Grahamian Value Longform ― August 17, 2020
“The intelligent investor is a realist who sells to optimists and buys from pessimists.”
― Jason Zweig, Foreword to Benjamin Graham’s The Intelligent Investor, Rev. Ed. (pg. xiii)
I. FEATURED COMPANY: FRIEDMAN INDUSTRIES, INC.
Headquartered in Longview, Texas, Friedman Industries, Inc., is a manufacturer and processor of steel products with operating plants in Hickman, Arkansas; Decatur, Alabama and Lone Star, Texas. The Company has two reportable segments: coil products and tubular products. The coil product segment consists of the operations in Hickman and Decatur where the Company processes hot-rolled steel coils using temper mills and cut-to-length lines. The Company is in the process of replacing it’s temper mill and cut-to-length line at the Decatur plant with a stretcher leveler line. The tubular product segment consists of the operations in Lone Star where the Company manufactures electric resistance welded pipe, provides pipe finishing services and distributes pipe. Select Primary Source Data – Updated August 14
A STEEL NET-NET (UPDATE)
“...The company completed a strategic review last year with a few tangible improvements underway. The first improvement is that they are making capital expenditures to boost capacity where they have been constrained. Overall they will spend $5.8 million, of which $3.8 million has already been spent. Given their last big capex project was just written off with a large impairment charge, we should be a little skeptical. But I also appreciate the initiative to try to grow. The second improvement is Friedman will start to use price-risk actions to hedge their steel exposure. This hedging will lower their earnings volatility. This makes a lot of sense. As I said before, there is no reason a company like this should not consistently earn money. The last major improvement is that the company announced a share repurchase authorization of 1 million shares or so, or about 15% of the company over the next three years. This is meaningful–if they actually follow through. Repurchasing shares at 55% of tangible book will be highly accretive... After the quarter [ended March 31], the company took in a PPP loan for $1.7 million, which will probably be forgiven. This will help offset the loss from the June quarter. What does all this mean for earnings? It’s hard to triangulate given the information we have. In the past decade the company has earned about $25 million in total, or $2.5 million per year. Most of that occurred in the 2011-2015 period, with virtually nothing earned from 2016-2020. If we assume 7% gross margins on $150 million of sales less $5 million of opex, we can get a $5 million earnings figure. This could be reasonable given what they have done in the past. Earning $2.5 million relative to a market cap of $36 million is not particularly enticing value. Earning $5 million would change the equation. And if they return capital via buybacks along the way, the earnings yield would ramp up even more. Will any of this happen? I can’t say for sure. But the downside does seem limited. As I said two weeks ago, it’s a heads I win, tails I don’t lose much situation. But maybe the odds on the coin flip are no longer less than 50%? As a net-net investor, I can only hope.” Nothing But Net-Nets – July 9 (twitter)
A STEEL NET-NET
“...This doesn’t seem like a great business. But everything has a price. So how cheap is it? The company is trading at a $35 million market cap. It currently has $55 million of net current asset value. Of this $22 million is net cash. Friedman owns its facilities and land which is another $15 million. It’s cheap on assets. Less so on earnings. Also, they have a new CEO. Michael J. Taylor was hired in September of 2019 with solid credentials. He ran Cargill’s Metal Supply Chain business for 10+ years. Could there be operational improvements? It’s too early to tell but there is certainly a possibility. In a downside case, assume gross margins are 0%. They will burn $4 million per year. It would take a long time to burn net-net value. But this business should have a higher gross margin (is higher than 0% too much to ask?). And there is always a chance the new CEO can get things going. Or prices spike for some reason. Both of those scenarios could see earnings go up. Tangible book will grow. And there is no reason why Friedman couldn’t trade at tangible book which is 100% higher. It’s a ‘head I win, tails I don’t lose too much’ situation. But the chance of flipping a heads may be less than 50%.” Nothing But Net-Nets – June 26 (twitter)
“...The situation currently appears bleak for the steel industry. The customers for steel products are hitting hard times as a result of the recession. Construction and manufacturing activity are likely to slow down. I think the hard times are already reflected in the stock price. At 55% of tangible book, this is near the lowest level that it has traded in the last 20 years. In the last five years, the stock usually trades in a range of 80%-100% of tangible book. When the steel industry was hot in the mid-2000s, Friedman traded at double tangible book value. I think it’s a reasonable assumption that this can return to 80%-100% range of tangible book, at which point I will sell. If the economy returns to some semblance of normal, then construction and manufacturing activity will get back to normal. Coiled and tubular steel are essential for a number of uses that aren’t going away. Meanwhile, steel plants are being shut down and steel production is down for the industry. This means that if demand returns back to normal, Friedman will be well positioned to take advantage of it. If that doesn’t happen, then Friedman has the balance sheet and discipline to survive. It already trades at a price which indicates that there won’t be a recovery in the steel industry.” Value Stock Geek – June 11 (twitter)
Important: All figures are as originally appeared in respective source articles and dated accordingly. While the co-editors admire the above showcased thought leaders, all opinions expressed are subject to error and intended for educational purposes only.
