Webco Industries: a cheap cyclical trading at 60% of NCAV

Webco Industries is a name that few people know, but at the same time it should ring a bell if you are reading the right value investing websites. The stock was discussed on OTC Adventures in 2012, OddballStocks.com in 2013 and more recently this year on Value Investors Club. Webco Industries is based near Tulsa, Oklahoma and is active as a manufacturer of various metal tubes. The company has more than a thousand employees and supplies specialty metal tubes to various industries such as oil & gas, (nuclear) power plants, (petro)chemical and automotive. A nice, but possibly biased, overview of what the company does can be found in this article. Before we start our deep dive in the financials, first a quick overview of some key metrics:

Last price (Sep 14, 2016): $51.50
Shares outstanding: (Apr 30, 2016): 812,900
Market cap: $41.9 million
P/B (mrq): 0.26x
P/NCAV (mrq): 0.61x
P/E (ttm): -29.3x
EV/EBIT (ttm): -429.7x

As visible from these stats the company is very cheap on an asset basis, while the metrics for profitability are not very meaningful since the company posted a small loss for the trailing twelve months. With Webco trading at 60% of net current asset value the company is trading below the famous 66% number that Benjamin Graham popularized as a threshold for buying cheap value stocks. It’s a stock worth investigating, but it’s clear that the profitability of the business is an aspect that needs closer scrutiny.

Financials

As is (unfortunately) common for unlisted microcaps the amount of disclosure provided in the quarterly and annual reports is limited (actually calling it a report is a bit of a stretch). But the most important information is there, and the upside is that it’s easy to get a good high-level overview of how the business has performed historically. In the graph below I have plotted the development of EPS, BV/s and NCAV/s (note that 2016 is the third quarter or the TTM) .

Webco historical EPS, BV/s and NCAV/s

As you can see Webco’s business is quite cyclical, earnings per share were as high as $31.99 in 2011 while dropping to negative $1.76 for the trailing twelve months. With the stock trading at $51 the market is obviously discounting the possibility of getting those peak earnings back anytime soon. Since the average earnings have been quite poor since 2008 I think that is the right viewpoint. In the article linked earlier the company boasts that they have achieved almost 10% growth since 1969 which I think is an okay result, but nothing more than that (and the question is what kind of metric that is, it’s probably equity and not equity/share).

Since 2008 equity has growth at a significantly slower rate of just 4.89% annually, and because the number of shares outstanding is slowly increasing as well the growth in equity/share is even lower. Shares outstanding have grown with just 0.86% per year since 2008 and as a result the growth of equity/share is just 4.00%. The difference between 4.89% and 4.00% isn’t that big on an absolute basis, but at the same time it means that management got approximately 20% of the profits of the company as share based payments while the operational performance was poor. There is not enough disclosure to know how high the base salaries were.Webco financials

One thing that should jump out from these financials is the amount of debt that the company is employing and how the amount of net debt has dropped quickly in the past three quarters from $75 million to $40 million. This is still a lot compared to the market cap of the company, but I think the amount should be manageable. Webco has a positive working capital of $115 million that presumable could be converted to cash relatively quickly in a liquidation scenario, and there is $91 million of PP&E on the balance sheet. Presumable some of this PP&E includes land and buildings that are recorded at historical cost while their value has grown through time.

Also noteworthy are the lines from the cash flow statement. As visible the company spend a lot of money in 2011 and 2012 on a new factory which in hindsight looks like a big mistake since they expanded right at the top of the cycle. The most recent years the amount of capital expenditures are a lot lower, and depreciation is actually higher than capex which is good for the cash flow generation of the business. But when we look at all the years since 2008 the net amount of free cash flow that is generated is very poor since most of the cash from operations is spend on capex. Perhaps most of it was growth capex that can still payoff when the industries that Webco serves switch to a higher gear, but for now it just looks like wasted money.

Valuation

There are multiple ways to value Webco, and the big question is what is the most relevant one. You can for example look at liquidation value, current earnings power, average historical earnings power or even the value of the company as an acquisition candidate. With the stock trading at just 60% of NCAV it’s intuitively clear that looking at liquidation value would yield a positive picture. You could even argue that in a liquidation scenario the deferred income tax liability would disappear since the company would record massive losses if all long term assets would be valued at zero (which you do when you look at just NCAV). NCAV/share plus the tax liability would give us a value of $104.75/share: a little bit more than 100% upside.

While liquidation value sounds like a conservative valuation technique I think that in this case it’s optimistic. I don’t expect that this company will liquidate anytime soon. They are proud of their long-term view, from the article linked earlier (Harmon is Marketing Director):

Harmon described, “Our mission statement can be summed up as we are a ‘forever kind of company’, and that’s the way we’ve always operated. We make decisions based upon the long term rather than what’s going to happen this quarter or next quarter.” This focus on long-term viability has driven significant investment in facilities, technology and product development.

