October 2016, World Series Edition: In Tribes I Played*

Well, yeah, the Series will have ended by the time you see this, the Fall Classic nearly becoming the Winter Wonderland and all with Game 7 moving into November, and clearly no degree of rooting for the Indians, even to the extent of finding this month’s song lyric snippet, will do anything to break what has now become the longest Series-winning drought. Oh, there’s been an election and stuff which took place after the month ended as well, but we’re not going to go nuts talking about all that because that’s what pretty much everyone else is doing and has been doing nothing but for weeks, and you’ve probably seen, read, and heard enough about that by now, and it’s the least I can do to provide a momentary respite from the noise, confusion, and general poo-flinging and besides, you’ve got to give me something for the November letter. On my site I’d been writing about polling, and polling only (which, you’ll refuse to believe, was not nearly so bad as people who can’t do math insist it was), because as many of you know that in a lot of ways I’m way more interested in process than results—you can have process without a conclusion, but you can’t reach a conclusion without process. Or, as Branch Rickey used to say, “Luck is the residue of design.” And, go figure, the luckiest kid on the block is often the one with the best plan. Who knew?

Now—with apologies to anyone from the greater Chicagoland area—if only the Cleveland Indians had had more of a plan than running the same few arms out there and hope they wait until after Game 7 to fall off instead of, as ultimately happened, after Game 6. I know, I know—what’s my investment in the Tribe? Well, I’ll tell you. OK, so for my sins in a past life, I’m a Mets fan. And by marriage, I’ve had the joy of rooting for the Pirates for the last seven years (and, trust me even if you trust me on nothing else, PNC Park is the place to go to see a ball game), but the Indians? Srsly? Yeah. So here’s the thing.

My dad’s family, parked if not quite rooted in the South for a couple centuries-plus, found itself unrooted somewhere around the start of the Wilson administration—and I’ll tell you the story of Uncle Neville the junior firebug another time. Oh, OK, fine, I’ll tell you now. Family saga goes that he, the youngest of six, was mercilessly teased by his siblings, who convinced him that there were monsters in an upstairs closet of the family abode. Enterprising young chap that he was, aged somewhere in the upper single digits, he figured that the best way to get rid of monsters was to smoke them out. Which he did, sadly discovering that it was also the best way to get rid of a house. And then things belonging to other people. So, having already (mostly—we had folk in Tennessee in both armies, thankfully) backed the wrong side in the rebellion, which was as poor a choice morally as financially, the depleted family coffers became even more full of nothing but cobwebs by dint of having to pay for serial incidents of fire damage. Personae non gratae status soon, and unsurprisingly, followed, and the Buckeye State looked like as good a place as any. So there they were. And, in 1928, in Cleveland, my eventual father made his initial appearance.

By the time he reached high school, he’d already decided that a career in journalism was where he wanted to head, and got whatever sort of sub-entry-level job was available to a 16 year old in 1944 at the Cleveland Press. There was something of a war going on, so it’s safe to imagine there was a lot to do at a newspaper, and there he was, doing it.


* As usual, I’m amusing myself by plucking out a random snippet of a pop lyric. This one didn’t really have anything to do with Ladies And Gentlemen Your Cleveland Indians. Until now. So deal with it. Go Tribe!




Four years later, as a student at Western Reserve University, he had moved on to one of the wire services and Ken Ford, Cub Reporter (left, looking not wholly unlike yours truly, only with a rad ’40s tie) helped cover the 1948 World Series. He wangled a transfer to New York shortly afterwards, and rarely looked back (except when he took my brother and me for a visit to our grandmother’s in 1978 and someone tried to break into our hotel room while we were sleeping in it, but that’s really another story). It was, sadly, the last Indians Series victory he’d see. Though through my childhood never a baseball fan, while those of you who know me well enough will recall that I caught the bug at age six and have not shaken it in the forty-seven intervening years (for a Mets fan, that’s three hundred sixty-four people years), in his seventies a degree of Cleveland nostalgia set in, and for the last several years of his life was often to be found proudly sporting a Tribe hat. He’d have loved this season, even if it fizzled a little at the end. So many things do, and that doesn’t make them any less delightful.

