
I don’t think Emeco has bid on any non-mining work (or nothing significant). They used to have a construction segment, but they exited that a couple of years ago.