Oddball Stocks Newsletter

Credit Bubble Stocks is known for a number of things: short ideas (DSL, WLT, XCO, BCEI), capital structure arbitrage ideas (CPE, RMIX, GMXR, KV-A, SHLD), micro cap value ideas (CNRD, TVOC, OPST, SFBK, LINSA), thoughts on interest rates, and our book reviews and links.

Some of our readers may also be familiar with Nate Tobik and his blog Oddball Stocks, which he turned into the Oddball Stocks Newsletter in 2014.

Nate also runs a software company called Complete Bank Data which tapped a market need at smaller banks and is now growing rapidly. It is taking up so much of his time that he asked me to help out with the Oddball Stocks Newsletter.

So from now on my writing about the micro cap stocks is mostly going to be in the Oddball Newsletter. We just published a new one, issue number 22. If you liked reading my ideas on these over the years and want to keep seeing them, you should subscribe.

The link to subscribe is here:

Loading...

In addition to the micro cap ideas, the Newsletter also has general commentary from us. I hope Credit Bubble Stocks readers will subscribe so they can continue to be part of that conversation. (The newsletter also has a members-only forum.)

Oddball Stocks Newsletter

Credit Bubble Stocks is known for a number of things: short ideas (DSL, WLT, XCO, BCEI), capital structure arbitrage ideas (CPE, RMIX, GMXR, KV-A, SHLD), micro cap value ideas (CNRD, TVOC, OPST, SFBK, LINSA), thoughts on interest rates, and our book reviews and links.

Some of our readers may also be familiar with Nate Tobik and his blog Oddball Stocks, which he turned into the Oddball Stocks Newsletter in 2014.

Nate also runs a software company called Complete Bank Data which tapped a market need at smaller banks and is now growing rapidly. It is taking up so much of his time that he asked me to help out with the Oddball Stocks Newsletter.

So from now on my writing about the micro cap stocks is mostly going to be in the Oddball Newsletter. We just published a new one, issue number 21. If you liked reading my ideas on these over the years and want to keep seeing them, you should subscribe.

The link to subscribe is here:

Loading...

The regular price of the Newsletter is $695 per year. For the first 10 subscribers referred from this blog, you can use code "creditbubblereader" and get a $45 annual discount.

In addition to the micro cap ideas, the Newsletter also has general commentary from us. I hope Credit Bubble Stocks readers will subscribe so they can continue to be part of that conversation. (The newsletter also has a members-only forum.)

"Getting Better: Deliberate Practice for Investors"

From Street Capitalist,

"Instead of actually analyzing companies, they often become fixated on celebrity-investor navel gazing. What I mean is, instead of going out and finding undervalued companies, they spend most of their time reading about what famous investors are doing. They have no real knowledge of the companies they invest in aside from the fact that someone famous has a stake in the company. [...]

To me, the more types of companies you can value, the more opportunities you can have. By being a generalist, you can look at practically anything. You should strive to be a generalist because there are times when one sector or another becomes overvalued. If you strictly stick within that domain, you need to be extremely disciplined in your approach. What I have seen is that most investors end up lowering their standards so they can remain active."

He has an interview with small cap investor Paul Sonkin.

Tariq Ali: A lot of the companies you invest in are pretty small. Do you ever interact with the management of companies you invest in? How receptive are they to your ideas? Many of these companies have small shareholder bases, do you ever have to work with them to help promote changes in these companies?

Paul Sonkin: I guess. Yes and no. Sometimes they are very receptive sometimes they’re not receptive. I would say that we always talk to management over the phone and we’ll sort of have them walk us through the story and we’ll discuss their capital allocation decisions and just you know, go through various things like that. [...]

Tariq Ali: And the other thing I noticed with some of them is they don’t register with the SEC, is this ever a problem for you? Do you ever have issues trusting their financial statements?

Paul Sonkin: No, I’d say that usually the financial statements are pretty good with the ones that don’t file. Sometimes they just file once a year. But it’s sort of like how the old pink sheets used to be.

