EHL.AX - Emeco Holdings

[SpecOps]

Emeco Holdings buys earth moving equipment and leases it to businesses in the mining sector: iron ore, gold, coal, and copper in Australia, Chile, Canada and Indonesia. The company was founded in 1972 and, after a period when it was owned by a private equity firm, was floated on the ASX in 2005.

 

This blog goes through the business, is quite old but the company is still trading well below book value.

http://quinzedix.blogspot.co.uk/2012/11/emeco-holdings-equipment-leasing.html

 

A more recent article - it was trading below liquidation value, although the price is up since then so its now at about the estimate http://investingsidekick.com/emeco-holdings-asxehl/

 

I took a look into the company, it is generating strong cash flow even in a bad market, and is able to sell down its PPE at around book value.

 

Anyone come across this company before?

[phil_Buffett]

i have a small Position. stock Price is to depressed imo.

 

here are other good articles about emeco

 

http://quinzedix.blogspot.de/2013/07/emecos-downside.html

 

http://quinzedix.blogspot.de/2013/06/more-on-emeco-holdings.html

[writser]

Yes, I have a small position as well. Also covered here: link. Main thesis is that it is (or was, actually trading a bit higher now) trading at 1/3 tangible book and PPE is actually inventory of leasable (is that a word?) mining equipment. Past years they've been selling this equipment at or slightly above book value. If they continue doing that they can scale down their balance sheet to solve their debt problems.

 

Margin of safety is the fact that you can discount their equipment by ~30% and the asset value would still support the current share price. Granted, if the economy collapses they might get into trouble since they are quite leveraged but the leverage works both ways. Seems like a good bet.

 

But all three blogs did a far better job of writing a thesis than I could, so I'll leave it at that.

[bz1516]

It sounds like its going to be a battle of good margin of safety vs a sharp multi year downturn in mining in Oz and the ROW.  Major projects have been cancelled for years out. 

[bz1516]

http://www.emecogroup.com/upload/pages/131118_ehloperatingupdate/131118_ehloperatingupdate.pdf?1390179149

 

It sounds like its going to be a battle of good margin of safety vs a sharp multi year downturn in mining in Oz and the ROW.  Major projects have been cancelled for years out.

 

The company's ebitda in 2012 was AUD260mm, in 2013 AUD175mm, and from the link you supplied AUD90-105mm in 2014.  So this is a pretty serious downturn with no turnaround in sight and China continues to soften. 

[bz1516]

You were expecting a company selling around liquidation value without terrible news? ;)

 

It's a great company to keep on your radar.  One day, probably several years from now, it will shoot up pretty quickly. 

 

The fly in the ointment though is in a sustained downturn as we will likely have in this sector, the fair value prices of equipment can fall pretty sharply making that AUD600mm BV drop pretty sharply.

 

I'm gonna put it on my watch list so I'm ready when the time comes.

[SpecOps]

The company seem to have been able to liquidate their assets at above or around book value so far, despite the downturn in the market. Most of the analysis I have read has haircut the assets and still got it trading at around liquidation value.

 

I just noticed that there is an Emeco post on value investors club which is currently the top rated, but its not 45 days old so I cant view it.

[A Dhandho Investor]

The 2014 interim results are out:

http://www.emecoequipment.com/upload/pages/140220_ehl_1h14resultspresentation/140220_ehl_1h14results_presentation.pdf?1392865772

 

The company seem to have been able to liquidate their assets at above or around book value so far, despite the downturn in the market. Most of the analysis I have read has haircut the assets and still got it trading at around liquidation value.

 

I just noticed that there is an Emeco post on value investors club which is currently the top rated, but its not 45 days old so I cant view it.

 

Where did you get the information that they are able to liquidate their assets at above or around book value? In the latest conference call they mentioned that the haircuts in the last half year were between 20% and 30%.

 

[Hielko]

Haven't listened to the latest conference call yet, but in the past they generated earnings on selling P&E.