II. PLATFORM UPDATES
III. FURTHER RESOURCES
THE WALTER SCHLOSS INVESTING ARCHIVE
Courtesy of Columbia University: “The Walter Schloss Investing Archive provides historical resources for scholars and showcases the unique history of the value approach. The archive includes a growing collection of value-investing materials, including: Books on investing and investment professionals; Articles from the press and finance journals, and other papers; Ledgers from the Schloss family that provide insight into holdings of a successful value investment manager, with a track record of nearly 50 years; Reports to shareholders, including shareholder letters from the Graham-Newman partnership and Schloss Associates; Original correspondence among some of the notable founders of investing Video recordings of classes and speakers at Columbia Business School.” The Heilbrunn Center for Graham & Dodd Investing
SECURITIES IN AN INSECURE WORLD, A REDISCOVERED MASTERPIECE BY BENJAMIN GRAHAM
Courtesy of Jason Zweig: “Here is the speech Benjamin Graham gave in San Francisco one week before John F. Kennedy was assassinated. In this brilliant presentation, Graham explores how an investor should go about determining whether the market is overvalued, how to tell which asset allocation is right for you, and how to pick stocks wisely. This speech is a rare opportunity to see the workings of Graham’s mind in the raw. I am grateful to Richard A. Rigg of San Francisco, who was in the audience that day, for providing me with what appears to be the only surviving copy of Graham’s speech, which to the best of my knowledge had previously been undiscovered. After I sent a copy to Warren Buffett, he told me that he hadn’t been aware of it but regarded it as one of the best of Graham’s speeches…” Benjamin Graham – 1963
BENJAMIN GRAHAM, THE FATHER OF FINANCIAL ANALYSIS
Courtesy of Ivey Business School: “Around 1931, Irving Kahn became Ben's assistant, preparing statistical analyses for use in classroom discussions as well as guiding and marking studies and exams. Often, when a question was asked, Ben chose to withhold his own reply. He knew the superior results that would come from study and participation on the part of the student. Thus, a question on the merits of land trust certificates might result in a team of four or five students being assigned to prepare an evaluation report. Irving would organize the team to prepare a plan for a thorough review of the topic and would coordinate preparation of the written report. Then Ben would bring it before the entire class, adding his penetrating questions and comments with everyone free to attack or defend the methods and conclusions. Ben understood the merits of the Socratic method, using it to re-examine his own conclusions as harshly as those of the students. He believed that a teacher should stimulate and guide the student with questions, so that the student not only was exposed to the answer but remembered how the answer was reached.” Irving Kahn and Robert D. Milne – 1977
HOW THE SMALL INVESTOR CAN BEAT THE MARKET
Journal of Portfolio Management: “In an effort to discover whether inefficiently priced, undervalued securities do exist, we turned to the acknowledged father of security analysis, the late Benjamin Graham. In his textbook, Security Analysis, he outlines in little more than a page the opportunities to be found in stocks selling below their liquidation value. In studies between 1923 and 1957, Graham reported superior results when market levels enabled him to buy a diversified list of these bargain stocks. We had followed for several years the dramatic success of companies that the market priced below their value in liquidation, and we decided to update Graham’s studies to see if his simple fundamental approach still provided the returns that could not be explained by an efficient market.” Joel M. Greenblatt, Richard Pzena, and Bruce L. Newberg – 1981
ABOUT GRAHAMIAN VALUE
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