Accumulating Micro Caps

From "undervalued Japan" blog:

"Benjamin Graham always said; that low volume in a stock should not discourage an investor taking a position in an issue that shows compelling quantitative readings. It is a huge advantage for the small investors over the big investment boutiques. We don't have too many and it would be a negligent act not to monetise on that one!"

Playing With Stock Screener

Public companies incorporated in the United States, no operations in Asia/Pacific: 22,225
Market capitalization between 5 million and 100 million: 3,223
Retained earnings greater than zero: 618
Insider ownership greater than 10%: 365
EV/EBITDA(ltm) between 1x and 6x: 63
Trading at less than 1.5x tangible book value: 43

Small Companies, Slowly Going Private

This reminds me of Conrad:

"[A] look at the company’s story over the last five years shows that good things can happen to investors who buy obscure but profitable companies with strong balance sheets. Abatix deregistered its stock in September, 2007, moving to the pink sheets. At the time, shares of Abatix traded for around $7. Over the next five years Abatix ticked along making consistent profits and paying off all debt. With this going private transaction, an investor who bought in September 2007 will have made about 111%, or 16.1% annualized."

I just did a screen for micro cap companies (between 5mm and 200mm) that are buying back stock, are cheap, and profitable.
Here's some high 5 year compounded ROE tickers: CNRD, QEPC, ACU, CLRO.
Some high current ratios (good for buybacks): NSSI, RSKIA, ELSE, WTT.

Another Geoff Gannon Post on Net Nets

That bigger concept is that a good net-net is really just a decent business. Why would insiders still control 10% to 50% of a company that has been public for 10 to 30 years? Because it’s a decent business. It may not be a great business. I’ve seen insiders happy to hold something earning 6% to 8% on equity for decades. And they think their lives are pretty good. And they’re probably not wrong.

Valuation Thoughts About Conrad Industries ($CNRD)

Executive Summary
Conrad Industries, Inc. (CNRD) is a small-cap shipbuilder engaged in the construction and repair of steel and aluminum marine vessels for commercial and governmental customers in the United States. These vessels include tugboats, ferries, liftboats, barges, and other offshore support vessels.

At $15/share, the current market capitalization is $92 million and the enterprise value is $57 million (assuming $35 million in excess working capital). For 2011, EBITDA was $33.6 million. That gives an EBITDA/EV yield of about 60%! Net income for the TTM was $19.2 million, which gives a P/E (ex-cash) of 3x! Net current assets are ~$9.27 per share and book value is $15.50 per share.

Valuation
Here is a share price valuation matrix for a set of EBITDA assumptions (left column) and EV/EBITDA multiples (top row). Again, this assumes that there is $35 million in excess working capital.

	2.0	2.5	3.0	3.5	4.0	4.5
20,000	$11.65	$13.20	$14.75	$16.31	$17.86	$19.41
22,500	$12.42	$14.17	$15.92	$17.67	$19.41	$21.16
25,000	$13.20	$15.14	$17.08	$19.02	$20.97	$22.91
27,500	$13.98	$16.11	$18.25	$20.38	$22.52	$24.65
30,000	$14.75	$17.08	$19.41	$21.74	$24.07	$26.40
32,500	$15.53	$18.05	$20.58	$23.10	$25.62	$28.15

Annual EBITDAs in 2011, 2010, 2009, 2008, and 2007 were $34, $20, $23, $40, and $33.4 million, respectively. Using the five-year average EBITDA of $30 million and a 4x multiple, give you a share price of $24, which is 60% higher than the current price. However, you need both a seriously bombed-out EBITDA and multiple assumption to come up with a valuation downside to the current price. That indicates a very high margin of safety.

Jones Act
Be sure to read our post from a while back about the Jones Act. This is a federal law which essentially guarantees the continued existence of a U.S. shipbuilding industry by requiring that all goods transported by water between U.S. ports be carried in U.S.-flag ships, constructed in the United States, owned by U.S. citizens, and crewed wholly by U.S. citizens.

