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  • Writer's pictureGreystone Capital

Some interesting microcap names – part one

This is just going to be the first part of an idea thread post, without full writeups on each business. I’ve been looking at some statistically cheap names recently and wanted to share some notes as I’ve gone through the list. I hope to make this a recurring post as I research new companies, but we’ll see how that goes! Disclosure: Long HIL, but none of the other names.

Gencor Industries (GENC)

Gencor manufactures and sells machinery and equipment for the production of asphalt and highway construction materials. Gencor is the leading producer of hot mix asphalt plants and related components, with the largest installed base of asphalt plants in the US.

The asphalt and highway construction machinery businesses are cyclical and capital intensive, which would normally be enough cause for me to drop the name right there as a potential investment (disclosure: I don’t own any), but GENC has a rock solid balance sheet w/ a huge cash position (60% of the market cap) and has at times traded below the value of it’s net current assets. The company’s CEO owns around 15% of the business (and 91% of the Class B shares), and has done a great job of conserving cash to prepare for any downturns in economic activity or fluctuations in oil prices (apparently a major component of asphalt).

Excluding cash, and using 2018 EBITDA and unlevered FCF numbers, GENC trades at 4.5x EBITDA and 6x uFCF, incredibly cheap valuations for a business that is poised to capture some benefit from increased economic activity and potential infrastructure spending. Of note, 2018 figures took place on the back of record volumes according to CEO John Elliott.

It’s probably not difficult to come up with reasons for the discount – cyclical, dependent on government spending, top of the cycle fears, tied to oil prices, sub-$200mm market cap – but perhaps less than 5x EBITDA is a bit too low given the market leader status and balance sheet. Those are also 2018 numbers. Annualizing 2019 figures – assuming no growth – gives an EBITDA figure of nearly $19mm, moving the multiple down to 3.6x, excluding cash. For those with ‘top of the cycle’ arguments or never buy cheap cyclicals, revenues are actually down 11% YoY. GENC doesn’t host conference calls or give guidance.

Hurco Companies (HURC)

Hurco is an industrial manufacturer. The company manufactures and sells machine tools to companies within the metal cutting industry. Hurco has a long history dating back to 1968, where it as founded in Indianapolis, and now has engineering, manufacturing and distribution facilities in countries all over the world. 87% of Hurco’s revenue comes from computerized machine tools, with software, parts and fees making up the remaining 13%. Machine tool sales are highly cyclical, and with a typical order backlog of 45 days, demand for HURC products is difficult to predict.

Hurco has a 150 or so product portfolio, and although there is no real competitive advantage in machine tool manufacturing, a wide product base at least allows for some leverage of shared resources for product upgrades, as well as some manufacturing cost efficiencies. HURC derives the majority of their revenues overseas, with the value prop of their products stemming from the need to be more productive, continued foreign industrial development, a lack of skilled machinists and helping customers replace an aging machine base.

Favorable macro conditions have led to increased demand for HURC products, leading to revenue growth above 20% YoY. If one were to believe in a continued pattern of this type of performance, HURC starts to get really cheap moving forward.

Hurco trades at just under 5.5x unlevered free cash flow using 2018 numbers, and right around book value, which has grown at a 6% CAGR over the past five years. Valuations are cheap, but at most likely peak revenues, margins and earnings. This isn’t a great business, with 6-7% net margins, mid-high single digit ROICs, capital intensive w/ large working capital needs, and as mentioned above, cyclical. With that said HURC set record numbers during 2018 for revenues, operating profit and EPS. I’d be cautious about buying this business today expecting this type of performance to continue, however the share price doesn’t seem to have reacted very well to what was a solid year, with the shares down some 20% in the last 52 weeks. The balance sheet isn’t too bad either, with $70mm in cash and no debt. Chairman and CEO Michael Doar, who transformed the business from 2001 ($70mm revenues, $8mm net loss) to today, owns 2.1%.

Hill International (HIL)

Hill International (full writeup here) is a worldwide leader in pure project management services and construction consulting. HIL has a long history dating back to 1976, and derives the majority of their revenues (63%) from government related business, with the remaining taking place in the private sector. Hill is one of the largest construction management firms in the US, and has the number one spot in Poland (HIL derives a large chunk of revenues from Europe). Construction management and consulting is a lower margin, cyclical business, so that, and recent corporate governance issues has led to a material decline in the share price, and potential opportunity.

Although there are more nuances, the situation is eerily similar to that of Ecology and Environment, although HIL actually ended up getting delisted, and doesn’t have the cash flow generation that EEI possesses.

During the past year, HIL has seen its share price decline by over 50%, due to a share delisting and plenty of forced selling, opening up an opportunity

Without breaking down the timeline, up until activist involvement in 2017, HIL was run by their founding family, the Richters, who took major advantage of shareholders while simultaneously destroying equity value. Following activists acquiring 30% control and booting the Richter family, the plan was to cut some costs and sell the business to a strategic buyer. However, during that same year, HIL announced they would have to restate 3 years of financials to deal with certain foreign currency translation adjustments.

