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This is written with serious investors in mind, though sometimes they're just drafts in progress. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

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.

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