[xxx1313]

"A Dhandho Investor", I too expected haircuts to be lower than 20 to 30 percent. However let us be pessimistic and assume that Emeco has to eliminated all long-term debt of AUD 335 mln, and the average haircut on asset sales is 30 percent, then they have to amount to AUD 479 mln  (in balance-sheet terms) in order to repay all the long-term debt at once. Book value would be reduced by AUD 144 mln (=30% haircut of AUD 479 mln) to AUD 293 mln. In this case, you would still be left with a debt-free company trading at price/book of 0.5, without debt and goodwill on its balance sheet.

 

Moreover, this scenario is rather pessimistic, because:

- Emeco does not have to eliminate all debt, but only has to stay within debt covenants of 3.5x EBITDA

- Emeco sill generates healthy free cash flow

 

Of course there are risks, because for example haircuts could be higher than 30 percent. A commodity price collapse could stil wipe out that company. Nevertheless, this is deep value with a good margin of safety.

[A Dhandho Investor]

I am also long Emeco. I however had expected asset sales of more than AUD 28 million over the last 6 months. At this pace, they will not be able to eliminate their debt fast enough in order to stay in compliance with the covenants.

 

Haven't listened to the latest conference call yet, but in the past they generated earnings on selling P&E.

 

They sold AUD 28 million of inventory for net proceeds of AUD 21 million. 

[Hielko]

Looks to me that they sold 33,8 million in equipment for 28,3 million (6.1 million impairment, but also 0.5 million profit on sale). This implies a 16.6 discount to book value which is of course not good news, but also not very bad. This is by the way based on note 7 in the interim report.

 

The current speed of their asset sales also seems to be enough to keep in compliance with the covenants. They now have 320M in debt. Mid-point of the latest EBITDA guidance for 2014 is 88 million. 88 * 3,5 = 308. With a bit more than 4 more months to go I don't think this should be a problem.

[xxx1313]

With the lower end of EBITDA guidance for 2014, 82 million, debt would have to be reduced to 287 million. I would expect 30 - 40 million FCF in the remaining 4 months with the current pace of asset disposals, so Emeco could really come close to breaching the covenants. But, if necessary, management would probably speed up asset disposals. So they should be capable to avoid a covenant breach.

[A Dhandho Investor]

Looks to me that they sold 33,8 million in equipment for 28,3 million (6.1 million impairment, but also 0.5 million profit on sale). This implies a 16.6 discount to book value which is of course not good news, but also not very bad. This is by the way based on note 7 in the interim report.

 

Your analysis seems correct. Based on the CC it seemed that they only sold AUD 28 million.

 

Today they announced the proposal to offer senior secured notes for a principal amount of USD 360 million:

 

http://www.emecoequipment.com/upload/pages/140227_ehl_proposedofferingofseniorsecurednotes/140227_ehl_proposed-offering-of-senior-secured-notes.pdf?1393480839

 

The Secured Notes will be guaranteed by Emeco and certain of its subsidiaries (other than the Issuer). The Secured Notes will be secured by substantially all of the Issuer’s and the guarantors’ tangible and intangible assets, including the outstanding capital stock held by Emeco, the Issuer and the guarantors.

The net proceeds of the offering will be used to repay Emeco’s existing indebtedness under its USPP notes and Australian senior bank facilities, and for general corporate purposes.

 

[yadayada]

However, book gains have been netted out in the cash flow statement, suggesting cash proceeds may be closer to book value

from the VIC write up, what does this mean?

[ukvalueinvestment]

So they've refinanced the original debt, which had leverage covenants in, for debt that doesn't have these covenants.  The interest rate seems high at over 10% (I haven't checked the average weight on the original debt).

 

It would be interesting to know whether the new bonds allow early repayment and deleveraging or are bullet?  If they are bullet, the 10% + rate will be painful.  If they can pay down the bonds to a reasonable level, less so.

 

How can I find out (apart from waiting for the next report?)

[ukvalueinvestment]

I am on the verge of buying a big piece of this.  It seems like the perfect case of a market pricing for disaster and not taking into account the various levers the management can pull.

 

I would like to read about the general mining environment in Australia and ideally try and work out where the big miners are in the investment cycle and how much unused inventory they have.  Does anyone know of good resources for doing this?  I guess I can read the reports of BHP, Rio Tinto etc..  I was just wondering if any knew of good industry journals etc.