That’s Nice, But You Do Follow Stocks, Right? 
I’m getting there. So, all of which being said, not wholly unlike the Indians, our own plan, which seemed to work so well in September, also fizzled a little in the post-season, though after such a surprisingly strong first three quarters it would only be realistic to expect a bit of a breather somewhere. And, for the most part, it was a breather, with only one name, LSB Industries (LXU), gasping for air like an asthmatic with a three-pack a day habit. Other than the misstep on that front, which is beginning to be something you can set your hourglass by, there was no negative news flow to speak of, and the first earnings reports that dribbled in were really rather promising. All the same, we’ve all been around here long enough to know that counting on security prices to march in lockstep with news is naive on a good day, even if it’s entirely to be expected on a bad.

So, as ever, let’s go to the videotape, or something like it.

Winning The Popular-ity Contest

So you end up following things you don’t entirely expect, and one of those, at the beginning of this year, was the biggest bank in Puerto Rico, Popular Inc. (BPOP). Having had some exposure to the overall situation in the commonwealth by my positions in some bond insurers, which are a whole different similar story, I was looking for other opportunities where a “the island is going to sink into the sea” mentality prevailed. Fortunately, every so often—if not nearly often enough—you find something n the very first place you look, and that place was BPOP. Seeing that the company’s exposure to commonwealth debt was minimal, capitalization was strong, it had been able to acquire troubled assets at an attractive price and had been able to streamline its mainland US operations and pay back over $1 billion in TARP loans, combined with a debt/tangible book value ratio of under 60%, it didn’t feel as though I were asking anyone to suddenly turn riverboat gambler to have a look at this name, and in fact the returns have been most gratifying.

How’re We Doing? BPOP reported a strong third quarter, with core EPS essentially in line with expectations of $0.87. Of course, since everybody calculates adjusted EPS slightly differently, “essentially in line” is about as close as you’re going to get with more moving parts than a Swiss tourbillon. Credit trends were positive, with NPLs essentially flat and delinquencies stable. Most importantly, Tier 1 Common Equity continues to climb, and stood at a tremendously impressive 16.64% at the end of the quarter. Book Value per share at the end of the quarter stood at $44.86, leaving the stock at $36.30 (as of October 31) continuing to trade at a 19% discount, though the gap has closed markedly since I first wrote on BPOP in February. The company also has stakes in payments processor Evertec and Dominican bank BHD Leon, both of which are carried at significant discounts to market value.

How’ve We Done? The first two quarterly results the company has posted since my initial recommendation have been strong, and the stock has provided a total return (including reinvested dividends) of 43% over that time, leaving the only remaining catalyst the result of the stress test; as the company had been posting a Tier 1 Capital ratio of over 16%, a disappointing result seemed unlikely, but we sat back to wait regardless. On October 17, BPOP did post the stress test results, which showed that even under the “severely adverse” scenario, the ratio would remain exceptionally strong, at above 12%. While the results were not actually necessary for a return of capital, the fact that the company wanted to put this result behind it to help prevent any US government objection is another sign to me of the solidity and financial conservatism of BPOP management, and I would expect an announcement of some sort of capital return to shareholders by the end of the year.

What’s The Roadmap? Management always talked about a few particular catalysts, most notably a resolution of the potential default of commonwealth debt, including the appointing of a financial control board, and the results of the 2016 stress test as opening the doors to a potentially significant return of capital. After what seemed like decades of wrangling and many games of solitaire chicken on the part of Puerto Rico’s governor, Congress passed the PROMESA bill over the summer, which should lead to resolutions of the overall commonwealth debt situation and establishes a strong control board to oversee the island’s finances for the immediate future. Future plans for the company could well include incremental small acquisitions, both in the US and Latin America.

Risks? Well, Yeah, But That’s Not What Won’t Let Me Sleep At Night (We’ll Talk Insomnia Another Time). The Puerto Rican economy remains soft, and no stimulus plan has yet been pronounced, though there may be signs of a flattening in the decade-long recession that has affected the commonwealth. Additionally, the potential ripple effects of a commonwealth-wide bankruptcy would ultimately have an impact on BPOP’s consumer business, as government workers would undoubtedly undergo massive layoffs and any signs of stability we may be seeing would be entirely wiped out. Finally, though I haven’t seen much commentary on this, there is a possibility that the advent of Uber and its competitors could lead to writedowns on loans in the company’s mainland taxicab medallion loan business.