Agricultural interests and industries that depend on shipping oppose it because is obviously raises the cost of shipping their goods. Given that it essentially pits populous coastal states against sparsely-populated farming states, the smart money would continue to bet on the Jones Act. People criticize the Jones Act for its protectionism, but the truth is, there is something wrong with economic theories about trade if the result of free trade is having your country hollowed out. Also, if petroleum becomes more expensive, the transport system will be shift to more efficient forms of transportation: from truck to trains and from trains to barges.

Catalysts
Everyone asks what is the catalyst for the Conrad long, as though a company whose stock is up almost 100% over the past two years (but still cheap!) is suffering for lack of a catalyst. Having said that, the ongoing catalyst is that the company is buying back shares. They bought back a total of $3.6 million in stock in 2011, which is equal to 3.9% of the end of year market capitalization. During the fourth quarter of 2011, they purchased 157,444 shares at an average price of $15 per share. A company that trades for less than 2x EBITDA and is buying back stock will quickly take itself private. Since the family and management own more than half of the company already, I could see them taking it private.

Disadvantages
The key disadvantages are the small size (<$100MM market capitalization), pink sheet status, and small public float due to the sizable percentage owned by the family and management.

There's always an "ick" factor in value investing. If these disadvantages are the only problems with Conrad, then I think there is more than enough compensation for the ick factor. If the company had a billion dollar market capitalization, it would not be this cheap.

I actually kind of like pink sheet investing. You have to pay attention to the order book, and buying is sort of like buying an actual piece of a business from a human instead of a robot.

Conrad Industries ($CNRD) - Highlights from 2011 Annual Report

One of our micro-cap long ideas, Conrad Industries published its 2011 Annual Report today. I'm going to go over the highlights, and then do another post later with thoughts on valuation and the long thesis. The company had record performance last year:

"[W]e achieved revenues of $246.5 million [up 78%], net income of $19.2 million [up 86%], EBITDA of $33.6 million [up 70%]..."

One of the big events last year was the flooding along the Mississippi. (John McPhee warned us that this would happen!) Anyway, Conrad's ability to react to this without missing a beat was amazing:

"During the second quarter of 2011 we were affected by rising water levels along the Mississippi and Atchafalaya Rivers. The primary adverse impact was the temporary suspension of operations at our Morgan City shipyard which is located on the Atchafalaya River outside the protection of the levee system. [W]e constructed our own levee system to protect our Morgan City shipyard. This resulted in no property and equipment damage and also allowed us to return to full operation with minimal clean-up, months sooner than otherwise. We relocated all of our production and support personnel and many of our projects to our other shipyards and continued operations at a minimally reduced level for approximately forty-five days. We resumed limited operations at our Morgan City shipyard during middle of June and were fully operational at this yard by July. All of our other yards remained fully operational. Due to the efforts of our people to plan for protection and move projects to other facilities, there was only a minimal impact on our profitability and no material adverse effect on our Company. Additionally, we were able to keep our people working and we were able to meet the delivery deadlines committed to customers."

What I really wanted to see was share buybacks, and they did not disappoint. They bought back a total of $3.6 million in stock in 2011, which is equal to 3.9% of the end of year market capitalization. Not bad for a company that survived a flood and also nearly doubled revenue and net income. Particularly impressive was the pace of share repurchases at the end of the year:

"During the third quarter of 2011, we purchased 81,386 shares at an average price of $13 per share. During the fourth quarter of 2011, we purchased 157,444 shares at an average price of $15 per share."

Shares were offered at $14.93 at the end of the day - cheaper than where the management of this very conservative company bought back nearly 5% of the public float in the fourth quarter alone. The previous buyback authorization was nearly exhausted, so on January 17, 2012 the board authorized an additional $5 million in repurchases. Note that the company has historically been rather timid at share buybacks; however, management is "currently engaged in a detailed business planning process to identify potential uses of the Company’s cash."

In addition to the share repurchase the company has also announced capex plans for 2012:

"Our Board of Directors has approved a $20.8 million capital expenditure program for 2012 which includes a contract we entered into July 2011 to purchase 50 acres of property adjoining our Conrad Deepwater facility for approximately $5.5 million which is subject to customary closing conditions..."