HIL currently trades at $3.15, with 55.9mm shares outstanding, giving us a market cap of $176mm. Cash of $27mm and debt of $45mm gets us to an enterprise value of $194mm. While it’s nearly impossible to use current financials for valuation purposes, and HIL hasn’t provided guidance in quite some time, the company did post $7.5mm in FCF during Q1 2019, and regularly had quarters of $5-8mm in FCF during 2018. FCF to date has largely been due to better working capital management and deferred revenue, but it wouldn’t be hard to imagine a normalized scenario of $5mm FCF per quarter within the next few quarters. That would get us to less than 8x FCF if one were to annualize those estimates. In addition, as large one-time costs are removed from the income statement, these numbers should improve.

Of note, HIL has been covered multiple times by both Yet Another Value blog as well as Laughing Water Capital. I highly suggest checking out their write-ups.

Monaker Group (MKGI)

I always love it when I think I’ve found an underfollowed microcap in a niche part of a large industry, growing fast, and with a management team that has experience building a similar business, and who are incentivized to deliver shareholder value. The Monaker Group (MKGI) has some of these elements, and will be a business I follow, but also has some hair, and I’d need to get a lot more comfortable before initiating a position.

Monaker Group is an online provider of Alternative Lodging Rentals (ALRs) similar to a HomeAway, VRBO or AirBnB. The company operates two segments, business to business (B2B) and business to consumer (B2C). The B2B segment uses a cloud-based booking engine (Monaker Booking Engine, or MBE) which utilizes their API to deliver global inventory directly to B2B partners – such as travel agencies – and their booking systems.

The B2C segment is a hodge podge of assets including a luxury tour operator, a DTC booking website, a high end vacation property rental site, and a business travel solution that showcases ALR products. Monaker estimates 90-95% of future revenue will come from the B2B segment.

Monaker’s strategy consists of scaling their booking engine (MBE) by partnering with OTAs to offer instantly bookable ALR inventory from their 1.8mm global properties.

The online travel industry is enormous, expected to grow at around a 10.5% CAGR through 2020, taking it to over $800B in online travel bookings. The ALR market – what Monaker is going after – is the fastest growing segment of online travel, where direct to consumer platforms who have access to reservations and instant booking capabilities are taking share from some of the established players. AirBnB, HomeAway, and VRBO are good examples of platforms that have experienced rapid adoption.

Shares are up over 200% in the past year, so the market has clearly enjoyed this potential growth story which could continue if their platform begins to gain traction.

At a current price of $2.15/share and 8.6mm shares outstanding, MKGI has a market cap of $18.5mm. With $32k of cash in the bank, and having finished the year with less than $500k in revenues, MKGI will be raising equity for the foreseeable future. The company reported FY 2019 EPS of $0.50, but that was the result of a valuation gain and a gain on the sale of one of their assets. Opex have been trending in the $5-7mm range over the past few years. Of note, Monaker has an interesting ownership stake in Bettwork and Group that amounts to about half the market cap $8-9mm.

This one isn’t for me, and right now it’s impossible to normalize things like revenues, earnings and even their potential take rate for bookings. I am going to continue to follow for any interesting developments, namely revenue growth.

Precision Optics Corporation (PEYE)

As with some of these names, this is another one for the personal account due to size and illiquidity.

Precision Optics Corp. is a manufacturer of optics and optical systems for medical, biomedical and industrial applications. The company builds small cameras and lenses for the use in minimally invasive surgical procedures.

Revenues are derived from the assembly of endoscopic medical devices (50%), engineering and design services performed for customers (30%) and the design and manufacture of military industrial products (17%).

Over the past decade, R&D efforts have been geared towards the design and manufacture of 3D endoscopes and small Microprecision lenses for use in the robotic surgery community. This is interesting because up until today, PEYE manufactured and developed other companies products such as Intuitive Surgical or Medtronic. The optionality here lies within PEYE’s ability to develop a product used for robotic surgical applications that they can then license to larger businesses in future products, or sell their own. For a business with YTD revenues of $4.4mm and gross profit of $1.2mm, this would obviously change the financial picture of the company.

For such a small business, PEYE has an impressive list of customers who would historically pay the costs of development for PEYE. PEYE would then benefit most if a specific product of theirs made it to commercialization.

Revenue multiples are all we have at this stage given the lack of sustainable earnings, but the company’s pipeline of projects is large, which should contribute to meaningful revenue growth within the next 12-24 months. In addition, with a recent acquisition completed of Ross Optical ($4mm in revenues, $500k in earnings) not yet showing up in the financials, it wouldn’t be hard to imagine PEYE cross selling some of their products to Ross’ customers. At $8-10mm in revenues and improved gross margins, it’s possible PEYE could be trading at low-mid teens earnings with growth on the horizon and optionality to develop their own IP.