Assuming that the company will continue operating as is seems therefore a good assumption. I think that investor in a company like this should roughly demand that they will grow their equity with 10%/year on average. This corresponds to a 10x P/E-ratio (when the amount of outstanding shares remains static). Because Webco has grown equity/share at a 4% rate since 2008 it basically means that the fair value of the company is a 0.40x P/B ratio. This is pretty cheap, but at the same time it still means we have 55% upside.

Webco valuation

Selling pressure

One factor that can possibly explain the low share price of Webco (besides the fact that it is unlisted, small and illiquid) is the fact that the Wells Fargo Small Cap Value Fund has been a consistent seller of the stock since 2015. The fund reduced their position from 81,000 shares in 2014 to 55,400 shares in 2015 and this year so far they have reduced their position with another 15,300 shares. That doesn’t sound like a lot, but for a company that has a trading volume of just a few thousand shares on most months that is a significant selling pressure. With 40,100 shares left the fund is still a big holder with a 4.9% stake in Webco, but thanks to the article on Value Investors Club trading volumes have increased and it should provide an opportunity for the fund to exit their whole stake relatively quickly.

Conclusion

Webco Industries is not a great business. Returns on equity have been low on average, the share count is slowly growing despite mediocre performance, free cash flow is low because earnings are plowed back in the company and the disclosure of relevant information to investors is poor. Despite all these factors I think that at the current price an investment in the company is warranted. With a 4% historical growth rate of equity/share you basically buy an equity yielding 15.4% at the current price.

At the same time the book value and the large amount of current assets inside the business provide a solid measure of downside protection if things take a turn for the worse. It’s hard to quantify how valuable this asset protection is, but I think it’s a pretty big deal. If a company with negligible (in)tangible and/or current assets becomes structurally unprofitable you are left with nothing at all. If it would happen with this stock you could, in theory, even make money. In reality a lot of assets would probably be used to try to turn the ship around, but even then you have a bigger possibility of making that happen and/or having something left at the end

While I don’t expect anything spectacular to happen with Webco anytime soon, this is also the kind of stock that at some point in the future could suddenly become worth a lot more. The Weber family might for example want to monetize their stake in the company, and for an acquirer I can imagine that this company is worth close to book value. It might not happen this year, next year or even next decade, but you get a bit of optionality on a very positive surprise.

Disclosure

Author is long Webco Industries

17 thoughts on “Webco Industries: a cheap cyclical trading at 60% of NCAV

  1. Paul

    Thanks for the writeup. Looked at Webco last week, but left undecided. Next to management eating the company there’s also some accounting questions to be asked. These relate to cash flow such as why cash from operations is negative in 2011. The way debt is handled also raises questions, particularly the current portion of long term debt. Key question is where the cash is going. Not everything seems to be explained by balance shortening.

    If I recall correctly only the most recent reports / press releases are available, but no historic reports.

    Reply
    1. Alpha Vulture Post author

      Paul, thanks for your reply.

      In 2011 CFO was negative because the amount of working capital increased by a huge amount compared to previous year (from $115M to $164M). Don’t see a problem here (well, at least not an accounting problem, a business with lower working capital requirements would of course be better). Agree with you that it is a bit curious that most of their debt is short-term. Don’t think debt is at the moment an issue though given how much they deleveraged this year.

      Reply
  2. bunty

    Management seems incompetent. Increasing share-count each year.
    Not buyback, at 0.25%bv!
    Invest in capacity at top of cycle…

    You may make some money flipping the shares. But I don’t want to be a partner with them…

    Reply
    1. Alpha Vulture Post author

      So is there any price where you would buy it? I think that at the current price you are getting a price that is low enough to compensate for those issues and then some.

      Reply
      1. bunty

        If they were not losing money…then sure it’s interesting.

        FCF is positive right? But earnings negative?

        I also don’t like inventory making up most of the NCAV….

        It’s a good question, at what price, personally would i feel comfortable. I’ll have to think and revert!

        Reply
        1. Alpha Vulture Post author

          I think the current low profitability was/is mainly a function of input prices (steel) going down. As a result they had a lot of inventory with a high cost base that couldn’t be sold a nice profit. Now they are clearing out the high-cost inventory, and profitability should restore a bit.

          And I agree that having a lot of the NCAV in inventory isn’t perfect. Could be worse though. Steel is something you can always sell, but the value will fluctuate based on the price of steel.

          Reply
  3. Kumar

    Given the size of the inventory, are you worried at all about how good that number is? Pipe & tube prices (in oil & gas at least) have fallen drastically as both steel prices have come down and demand has fallen off a cliff (with supply remaining pretty steady). I assume as WC has fallen (due to decreased production from decreased demand) they have paid off some type of ABL facility they have.