Other notable items:

During the year, we added $144.2 million of backlog to our new construction segment all of which is from other commercial contracts. This compares to total contract signings of $139.0 million during 2010. Our backlog was $47.1 million at December 31, 2011 as compared to $89.5 million at December 31, 2010.

During 2011 we delivered 47 vessel construction jobs comprised of 2 crane barges, 2 ferries, 9 LPG barges, 2 tow boats, 9 deck barges, a spud barge, 9 30,000 bbl. tank barges, 2 10,000 tank barges, 5 hopper barges, 3 striker barges, a push boat and 2 docking barges.

At December 31, 2011, 91.2% of our vessel construction backlog was from other commercial contracts, 7.5% was from government contracts and 1.3% was from energy contracts. This compares to backlog at December 31, 2010 of 58.9% other commercial and 41.1% government. Subsequent to year end, we signed contracts totaling $61.8 million which includes the sales of six of the stock barges in progress at December 31, 2011. Our estimated backlog at March 31, 2012 is $68.7 million.

When we first mentioned Conrad a year ago, it was trading at $10. It is almost as cheap now at $15, valuation wise, as it was then. More on that later.

Conrad Industries Announces Second Quarter 2011 Results ($CNRD)

Micro cap value idea Conrad Industries (CNRD) recently released its second quarter results. Revenue and net income were both up substantially year-over-year:

Revenue for the second quarter of 2011 increased $21.6 million, or 58.0%, to $58.8 million compared to $37.2 million for the second quarter of 2010, while revenue for the first six months of 2011 reflected an increase of $56.1 million, or 85.2%, compared to the same period in the prior year.

There had been some concern about how the company's Louisiana shipyards would be effected by the flooding earlier this year.

During the second quarter of 2011 we were affected by rising water levels along the Mississippi and Atchafalaya Rivers. The primary adverse impact was the temporary suspension of operations at our Morgan City shipyard which is located on the Atchafalaya River outside the protection of the levee system. In order to minimize the impact of the imminent flooding and decrease the amount of down time, we constructed our own levee system to protect our Morgan City shipyard. This resulted in no property and equipment damage and also allowed us to return to full operation with minimal clean-up, months sooner than otherwise. We relocated all of our production and support personnel and many of our projects to our other shipyards and continued operations at a minimally reduced level for approximately forty-five days. We resumed limited operations at our Morgan City shipyard during middle of June and were fully operational at this yard by July. All of our other yards remained fully operational. Due to the efforts of our people to plan for protection and move projects to other facilities, there was only a minimal impact on our profitability and no material adverse effect on our Company. Additionally, we were able to keep our people working and we were able to meet the delivery deadlines committed to customers.

Very impressive. The flooding was terrible this spring and the company didn't miss a beat. They have been able to book enough new work to keep the backlog up, as well:

Our backlog was $88.7 million at June 30, 2011, $89.5 million at December 31, 2010 and $41.0 million at June 30, 2010.

The good performance has resulted in a cash buildup:

Our working capital position was $61.6 million at June 30, 2011 compared to $52.9 million at December 31, 2010. The increase in working capital during 2011 was primarily a result of net income earned during the year. Management is currently engaged in a detailed business planning process to identify potential uses of the Company’s cash.

It would be nice if they would disclose more detail about the potential uses of cash that are being considered. The company has been buying back more stock, although still at a glacial pace:

We purchased 38,075 shares during the third quarter of 2010 at an average price of $7 per share. During March 2011, our board authorized a 10b5-1 stock purchase plan, in an attempt to increase the amount of stock we repurchase pursuant to the share repurchase program. During the second quarter of 2011, we have purchased 16,209 shares at an average price of $13 per share.

Another big use of cash is apparently going to be a land purchase:

In July 2011, we entered into a contract to purchase 50 acres of property adjoining our Conrad Deepwater facility for approximately $5.5 million which is subject to customary closing conditions.

No disclosure about what this land is needed for. Are they planning to expand? I was not under the impression that they were capacity constrained.

By the way, value blogger Frank Voisin also follows Conrad and agrees that their performance has been impressive recently.

