Some Updates

This has been an interesting year so far. Despite being 30% in cash, I am down about 1.5%, which is more than the market.

Two relatively large positions are down significantly YTD. LUK is down nearly 20% ($26.50 to $22), and CFX is down nearly 25-30% ($40 to $30).

LUK made quite a few changes including changing its name and ticker to JEF, selling a large part of National Beef and all of Garcadia, and bought back nearly half a billion dollars in stock. For a $8B market cap company that is nearly 6%. While LUK or JEF has been a frustrating stock to hold, I can’t help thinking management is trying to do the best they can. I still think this is a stock worth north of $30, and am happy to hold on.

CFX expects to earn between $2.05 – $2.20/share (slide 20 on Q1 2018 presentation, link) for 2018. It seems like it is getting itself back on track. At a 18x multiple, they should be worth $36-40/share. Plus, it is a cyclical business that gets better with time, and it seems like a lot of its end markets are improving.

My most frustrating holding has been ALJJ. 2018 has been absolutely disappointing for reasons outlined in my last post on the company. Since then an additional “meh” quarter has gone by. The stock has halved from $3.15 at year end to $1.50-$1.60 last week. The company issued updated guidance calling for adj. EBITDA of $31-34m compared to $36-39m at the start of the year. If I assume interest, capex and tax to be on the higher end of previous guidance ($10m, $9m, and $1.5m), and divide by number of shares (37.9m), I still come up with a FCF/share of 28c – 35c. At 10x FCF, the stock could be worth twice its current price! The valuation was too compelling to pass up. I held my nose, and increased my position by 40%. I currently own 7000 shares at an average price of $2.81.

If the price of Under Armour holds steady, I will have escaped another holding full of drama with a small profit (5%). I started chasing UA to teach myself some options trading, and ended up buying at $20 and $16.50. The stock got halved from $20 to $10 over 2017, and has now jumped back to near $20. I think it is easily worth $15-$20, and might, with good execution, be a worth several times more. However, with the market getting choppy, I thinking there are more lower risk propositions available than last year.

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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.

ALJJ Update

I initiated a small position in ALJ Regional Holdings earlier this year. I was hoping to add more when the stock drifted below $3, but was not able to build out the position to its desired size.

I thought ALJJ was worth at least $3.60, and quite possibly $5-$7.

Then a few weeks ago, I read Dave Waters’ (Alluvial Capital) letter to partners. I have tremendous respect for him as an investor and writer.

He made ALJJ his largest position. Some key takeways from his assessment:

  • accounting obfuscates FCF (amortization of intangibles); true cash flow > reported earnings
  • using numbers, not terribly different from the ones I used, he came up with a valuation of $4.70, somewhere between my bear and base cases
  • the jockey, Jess Ravich, provides upside optionality

I have been waiting patiently for the price to dip back closer to $3 to increase my position.

 

ALJ Regional Holdings

ALJ Regional Holdings (ALJJ) is a small-cap jockey stock, led by an enterprising CEO – Jess Ravich. It has attained celebrity status in the tiny universe of small-cap value stocks.

Over the years, it has been chronicled by OTC Adventures, Whopper Investments, Ragnar is a Pirate, GeoInvesting, etc. It has an active presence of COBF, and (is?) has been owned by savvy investors like Arquitos Capital Management, and JDP Capital Management.

As it was being showered with attention, it rose nearly 20x, from a penny stock ($0.30 in early 2011) to a high near $5.50/share in mid 2016. It has since deflated a bit, and currently sits around ~$3.40.

The clamor around the stock has also subsided substantially.

Since things had cooled off a bit, I thought I’d take a closer look.

If you want to know what happened to ALJJ in the last two years, I recommend looking at the following three sources:

  • In June 2015, Arquitos Capital Management published a case study (pdf). At the time, it had only two subsidiaries.
  • In Jan 2016, JDP Capital did a fantastic slide deck outlining ALJJ’s history, value proposition, and investment thesis (pdf).
  • In Aug 2016, Ares took a deep dive into the three segments at VIC, and came up with three valuation scenarios. Although the stock was trading at ~$4.80 at the time, the author was bullish.

The first two sources are useful in understanding the company, while the third provides a decent valuation framework.

Here’s the narrative. Jess Ravich, the “outsider”-ish CEO, inherited a company with significant NOLs. These NOLs have to be used before they phase out, starting from 2020. ALJJ has three subsidiaries (Faneuil, Carpets, and Phoenix color) all of which operate in tough niches. However, the CEO has demonstrated skill in acquiring businesses on the cheap through his deal-flow network, fixing them up by retaining and incentivizing management, shielding profits using NOLs, and, if needed, selling them when appropriate. The company runs a lean operation, and there is plenty of skin in the game.

Valuation

We can piggy-back on the VIC valuation. In that writeup, the author considered three cases – bearish, base and bullish. You should read that report, but I present some updated numbers (all numbers in million $), just to see how things are tracking since his report.

Screenshot from 2017-05-13 17-19-07

Essentially, 2016 was a year of sowing, and things seem to be turning a corner in 2017 (after two quarters). Currently, the performance of the units is tracking the “bear case”, based on which one could justify a price target of $3.40-$3.60. This is slightly essentially where it is currently trading.

However, if one is betting on the jockey and his team to turn things around, then one ought to look at normalized numbers. The numbers presented in the base case seem quite reasonable to me in a 1-2 year time-frame. If the stock rises to $5.40 in two years, we are looking at a respectable 25%/year return.

What are possible downsides?

The debt load, while manageable, is larger than I would like. The time-clock on the NOLs is ticking out – gradually, but surely. Collectively, this might reduce their edge in landing and monetizing new deals. Jess Ravich is 59; while there is “key man” risk, it doesn’t seem imminent. The operating businesses occupy tough niches; a big recession could create a perfect storm.

Overall, though, this is starting to look like a good risk-reward bet, in an environment with few bargains. I bought a starter position at $3.30.