The CEO’s father founded the business, and put his son, Dr. Joseph Forkey, in charge (current CEO), who now has a few large funds and the board helping to manage the business and guide capital allocation decisions. Risks here include dilution, the inability to scale profitably, and failed R&D efforts. With a large engineering pipeline and blue chip customer base, this could be a potential acquisition target.

Scott’s Liquid Gold (SLGD)

In case anyone is interested in a deep value specialty retailer whose business appears to be in decline, I figured I’d include SLGD in this post.

Scott’s is a developer, manufacturer and wholesaler of household, skin and haircare products. The company has a cool history dating back to their first household product, Scott’s Liquid Gold, developed by Lee Scott, who later sold the business to a woman named Ida Scott, who purchased it for her three adult sons in 1951. For $175. Mark Goldstein, current President and CEO, is Ida’s grandson.

I’m not interested in these types of situations, but this is may be a purely quantitative play. With a share price of $1.09, Scott’s is trading at 58% of book value, with $8mm in cash on the balance sheet and zero debt. The company has a market cap of under $14mm, and generated over $6mm in free cash flow over the past two years. Those numbers have since turned negative (although they’ve generated about $1.5mm in FCF YTD), with the company’s sales of skin care products (making up 85% of revenues) in a downward spiral, and the elimination of sales to discount retailers like TJ Maxx.

To add to the mess, Scott’s has extreme customer concentration, with 68% of revenues being generated by three customers, Wal-Mart, Ulta, and HK NFS Limited, none of which are on long-term contracts.

However, if the company can continue to generate free cash flow in that $3mm/year range (not overly ambitious given the current state of the business and continued cash flow generation), it’s possible the shares could re-rate. The selloff over the past year could be overdone, as the company is being priced as if it’s worth more dead than alive. In addition, there are some interesting niche brands, President and CEO Mark Goldstein owns 24% of the business, and there’s ample downside protection given the balance sheet.

Some risks include CEO value destruction, history of unprofitability, management isn’t buying shares. and a history of unhappy shareholders.

Town Sports International (CLUB)

Town Sports International is a gym owner/operator. The company owns 190 fitness clubs across the US under various brand names such as New York Sports Club (along with Boston and Washington Sports Club), and Lucille Roberts and Total Women Gym and Spa. The company has nearly 650,000 members with a strategy to cluster locations in dense metro areas close to where people live and work. Across the business, CLUB does around $450mm in revenues, broken down into membership dues, personal training and ancillary services.

CLUB was put on my radar recently as Chairman and 11% owner Patrick Walsh has been gobbling up shares, with some timely purchases taking place a few weeks ago (08/28). The purchases precede what appears to be a price increase across the board at many of the company’s Sports Clubs, and on the back of additional acquisitions. Walsh seems to be incredibly bullish about the business which is evidenced in his letters. 

CLUB doesn’t hold conference calls or provide guidance, as their Chairman has adopted a bit of a Warren Buffett approach to managing his business. I tweeted the other day that I can’t tell if he’s full of shit, which is probably not a great sign. He can be found attempting to quote Buffett in his letters, which comes off sometimes as a bit cringeworthy.

I’m not a member, nor have I been to any of their gyms, so I’m not the best source of information for the qualitative aspects of this one, but was interested in the Chairman purchases as well as the financials which indicate a very cheap stock. CLUB did just under $50mm in EBITDA during 2018, and is estimated to do another $45-50mm in 2019. The company has spent $9-12mm in capex per year over the past few years, giving us a $35-$38 UFCF figure. For a business with an EV of $221mm, CLUB trades at under 6.0x UFCF.

Having laid that out, CLUB’s market cap is $58mm! They are extremely levered, and have a huge debt balance coming due in 2020. I walked away from this one right there, as it doesn’t fit my criteria, even though refinancing is more than likely, and any significant debt paydown would result in meaningful gains to the equity of the business. In addition, I read that the quality of the gyms isn’t always great, so raising prices for an inferior product isn’t the best business strategy. The fitness industry and gym space is now as competitive as I’ve ever seen it, with more participant/consumer options than ever before. I don’t know where CLUB sits on the pricing scale, but seems to be somewhat of a mid-tier gym, below places like Equinox and Orange Theory but above places like LA Fitness or the YMCA etc. I also have no insight into churn as it’s not disclosed (other than the Chairman mentioning increased churn in his most recent letter).

Price increases that users/members are happy to pay is a great way for a fitness club to boost the top line (high fixed costs means additional memberships and price increases above breakeven fall straight to the bottom line), and it’s easier to sign up new members than acquire/build new locations. However if churn is in fact increasing, but more acquisitions are made and prices keep increasing, the sustainability of that model will be called into question at some point. With growth at a bit of a standstill, this one isn’t for me. I will continue to follow and post any interesting updates.



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