CRH Medical:  ASC and Ye Shall Receive

One company that I’ve been especially keen on this year, and which reported a more than solid September quarter is CRH Medical (CRHM if you’re in the US, CRH.TO if you ain’t), a Vancouver, British Columbia-based owner and operator of gastroenterology anesthesia practices in the United States, as well as the manufacturer and distributor of the O’Regan hemorrhoid banding system. And, as a veteran of a couple decades of having things that look like crappy roll-ups thrown at me, from 30,000 feet I get why this might be a story that some people might have trouble buying into; at first I didn’t really want to, myself. But ever since I first wrote this one up for The Client™ in February of this year, I’ve thought there was something different about this company. I liked the fact that the entrée to the world of gastroenterology anesthesia was through doctors who were already long-time O’Regan customers, and that there was no competition for acquisitions, leading to low purchase prices (typically in the 4.5x EBITDA range), that margins of acquisitions were uniformly high, around 50%, and that there was the possibility that a changing regulatory environment might push more GI endoscopy ambulatory service facilities that owned the anesthesia practice that served their practices to sell. Given that, questions still remained: could CRH find suitable acquisitions to grow its platform? Could the company either generate enough cash through those very healthy margins or have access to suitable capital to keep a high-quality acquisition strategy alive? Would an increasingly tight reimbursement environment make it possible for CRH to maintain the levels of profitability at their facilities post-acquisition? So far, the answer to those questions has been a solid “well, duh!” as borne out by the company’s third quarter results.
Total revenue of $22.1 million beat street consensus of $20.1 million, in the first quarter since the company began acquiring anesthesia practices that it did not buy anyone, so the number should be a decent guide for what a clean quarter looks like. GAA, the core acquisition, posted an 8% increase in patient volume, more than offsetting a 7% decline in average revenue per case, leading to a net revenue increase of 1%, far above the 3-5% decline that had been expected. Total revenue per patient declined sequentially, but analysts whose work I’ve seen do not seem to be projecting further declines, and q3’s$ $461 was still higher than the $455 recorded in the fourth quarter of 2015.

AGAA in Austin, Texas, which CRH bought 51% of in June, blew the doors off on both revenue and margins in its first full quarter as part of the company, top line of $4.1 million compared with estimates in the $2.8 million range, and EBITDA margin of 61%, compared with its historical 55%. Management suggested that as it dug more deeply into the company after taking control, it found ways to improve revenue cycle management, particularly suggesting that insurance reimbursement had not been as efficient as it might have been.

Finally, between cash on hand, availability on its revolving line of credit, and the prospect of generating north of $6 million a quarter in free cash flow, which with acquisitions could be north of $8 million as we exit 2017 , CRH would have approximately $60 million to spend on future acquisitions by the end of next year. A high-coupon note (C$22,500,000 at 12%) comes due at the end of next year, and I also believe that CRH should be able to refinance that debt at a significantly lower rate of interest, which could also add to free cash in 2018 and beyond.

At the end of the day, assuming a steady level of acquisition activity, CRH could generate approximately $35-40 million in operating EBITDA to shareholders in 2017 and a run rate leading into 2018 north of the high end of that range. At the end of October, this equated to a healthy valuation in the range of 10x 2017 estimated EBITDA and 8-8.5x 2018, in line with its significantly larger, if slower-growing comp group. Even though the shares as of the end of October had climbed 42% since I first wrote the company up on March 14 at C$4.57, they have been exceptionally strong in November to date, rising from C$6.50 on Oct 31 to C$8.50 today, making a valuation case on a steady-state basis difficult to make at the present time, though the story is as intriguing as it was at the beginning of the year. I’d be inclined either to wait for a pullback in the share price or look to further clarity on both 2018 acquisition plans and a potential refinancing of debt at a lower coupon in order to discern where the next phase of growth will originate. Additionally, at a critical mass, CRH may become attractive to a larger competitor for whom the company is at present too inconsequential to notice but which may find appealing the idea of entry into gastroenterology anesthesia through an operation which has already begun the task of creating economies of scale and done the evangelization to doctor-owned ambulatory service centers.

