Yet Another ALJJ Update

My financial stake in ALJJ is not a particularly meaningful (~1.6% portfolio weighting). Yet, I’ve spent a disproportionately large amount of time following it.

It has taught me a whole lot – both from an investment standpoint, and a psychological standpoint. From an investment standpoint it showed me how accounting can obscure true cash flows, and how one ought to relentlessly focus on normalized free cash flow – because, eventually, the stock price catches up. I wouldn’t have taken a meaningful position in CHTR, if I didn’t understand these drivers.

It has also taught me how leverage can be dangerous, especially if it is intertwined with the financial and deal-making skills of a leader, who is accused of sexual harassment (key man risk).

For me, the financial/business risk spilled into behavioral risk as the stock got cut by more than half of my initial purchase price. Bankruptcy seemed a possibility. Some investors I admire bailed on the stock (for good reason!).

In May, as the stock fell to $1.80, I increased my position by 40%. It didn’t feel good when I was buying – but the valuation was too compelling, and insiders were buying. It felt a lot worse as the stock got chopped to ~$1.50 rather quickly. Talk about instant invalidation! Since then, it has bounced about 40% off the lows to $2.00-$2.20 range.

ALJJ recently reported quarterly earnings for the quarter ending on 6/30.

I thought it might be a good idea to take a longer term view first. The revenue and EBITDA numbers for the past few years are below (from Morningstar)

Year       Sales     EBITDA
2014     $149.6M      $17M
2015     $209.9M      $16M
2016     $268.4M      $27M
2017     $326.7M      $29M
 TTM     $366.1M      $25M

Overall, sales and earnings seem to be moving in the right direction. The expected adjusted EBITDA this fiscal year is $31-34M. Since we are three quarters in, and the 9-month adj EBITDA is $23.7M, landing in this range seems reasonable even from simple extrapolation.

Subtracting capex, interest, and tax of $21M, and dividing by #shares (37.9M), we get an FCF of $0.30/share. So currently shares are trading at 7x FCF or a (14% FCF yield), which seems attractive.

Furthermore, bankruptcy risk has abated significantly over the year. ALJJ diverts most of the FCF to delever.

Here are “debt covenant” portions from the past three quarters.

quarter  leverage    fixed charges   net debt 
12/2017   3.38          1,35          $113M
03/2018   3.18          1,29          $100M
06/2018   3.02          1,28           $93M

The leverage ratio needs to be <3.5 and the fixed charges ratio need to be >1.25.

Here too, things seem to be trending in the right direction. Bankruptcy is no longer on the table.

So what next?

If trends continue, adj EBITDA will improve and debt will come down further, which should lower interest costs. Both these should help boost FCF.

Furthermore, the reduction in leverage should make the balance sheet healthier, and make the stock less hairy.

Let’s try to speculate what this might mean by putting together some made-up numbers.

Suppose sales and adj EBITDA increase by 10% ($32.5m * 1.1), and interest payments decrease by 10% ($8m). Assume normalized maintenance capex remains at 2.5% of sales ($366m * 1.1 * 0.025 ~ $10m). This would imply a conservative per share FCF or 40c/share – a 25% improvement!

As the balance sheet improves, perhaps there will be a simultaneous re-rating from 7x FCF to 10x FCF (10*0.40 = $4). If that happens, the stock could be a near double ($4+) in a relatively short time.

I think it is a compelling risk-reward opportunity.

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