About Me

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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Saturday, May 30, 2015

$STRL: A few add'l comments on the co's tarnish and the potential for it to shine

A few additional comments on my earlier post …

On owning construction equipment. 4Q12 - MacKenna's first full quarter – saw growth in leverage and PP&E. New equipment to an E&C is like bacon to a fat man; it looks great but it’s usually a bad choice. A construction company that owns non-specialized equipment and does projects across a wide region has to move equipment from job to job instead of renting from a local service. It is the providence of ego over valor and stupidity over wisdom. If an aggregates plant could be acquired central to operations, this may be a good investment. But generally, with regards to construction equipment, renting is better than buying.

On the industry, in general, how bids are awarded and margin set. Sterling is a heavy construction company. It does NOT build structures - homes, towers, office buildings, arenas, etc. - but rather builds transportation infrastructure (roads, highways and bridges, rail / light rail) and water / wastewater infrastructure (water, wastewater and storm drainage).

These are publicly funded projects awarded under "open-bids" meaning any company - or sometimes any pre-approved company - can bid on them. While there are exceptions to this rule, the general process is that projects are publicly advertised, bids are submitted and - like a reverse auction - awarded based on the lowest submitted cost.

During recessions, private work tends to slow down and everyone with a truck and a shovel bids on public work. The oversupply of bids drives down project price – good for tax payers – but crushes margins to the contractor.

Since projects tend to burn over a multi-year period, the long tail on margin pressure can be crushing. To his credit, the prior CEO inherited a company with such low margin work and part of his explains the decline in ROE and ROA from the mid-teens to single digits to negative returns. However, larger competitors like GVA, TPC and PRIM all navigated the post-recession environment better than he did.

In a “normal” environment most contractors will bid around the same ball park and above the state estimate. And you can look at the bids TX-DOT bids for evidence of this. Here is an example of a bid where STRL was in the middle of the pack but everyone was over the state's estimate ...

http://www.dot.state.tx.us/insdtdot/orgchart/cmd/cserve/bidtab/03063206.htm

... during the recession, it was not unusual to find avg bids 20% below the state's estimate.

Estimators = portfolio managers. Bids are put together by each company's estimators who are a bit like portfolio managers – they all look at the same information but everyone value’s a project differently. Sometime estimators are lucky and find a mechanism for building a project at a lower cost than the competitors – perhaps by sourcing their own aggregates or parking trucks closer to the site – but mostly projects are won based on a willingness to accept a slightly low margin than competitors, with the idea that change orders can make up the difference in the future. The new CEO has been drilling this issue home to investors and has hired new managers who drill it home internally.

Information = visibility. Since projects are public, so is information related to them. As an example, here is a project that STRL is pre-approved to bid on ...

http://www.txdot.gov/insdtdot/orgchart/cmd/cserve/bidlist/state/bidlst12.htm#011412007

... the contract # is 0114-12-007 and defines a project to widen 6.5 miles of road. There are six other companies invited to bid. It is estimated by the state to cost $66.8M. The bids will be opened on June 3rd. (And yes, these days, a road costs +$10M / mile to build. When eisenhower built the interstates it was ~$1M / mile).

Here is a $19.3M project awarded in late 2014 that is still in the early phases of construction ...

ftp://ftp.dot.state.tx.us/pub/txdot-info/cmd/cserve/distinfo/cisrpts/007207059.pdf

... the point of showing these links is that with enough leg work, for heavy construction companies that perform open-bid work, investors can have visibility into both potential new awards and progress on projects already in progress. This visibility is important for all construction companies but especially for a company like STRL that's dealing with a near term headwinds related to its credit facility and trading below its hard asset value.

On valuation. The mismatch in market value and asset value reflects both a margin of safety for equity investors but also the distress faced by the company on its bumpy ride out of the great recession.

The credit facility issues are no small matter to overlook. However, taking a step back from the emotional aspects of a company dealing with leverage issues, banks are as prone to stupidity as investors are.

But make no mistake; this investment is a measure of faith in the new CEO, Paul Varello. What attracted me to the investment was his initial conf call. It was simply, straightforward and credible and reminded me in some ways to Ray Milchovich who took FWLT out of bankruptcy. Both understood that E&C is at heart a simple business: bid right, execute well and stay safe. Varello has managed road building businesses and complicated industrial businesses and that gives me comfort in the investment decision.

Thursday, May 28, 2015

$STRL: New CEO (Slowly) Restoring Shine

STRL is a small-cap heavy construction company based in Texas with operations in Texas as well as in the Southwest (UT, NV, AZ and CA) and Hawaii through prior acquisitions of Wadsworth, CC Myers and Road and Highway Builders, LLC (RHB).

At the current price of ~$3.60 per share and with 19M shares outstanding, the company has a market capitalization of $68M. The current price reflects a 22% DISCOUNT to its hard asset value of $4.60 per share. Hard asset value = $2 in net current asset per share + $4.40 in PP&E less $1.80 in long term debt. The company is also trading at a 45% discount to book value of $6.60, but this includes $2.90 in goodwill, which is a meaningless figure that simply reflects how much it overpaid for acquisitions.

The discount to the $4.60 hard asset value reflects how poorly the company was managed under the prior CEO, Peter MacKenna, who ran the company from August 2012 to January 2015. MacKenna oversaw a 42% destruction of shareholder equity, mismanaged operations and worst of all, levered up to buy equipment, which is about the dumbest thing to do for a construction company with operations across a wide region. I realize it seems counter-intuitive but the dark secret of successful large E&C's is that they tend to be asset light.

One flow-through of these poor decisions under prior management terminates with the credit facility, which is now facing duress. Comerica, which has banked the company for decades, is pulling out and the uncertainty about a new credit facility weighs heavily on the stock price. I'm told Comerica is over-extended in Texas and is trying to withdraw leverage to anything in the area, including STRL.

The credit facility uncertainty should be resolved shortly. In its last press release STRL indicated that it is near to announcing a new lender - potentially an asset based lender - and while this will undoubtedly lead to higher interest expenses, the resolution of the issue will remove one of two major headwinds for the stock.

The other flow through of prior mis-management are legacy projects. These will take more time to resolve though the 1Q15 "kitchen sink" revaluation of all Texas projects dealt with the majority of that. There will be additional losses in 2Q and potentially further in the future, but if new CEO Paul Varello gains investor credibility by meeting his targets, investors will value the stock on a forward looking basis, based on new projects in backlog not old. And new projects should enter backlog at a higher margin and with an eye on generating add'l margin via change orders.

So, longer term - b/c investing is about the future - when these issues are behind the company, as they should be by 2H, investors can better judge the turnaround initiated by Varello. He has significant experience in "rip and read" fixed price heavy construction, from growing up in his family's road building business, to working to FLR where he was eventually President of its process management business, to the company he started in 2002 managing capital projects.

If he is successful in instilling new processes and procedures and improving operations in the core "Texas Sterling" business's estimating and project-management then this is a home run. The reward to investors is a 70% return in a year's time, which would come from both an improvement in operations and a revaluation towards the heavy construction peer group multiples of 8x EBITDA / 12x PE.