ALJJ: From Gray to Black and White

Last year, I took a 3% position in ALJ Regional holdings at about $3.20 (and wrote about it here and here). Today the stock trades below $2, and I have lost nearly 40% of my invested capital.

The central question is: should I hold on, or cut my losses?

The investment case for ALJJ has morphed over 2018 from something that could take years to play out to something that might take only a few quarters. In less than a year, it is conceivable that ALJJ goes bankrupt, or doubles from here!

The bear case is straightforward:

  • Q1 2018 results were a disaster! Two of the three operating segments are becoming an increasing drag!
  • the company is highly levered, and is uncomfortably close to breaching its debt covenants. Bankruptcy is on the table.
  • the CEO is accused of sexual harassment by a former colleague, and may be distracted

On the other hand, the bull case is:

  • The company is dirt cheap on a cash flow basis! On the Q4 2017 earnings call (Jan 8) about a month before the Q1 2018 results came out, the company projected about $18M in FCF for 2018 (FCF = EBITDA ($36-39M) – CapEx ($7-9M) – interest ($8-10M) – tax ($1-1.5M)). For a $72M market cap company, this translates to $18/$72 = 25% FCF yield!
  • The CEO increased his already large ownership in the stock by 3.7% after the debacle in the stock price (he paid ~$2.25/share). He comes from a distressed debt background, and probably has a more sophisticated understanding of how to navigate the covenants.
  • Dave Waters of Alluvial Capital summarized the bull case pretty effectively.

Because of the binary nature of the payoff, I haven’t added to my holdings. My plan is to hold on to my shares for a quarter or two more, and see which way the wind blows stronger.

Subjectively, I think the risk of bankruptcy is elevated but not overwhelming (if I had to pull a number from my ass, I would guess something like 1/3).

Currently, the expected 2018 FCF/share $18M divided by 37.6M shares is over $0.45/share. If the debt fears go away (perhaps as incremental FCF is directed towards debt reduction), the company might deserve a 10x FCF multiple or be worth $4.50/share. The expected value is then $3 (2/3 * $4.50), which is 50% above the current price.

Thus, while the position has a lot of hair, a lot of the bad news is more than baked in, and I plan on holding until 2Q or 3Q 2018.

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