Micro Cap Value Idea: OPT Sciences Corp (OPST)

OPT-Sciences (OPST.PK) manufactures anti-glare and transparent conductive optical coatings which are deposited on glass used primarily to cover instrument panels in aircraft cockpits.

This is another micro cap company that has a tiny enterprise value due to a massive amount of cash and securities on the balance sheet. At a share price of $13, the market capitalization is $10 million, but the enterprise value is only $1.4 million.

At $13, the company trades for ~1x its net current assets ($12.92 per share) and 0.9x its book value ($14.12/share). So, at a minimum, the downside is small: the company could shut down and liquidate with a small or no loss to shareholders at this price.

The company has $10.6 million in retained earnings; approximately 100% of the market capitalization. That is evidence of value creation.

Whopper Investments did a write-up of OPT Sciences that was posted on Seeking Alpha:

in the past five years it has never earned less than $409,000 in operating income, and has twice earned more than $1 million (the highest op earnings were just under $1.3 million). So, on an EV/EBIT, you are paying somewhere between 2.5x cyclically depressed EBIT to somewhere less than 1x, depending on what you think the sustainable earning amount is

Right. It is hard to know for sure what the sustainable earnings / cash flow are (i.e. over an entire economic cycle), but it is clear that you are buying the business very cheaply and with a great margin of safety due to the net current asset and tangible book value coverage.

The company discloses:

"Sales for recent quarters have been positively affected by the substantial inventory accumulation of one of our largest customers in anticipation of a transition of principal manufacturing operations from Japan to Taiwan. The inventory accumulation is now completed. During the balance of the year, we expect sales to that customer to be substantially curtailed..."

As the Whopper article mentions,

The biggest risk is economic, as the economy’s downturn has caused several delays in orders and the weak economy could continue to impact the company. Other large risks include concentration risk (two customers represent 60%+ of sales) and especially risks from the new Boeing Dreamliner.

However, the company has reported an improvement in backlog,

"During the first quarter of 2011, the Company booked $1,369,000 in new orders compared to $1,882,000 in new orders booked for the fourth quarter of 2010 and $1,307,000 in new orders booked in the first quarter of 2010. Our backlog of unshipped orders was approximately $1,956,000 at the end of first quarter, down approximately $456,000 from the end of the fourth quarter of 2010 and up approximately $402,000 from the first quarter of 2010."

That is a year over year improvement in new orders booked, and in size of backlog.

The best bid in the order book at the close on Friday was $11.57. At any price under $12.92, you are getting paid to take part of a profitable (albeit small and illiquid) business.

Disclosure: I am currently long shares of OPST.

Paper: "Do investors overpay for stocks with lottery-like payoffs?An examination of the returns on OTC stocks"

I've posted a number of micro cap value ideas on the blog recently. Companies this small tend to trade "over the counter" (OTC), i.e. on the pink sheets or other venues that are not exchanges.

This is something that has negative connotations. Stocks are generally traded OTC because they are unable to meet an exchange's listing requirements or because they are unwilling to pay listing fees and conform to the exchanges’ regulations.

I was reading a study, "Do investors overpay for stocks with lottery-like payoffs?An examination of the returns on OTC stocks", that looked at how these OTC stocks do over time. The study finds that most OTC stocks are money losers, which I agree with, although this is emphatically not true about the deep value situations that we look at on this blog. [For example, Conrad Industries, which has risen over 40% since I first posted about it.]

The sample in the paper covers the period from January 1, 2000 through December 31, 2008. They found that

[T]he median total cross-sectional return in our sample is an astonishing -97%. [...M]ore than half (53.8%) of the stocks in our sample lose more than 95% of their value over the sample period. 84.8% of the stocks have negative total returns. The table also shows that 117 stocks have more than a ten-fold increase in value. But this is only 1.8% of the stocks in the sample - far too small a fraction to make up for all the stocks that become nearly worthless.

This is actually good news from the perspective of a value investor trying to find underpriced companies on the pink sheets. A distribution that is so lopsided will cause many investors to shy away from the market completely. The study authors even recommend this:

"In the aggregate, investors in the OTC markets lost about one hundred and eighty billion dollars over our sample period... We think the size of the capital loss in the OTC market along with the very substantial negative annualized rates of return we document suggest that individual investors are well advised to stay far away from OTC stock markets, unless they possess substantial ability to gather fundamental information..."