    Reply
    1. Alpha Vulture Post author

      No, but it’s a good point. I think that mainly their poor profitability of this year so far is the result of having high cost inventory that subsequently needed to be sold for less than they originally anticipated. But now they have purged a large part of the high-cost inventory (if not all of it: DIO is 115 days, so they turn it over relatively quick). At the same time prices have gone up, so now they should have low cost inventory that will provide a bit of an earnings tailwind the next 1 or 2 quarters. From the latest PR of the company

      Dana S. Weber, Chief Executive Officer, commented, “The industrial economy has continued to be difficult for almost all that are associated with the metal and energy industries. We were successful in purging some high cost inventories over the course of the quarter. The market price for steel sheet coil began increasing towards the end of the quarter and the tubing industry has raised sales prices in response. Expense and working capital management continue to be priorities in this lower demand environment. Since January 2015, we have reduced our inventories by $58.6 million, substantially on tonnage reductions, and our debt by $52.7 million.”

      Reply
  4. Arma Virumque Cano

    Thank you for the write-up. Perhaps below portion could use an updated/better explanation of thought-process to illuminate a little more.

    “I think that investor in a company like this should roughly demand that they will grow their equity with 10%/year on average….. Because Webco has grown equity/share at a 4% rate since 2008 it basically means that the fair value of the company is a 0.40x P/B ratio…”

    – Why for this type of company should investors specifically demand a 10% RoE as baseline (i.e. 1.0x P/B)? Why not 20% in which case fair value would be 0.20x? Of course this is the value investing profession’s long-running contentious issue. I could change that number to fit my circumstances. Why not simply a hurdle of long-term treasuries, say 6%? Admittedly, it would look even better
    – Then, a 4% compound growth in BV is very different from a hurdle rate, presumably fixed coupon which doesn’t. Even only 4% will double every 17 years or so, hence assuming the company runs another 10 years and liquidates, that’s 1.5x today’s book value. Discounting at long term treasuries yields 0.8x P/B, which is a 68% margin of safety compared to the 35% implied by 0.4x.
    – Lastly, just because book value grows, doesn’t mean liquidation value will as well. Hence why departures from Graham’s simple requirement of significant margin to NCAV continues to be hard to beat in the arena of cyclical companies..

    Reply
    1. Alpha Vulture Post author

      * It’s a question that doesn’t have a definitive answer, but 20% would be twice as much as the long-term historical real-return of equity in the US. So buying that in this low-rate environment would be an obvious awesome deal IMO. Same return as long-term treasuries is obvious too low since treasuries have less risk than equity. The current yield of long-term treasuries is by the way a lot less than 6%. But determining whether 8%, 10% or 12% is the current discount rate is a lot tougher. I go for consistency here and almost always go for 10% unless a company is obviously way more or less risky than average.
      * I’m not totally sure I understand what you are trying to say
      * True, but I’m basically using NCAV for determining liquidation value. And often NCAV grows with book value. It’s even true for this company that has also been investing heavily in PP&E a few years back (that’s almost always very bad for NCAV).

      Reply
  5. Arma Virumque Cano

    * Obviously wouldn’t use current treasuries as a hurdle when history suggests a lot higher. That’s why I said 6%. My question was regarding the comment “for this kind of business, investors should demand 10% compound growth in book value…” Whether you ask for a specific hurdle or use long term (historical average) treasuries and demand a (significant) margin of safety is the same thing.
    * 4% RoE is equivalent to saying 4% compound growth in book value. You equate 10% RoE as deserving a 1x book value and hence 4% as deserving 0.4x essentially. What I’m saying is if you really believe the is able to compound its book at 4%, then a book value of $1 today will be $1.50 in 10 years. Discounting that back at 6% would be 0.8x. Even discounting at 10% would yield 0.6x. That’s higher than the 0.4x an investor “should be willing to pay”
    * Agreed, merely pointing out the simplicity of Graham’s concepts illustrated 80 years ago!

    Reply
  6. Peter

    Puzzled by your comment that average earnings are poor since 2008. 90 plus dollars per share over eight year is Pretty strong for a $50 stock? Could take a pop if earnings are good.

    Reply
    1. Alpha Vulture Post author

      I was mostly talking about earnings relative to book value. Versus the current market price it’s pretty decent, mainly because of the cheap price. But still you have to realize that probably all those earnings will be reinvested in the company, and will probably not generate a great return.

      Reply
      1. Peter Priest

        Up on decent volume today. Hitting a new 52 week high each time it closes up which should draw eyeballs. Let’s hope next quarter earnings are improved.

        Reply
  7. Peter Priest

    Good volume again today. If Wells Fargo finishes selling off its position, then there may be very little stock available for sale.

    Reply

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