 

 

[yadayada]

My take on this is, that they are expanding in canada? And the big hit in earnings seems to come mostly from coal mining and Zinc mining. -40 million over that period (2011-2013) comes from coal, -50 million from zinc. And it seems the market will expect another big drop in revenue this year, which will most likely come from Coal. Note how Oilsands is increasing tho.

 

Break down by commodity in 2013 (only largest):

Coal 30%

Coking coal 11%

Gold 21%

Oilsands 20%

Iron 7%

Copper 4%

 

on 439m revenue

 

And in 2011 it was

Coal 34%

Coking coal 11%

Gold 19%

Oilsands 12%

Zinc 10%

Iron 6%

 

on 500 million of revenue

 

 

So it seems coaking coal isn't really hurt long term, but regular coal is (at least that is the perception), probably a large part of income drop comes from that? They did indirectly ban the newbuilds on new Coal power plants in the US recently, and there was overexpansion in coal mining. But Chinese and indian demand is sure to grow in the next 10 years. You see these headlines stating that coal is dead, but they even say in their conclusion that demand will v likely keep growing in the next 10-20 years, because country's like india and China dont really have cheap alternatives.

 

About Zinc, read the ZINC thread in investment ideas here somewhere. Everyone seems to believe ZINC prospects are bullish, and some Zinc mines are coming back online. There will be a shortage of zinc supply in the next few years.

 

Not sure about gold and oil sands tho. It seems they are expanding in Canada, but do they have the same scale advantage as in australia? In Australia they are by far the biggest. They had 64 million of revenue in canada in 2011, and now they have 92 million in revenue there. So seems to be growing.

 

I think the better way to go about this is to calculate what annual return is over longer periods, and what the odds are they will get in trouble with their debt. It seems if they survive, and business picks up in like 5 years, you will still make north of 30% annual return on this if the stock goes to previous levels. And it seems unlikely to me that it will take longer for the overcapacity to get out. Does that sound conservative enough? Seems that in 5 years, demand for coal is up, and it is likely that a lot of lose making coal miners willl be shaken out.

[ukvalueinvestment]

I don't really worry about what the future looks like.  Over the long time, demand for mining will always exist and providing rental equipment to give extra capacity to miners is a business that has a place in the industry.

 

The only thing I worry about is what happens if there is a massive economic construction crash in China.  In that event, can they cover costs, and what will their equipment be worth and can they repay their debt in 3 years time?

 

In all other scenarios, I think this is a double, at least, over several years, with a multi bag if the mining economy surprises positively.

 

I just listed to their most recent conference call and apparently in January and Feb they were selling equipment at around a 25% discount to BV.  When the thing trades at 40% of tangible book, with 40%ish leverage, this is acceptable, I think.  Now that they have refinanced, I think they can be a bit more orderly with their sales and wait things out.

[ukvalueinvestment]

I just bought a decent chunk - now 12.5% of my portfolio.

[xxx1313]

You might also take a look at MacMahon Holdings. Similar story, similar valuation (price/book 0.3), smaller company, but with less financial leverage and positive earnings.

[yadayada]

be carefull tho (imho) to not add too much of those type of cyclicals.

 

And why did macmaho offer 83 million worth of shares last year? They have well over a 100 million in cash vs 200 million in debt? They dont seem to like paying out to shareholders.

[ukvalueinvestment]

I won't be increasing my Australian mining exposure, that's for sure!

[writser]

You're not very lucky with your timing. Update from Emeco: link. They quit Indonesia - impairment of $38m of their inventory there. Good thing is that the division wasn't very profitable anyway and the decision generates quite a bit of cash.

[xxx1313]

yadayada, good point. But also Emeco diluted shareholders, not in this mining downturn but in the last one (2002). With price/book at 0.3, little net debt after the capital increase and positive earnings, MacMahon does not need perfect management to work for buyers at current prices. But the bad news from Emeco shows that the worst still is not behind us. I expected operations in Indonesia to stop, but the reduced guidance is bad news.

 

However, there are some companies too cheap to ignore. I find also Sedgman and Swick Mining Services interesting. Emeco now seems to be one of the weakest plays with its high debt load low ebitda and negative earnings.