Many of the market participants are there to buy stock promotion scams. Also, there is a very large fraction of retail investors that buy and sell securities, including OTC stocks, with out any regard to valuation whatsoever. Concepts like capital structure and cash flow multiples are outside of their experience. This leaves the actual value investments ignored and unloved!

For example, as Gannon puts it, there can be a company on the pink sheets that is

"an old, family controlled company with tons of retained earnings in some mundane business... If it's hoarding cash, it's usually doing it for the same reasons a big cap company hoards cash. Management has few options in the existing business and doesn't know much about putting money to work elsewhere. They aren’t doing right by shareholders. Paying the cash out would be better. But they probably aren’t criminals either. They’re probably just humans running a no-growth business that throws off more cash than they can use."

This was basically the story with Conrad, and with George Risk, and a number of other microcaps that are net current asset value plays. So, we will continue to look for profitable companies on the pink sheets with huge margin of safety (thanks to very low enterprise values) and low valuations.

"Michael Burry: Notes from Vanderbilt Speech"

Michael Burry was one of the hedge fund managers profiled in The Big Short by Michael Lewis.

As I mentioned in my review, I liked Burry and his value investing concept of "ick" investments, which means "taking a special analytical interest in stocks that inspire a first reaction of 'ick.'"

Burry gave a speech last week at Vanderbilt, and the distressed debt investing blog attended and posted their observations.

One of Burry's observations was that there are value opportunities in small caps because they have lost research sponsorship at most sell-side firms.

This rings true, and I have a post coming out about the micro cap universe on Wednesday.

Conrad Industries (CNRD, CNRD.PK) Hits Another 52-Week High on Release of 2010 Results

CNRD up almost 10% today. I'll have a post about the annual report for 2010 later.

Micro Cap Value Idea: Texas Vanguard Oil (TVOC)

I have some more micro cap value ideas besides Conrad Industries. Next up is Texas Vanguard Oil (TVOC) which engages in the production of onshore oil and natural gas, mainly in Texas.

At $8.50, the market cap is $12 million and enterprise value is approximately $5 million. Annualized EBITDA (based on YTD) is $2 million, so EBITDA/EV yield is 40%.

As of December 31, 2009, the company’s oil reserves were 431,638 barrels; and natural gas reserves were 2,108,346 MCF. It also had 8,018.08 net undeveloped acres under lease. So, the reserves are 572,000 boe (assuming a 15:1 ratio), which means the EV/boe is $8.91. Net net current assets per share is $4.65.

Another way to look at the valuation is to take the net current assets and add the PV-10 of the oil and gas reserves. That gives a figure about 20% higher than the market price, although that's based on the PV-10 from 2009. Oil prices were much lower then, which means that both the quantity and valuation of the reserves are understated relative to what they would be today.

Whopper Investments has done a post about TVOC as well.

Share Buybacks, Dividends, and Inefficiency Caused by Government Regulation

One of my axioms is that, behind any incongruous anomaly in the markets, there is usually some government regulation or intervention causing it.

For example, why do so many people drive SUVs? Why, because of Section 179 of the United States Internal Revenue Code, which allows a taxpayer to deduct the cost of a vehicle weighting more than 6,000 pounds gross vehicle weight as an expense, rather than requiring the cost to be capitalized and depreciated over time.

I have been studying share buybacks because of my micro-capitalization value investments like Conrad Industries. Apparently, as recently as three or four decades ago, companies in the US were wary of buying back their own shares because this could be considered illegal price manipulation.

However, the SEC established a safe harbor for stock buybacks called Rule 10b-18, which provides a safe harbor for purchases on a given day. The rule has manner, timing, price, and volume conditions that a company must satisfy when repurchasing its own stock in the market.