The risks are pretty much what we’d expect: reliance on insurance companies which are always looking to lower reimbursements, though the company thinks things will be stable on the private insurer front and CMS has already released its 2017 schedule with no cuts; changes in payor mix may shift the business towards insurers with lower reimbursement rates for deep sedation endoscopic procedures; or a turn in the trend towards deep sedation endoscopic procedures, driven by payors’ preference for lower-cost conscious sedation.

Let’s close with a couple shorter comments, and be on our merry way.

Under The Radar, As It Were

Firan Technology Group, (FTG.TO), a supplier of aircraft electronics and assemblies, and by far the smallest company on my list, with a market cap of approximately just C$70 million, is perhaps my favorite (way) under-the-radar idea, poorish sort of pun intended. Firan reported an excellent quarter that had the few analysts north of the border who follow it (four buy recommendations), scrambling to increase their earnings estimates and target price.

Even though organic sales growth was slightly negative, reflecting two projects that have been deferred into the fourth quarter, the acquisitions of PhotoEtch and Teledyne PCT may be retaining more revenue than expected. Bookings were strong, with a book-to-bill of 1.6, and while the company does not publish backlog numbers, management did state that the Teledyne segment alone ended the quarter with a C$9 million backlog, all of which could be booked in the fourth quarter.

What intrigued me about FTG from the outset was the fact that the company was performing adequately despite at least one nearly-empty facility, in Chatsworth, CA. The acquisitions will take that plant from approximately 20% capacity to essentially full, which should lead to significant operating leverage while dramatically adding to top line. According to Bloomberg, consensus estimates for 2017 are now in the $105 million range for revenue and $14.1 million in adjusted EBITDA; at a month-end stock price of $3.34, FTG shares were trading at 5.7x estimated EV/EBITDA compared with approximately 8x for Canadian and US Small Cap aerospace stocks. While the shares had appreciated 50% as of the end of October, as estimates climb, so do target prices, and Firan remains an attractive microcap Canadian opportunity.

LXU: (Lyric Bonus Dept.): I Never Asked For The Truth But You Owe That To Me, Or What Was That About Lightning Never Striking Twice?

And, finally, last and most especially least, I suppose I should be happy that so far this year there’s only been one and only problem child, by name LSB Industries (LXU). OK, so the honeymoon with new management is over. After recovering from the literal lightning strike on the El Dorado facility, the company was hit with a figurative one, as planned downtime at all three of its facilities revealed significant structural weaknesses that needed immediate—and expensive—repair, causing them to be offline significantly longer than expected.

What Now? Yeah, it happened again. They were getting El Dorado back up and running after the lightning strike and discovered leaks in heat exchanger tubes, which caused the plant to be down longer, though the company at least believes that the expensive, extensive repairs will be covered under warranty. The Cherokee, OK plant had a turnaround in the third quarter, but lost additional time because a head gasket failed in one of its ammonia plants. Finaly, to complete the trifecta, The pryor, OK facility, which as always been kind of the problem child of the problem child (OK, call it the problem grandchild), also had a planned turnaround during which significant operational faults were found which also required a few weeks additional downtime. Coming on the heels of the El Dorado lightning strike which wasn’t reported for a few weeks after the event and during the consent solicitation of the senior debt holders, who may be a shade peevish. I fear that new management’s credibility has been pretty well shot at this point.

Are They Fixing That? I think so. The company had a group of analysts and investors down to El Dorado to kick tires, and in early November had their recently-appointed head of operations on the third quarter earnings conference call to go a little more in depth than usual and answer any questions anyone might have had. It’s a long, slow road back, and even with the unexpected announcement that the company was examining strategic alternatives in advance of showing a proven turnaround, there’s a lot to prove, and I wouldn’t be in the least surprised if it took til mid to late 2017, assuming a few quarters at greater than 95% efficiency in all three plants, before operational credibility is restored. Overlaying on that depressed nitrogen prices, weak corn markets and significant questions as to whether farmer income will plateau in 2016 or 2017, leading to increased demand for LXU’s fertilizer products, it’s all very much in wait and see mode at present.

On the plus side, they’ve only got three major plants, so they pretty well covered all the bases this time.

And, on that note, so have we. See you considerably earlier next month!


I've got a dog. Used to have a fish.

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