• The manner of purchase condition requires an issuer to use a single broker or dealer per day to bid for or purchase its common stock.
• The timing condition excludes from the safe harbor purchases at the opening and during the last half hour of trading because market activity at such times is considered to be a significant indicator of the direction of trading, the strength of demand, and the current market value of the security. Therefore, where there is no independent opening transaction on a given trading day, the issuer is precluded from making purchases under the safe harbor for that day.
• The price condition is intended to prevent the issuer from leading the market for the security through its repurchases by limiting the issuer to bidding for or buying its security at a price that is no higher than the highest independent published bid or last independent transaction price.
• Under the current volume condition, an issuer may effect daily purchases in an amount up to 25 percent of the average daily trading volume in its shares (the "25% volume limitation").

If you look at the trading history for CNRD, you can see there are days when the stock doesn't trade at all. So, the company cannot use any of its massive cash horde to repurchase its own stock on those days.

Share repurchases are more advantageous for shareholders than dividends, due to the disparate tax treatment. I read a study which said that "one year after the approval of Rule 10b-18, the aggregate amount of cash spent on share repurchase programs tripled."

Here's an interesting argument though, that may explain why share buybacks don't appeal to value investors as much as dividends: "[I]f - for whatever reason- managers are more reluctant to cut dividends than to cancel repurchase programs, then it can be argued that dividends may be a better controlling device than repurchases because they represent a stronger commitment (in the same way that debt is a stronger commitment device than dividends.)"

Truth be told, there is more than government regulation behind the odd capital allocation decisions (or, lack of decisions) at these micro-cap value companies. Most of the time, it seems to reflect extreme management conservatism.

Conrad Announces New Business and Backlog (CNRD)

Morgan City, Louisiana (January 6, 2011) - Conrad Industries, Inc. (OTC Pink Sheets: CNRD.PK) announced today the signing of new contracts and sale of stock barges, bringing estimated current backlog to approximately $92.8 million compared $86.1 million at September 30, 2010, $41.0 million at June 30, 2010, and $38.3 million at December 31, 2009.

Small Cap Value Idea: Conrad Industries (CNRD)

Executive Summary
Conrad Industries, Inc. (CNRD) is a small-cap shipbuilder engaged in the construction and repair of steel and aluminum marine vessels for commercial and governmental customers in the United States. These vessels include tugboats, ferries, liftboats, barges, aluminum crew/supply vessels and other offshore support vessels. Conrad was founded in 1948 and based in Morgan City, Louisiana.

At $10/share, the current market capitalization is $64 million and the enterprise value is $29 million. EBITDA for the trailing twelve months (TTM) was $18.4 million. That gives an EBITDA/EV yield of 64%! Net income for the TTM was $9.8 million, which gives a P/E (ex-cash) of 3x! Net current assets are ~$7 per share.

Description of Business
Conrad operates four shipyards: one in Morgan City, Louisiana, two in Amelia, Louisiana and one in Orange, Texas.

The company constructs various offshore barges, including tank, container, and deck barges for commercial customers, and yard barges for the U.S. Navy; inland barges, including deck and tank barges; lift boats to support construction and ongoing operation of offshore oil and gas production platforms; tug boats; offshore support vessels; ferries; aluminum crew/supply vessels to transport crews to offshore facilities; aluminum fire/patrol vessels for governments to fight fires and patrol rivers; and drydocks to lift marine vessels from the water. It also does conversion projects involving the lengthening of vessels and other modifications to increase the capacity or functionality of a vessel. The company’s marine repair activities include shot blasting, painting, electrical system and piping repairs, and propeller and shaft reconditioning.

For the nine months ended September 30, 2010 the new construction segment accounted for 63.4% of total revenue and the repair and conversion segment accounted for 36.6% of total revenue. They received approximately 11.7% of their total revenue from customers in the oil and gas industry, 10.9% from government customers and 77.4% from other commercial customers.

Valuation
At $10/share, the current market capitalization is $64 million and the enterprise value is $29 million. EBITDA for the trailing twelve months (TTM) was $18.4 million. That gives an EBITDA/EV yield of 64%! Net income for the TTM was $9.8 million, which gives a P/E (ex-cash) of 3x!

Here is a share price valuation matrix for a set of EBITDA assumptions (left column) and EV/EBITDA multiples (top row).

	1x	2x	3x	4x	5x	6x
10,000	$7.34	$8.90	$10.45	$12.00	$13.56	$15.11
15,000	$8.12	$10.45	$12.78	$15.11	$17.44	$19.77
20,000	$8.90	$12.00	$15.11	$18.22	$21.32	$24.43
25,000	$9.67	$13.56	$17.44	$21.32	$25.20	$29.09
30,000	$10.45	$15.11	$19.77	$24.43	$29.09	$33.74
35,000	$11.23	$16.66	$22.10	$27.53	$32.97	$38.40

Annual EBITDAs in 2009, 2008, and 2007 were $23, $40, and $33.4 million, respectively. For simplicity, I am going to take the average of the current TTM plus these three preceding years' EBITDA, which gives a four-year average EBITDA of $29 million.

Using the four-year average EBITDA of $29 million and a 4.5x multiple, you get a share price of $26, which is 2.6x the current price. The company's backlog has grown over 50% year-over-year, so it seems reasonable to use an EBITDA figure that is higher than the trailing twelve months.

However, you need both a seriously bombed-out EBITDA and multiple assumption to come up with a valuation downside to the current price. That indicates a very high margin of safety.

Discount to Tangible Book Value; Current Asset Coverage
The company trades at 80% of tangible book value. There is over $7/sh in net current assets, which provides a nice valuation backstop.

During the past nine years, the company has made $41.8 million of capital expenditures to add capacity and improve the efficiency of its shipyards. If you take that figure plus the net current assets, you get $13.86 per share.

Protection from Foreign Competition: The Jones Act
The Merchant Marine Act of 1920 regulates maritime commerce in U.S. waters and between U.S. ports. The MMA has a section known as the Jones Act that deals with cabotage (coastal shipping), which requires that all goods transported by water between U.S. ports be carried in U.S.-flag ships, constructed in the United States, owned by U.S. citizens, and crewed by U.S. citizens and U.S. permanent residents.

This is ridiculous, protectionist legislation, but it has been around a long time and it is not very likely to change. The U.S. would be without a shipbuilding industry without the Jones Act, which would be a national security and employment problem. 

Catalysts
Everyone asks what is the catalyst for the Conrad long, as though a company whose stock is up 50% in the past six months (but still cheap!) is suffering for lack of a catalyst. Having said that, there are several catalysts:

The company is buying back shares. In August 2010, the board authorized the company to repurchase up to $5 million of common stock, and they purchased 38,075 shares during Q3 2010 at an average price of $7. I will be interested to see the annual report, and find out how many shares were repurchased during Q4. The stock was under $9 for all of October, so they had the chance to make some attractive purchases. A company that trades for less than 1.5x EBITDA and is buying back stock will quickly take itself private.

The Conrad family (J. Parker Conrad, John P. Conrad, Jr. and Katherine Conrad Court) own or control 2,963,463 shares of common stock (46.0% of the outstanding shares), and members of their immediate families own approximately 297,654 additional shares, which together total more than 50.6% of the outstanding shares.

Since the family and management own more than half of the company already, I could see them taking it private. In fact, the company would make a great leveraged buyout target. If I had a few hundred million dollars, I would feel pretty comfortable doing a tender offer at $15. 

As of the most recent quarterly report, the backlog had gotten much larger: "Our backlog was $86.1 million at September 30, 2010, $38.3 million at December 31, 2009 and $56.1 million at September 30, 2009." This implies that there will be an increase in EBITDA, which could be a positive "surprise" and therefore a catalyst.

Disadvantages
The key disadvantages are the small size (<$100MM market capitalization), pink sheet status, and small public float due to the sizable percentage owned by the family and management.

There's always an "ick" factor in value investing. If these disadvantages are the only problems with Conrad, then I think there is more than enough compensation for the ick factor. If the company had a billion dollar market capitalization, it would not be this cheap.

I actually kind of like pink sheet investing. You have to pay attention to the order book, and buying is sort of like buying an actual piece of a business from a human instead of a robot.