EHL.AX - Emeco Holdings

[writser]

My thesis was that simple as well. I still think it's mostly valid but the .35 tangible book seems questionable if you suddenly have to discount 28% of your inventory by 50%. I'll leave the discussion for now, don't think it's very useful anymore. The facts are out there, up to individual investors to figure out to what degree they're comfortable with the risk.

[yadayada]

yeah and I appreciate people trying to bust stocks I own :D . I just offer reasons why I dont think its a big deal.

 

You have to look at the upside here. And you stand to make a ~40-200% annual return here. In the base and bull case basicly. Depending on how soon things pick up.

 

So if you couldnt lose, this would be a dream stock.

 

But it seems the downside case here is mostly coal going away in asia, failure in canada and chile. That seems pretty unlikely. If i had to give it a rough estimate, id say the odds are below 50%. So some of the time you lose maybe some capital (discounts to book value in different liquidation scenarios could v well be lower in downside case here). And if it goes right you stand to make a fat return. So I too make this only like 5% of my portfolio, but it seems a very attractive bet with assymetrical risk/return ratio.

 

And I think that by going into specifics you can try to deconstruct it and  figure out the risks. You can't have an edge in timing the mining sector, but with common sense you can figure out that it is extremly unlikely that demand for coal in Asia will go down, by simply looking at the facts. Even the biggest coal haters who think coal will die, they think coal demand will keep rising in the next 10 years. And that is a major revenue driver for Emeco.

[yadayada]

Report on earth moving equipment

http://upetd.up.ac.za/thesis/available/etd-03232010-121733/unrestricted/dissertation.pdf

 

they state that the very large trucks and dozers etc, they have lower resale value then smaller trucks. Because the market is smaller and more specialized.

 

If you look at annual report, it says fleet size compared to ebitda in Indonesia was very large. Is fleet size in tons or units?

 

From 2011 AR, it says large and smaller equipment is roughly a 50/50 mix (again is this units, or tons?). If you assume 35% discount, then liquidation value is around 173 million. But i supose you need to give receivables some discount as well. 40% discount gives 133m. But probably closer to 60-70 million$ in reality.

 

Also looked into their write down in 2013.  It seems the write down was in inventory of spare parts, the trucks or dozers they sold itself were sold at a tiny discount to book value.

 

http://www.emecoequipment.com/upload/pages/annual-reports/appendix-4e-and-2013-annual-report.pdf

at page 124, disposal was 46k, and write off was 377.

 

Inventory went from 34k million to 14k million. If part of the write down in equipment in indonesia was one, large equipment and two, partially inventory of spare parts, then liquidation value isnt as bad.

[writser]

I assumed fleet size was in % of book value. Can't find a confirmation though. You guys probably already knew, but you can check out all equipment for sale on the Emeco website. Pretty cool. Maybe one of you Americans should buy a couple of these: link. No more traffic jams and you support a distressed company  8) .

[yadayada]

Also the discount was mostly rental equipment in their Indonesia liquidation. And rental equipment is also parts, which get a bigger discount, and office equipment, cars etc also were liquidated. They likely get a much bigger discount too. Given that they were winding down, this was probably still a bigger part then average of their trucks and dozers.

 

I guess a 35-45% discount is still bad, but it means you will only lose half your capital instead of all of it. And if it was mostly large equipment, then the actual discount for their fleet in bad times will still be lower.

[writser]

Ok, one final question. An interesting point was raised in the comments of the blogpost that started this discussion. Their rental equipment (a coal truck in Indonesia) should be quite generic I assume. That's also demonstrated by the fact that they relocated $10m worth of Indonesian assets after shutting down operations there. But if these assets are interchangeable, what does the writedown suggest about the resale value of their equipment in other countries?

[yadayada]

So far I see two problems with the write down in Indonesia.

 

1: How much of it was spare parts and other operating equipment? Those things seem to hold their value badly judging from recent AR's. But luckily make up a v small % of total assets.

 

2: How much of it was old and/or very large equipment? As i said, the larger trucks (the ones that are as large as a house) lose more value in a bad market, and are likely more expensive to transport. So far they liquidated equipment over the years, and they either took no or only a v small write down, or they took around 30% write downs. So to bluntly say write downs will be the same for all equipment in a certain market is too simple.

 

In their 2011 AR you see that it is split 50/50 small and large equipment. Small equipment can be sold to construction etc, so there is a larger market with less variance. But the super large trucks have a smaller market with more variance. And coal mining (which they did in Indonesia) requires the really large ones. In a good market demand shoots up, and they hold their value well. But if things go badly, demand dries up quickly and you see larger write downs.

[SpecOps]

Ok, one final question. An interesting point was raised in the comments of the blogpost that started this discussion. Their rental equipment (a coal truck in Indonesia) should be quite generic I assume. That's also demonstrated by the fact that they relocated $10m worth of Indonesian assets after shutting down operations there. But if these assets are interchangeable, what does the writedown suggest about the resale value of their equipment in other countries?

 

I contacted the company about the 50% discount they sold the Indonesian equipment at. They said that most of the equipment was sold internationally and shipped, and that the discount reflects the global slump in value of this kind of machinery.

 

Definitely doesn't bode well, I am thinking of exiting this investment as a 50% discount on book value of equipment essentially wipes out the equity and downside protection is gone.

[yadayada]

Ok, one final question. An interesting point was raised in the comments of the blogpost that started this discussion. Their rental equipment (a coal truck in Indonesia) should be quite generic I assume. That's also demonstrated by the fact that they relocated $10m worth of Indonesian assets after shutting down operations there. But if these assets are interchangeable, what does the writedown suggest about the resale value of their equipment in other countries?

 

I contacted the company about the 50% discount they sold the Indonesian equipment at. They said that most of the equipment was sold internationally and shipped, and that the discount reflects the global slump in value of this kind of machinery.

 

Definitely doesn't bode well, I am thinking of exiting this investment as a 50% discount on book value of equipment essentially wipes out the equity and downside protection is gone.

Could they tell you if it was large or small equipment? And how much of it was parts?

[ukvalueinvestment]

Who cares what market is like today? Apart from Indonesia, company has no need to sell today. That's why it refinanced.

[Hielko]

Who cares what market is like today? Apart from Indonesia, company has no need to sell today. That's why it refinanced.

Don't you think that current market prices also tell you a lot about what the value of the company is today?

 

Lets say I would start a car rental company. I borrow $12,500 and I buy one car for $25,000 and if I rent it out I can make a fair return. Value of the equity? I'd say around $12,500. Now an economic crisis hits and car prices decline to $12,500 and rental rates decline with a similar amount so the equity of the business is basically zero and the 'company' has to spend the majority of its cash flows on repaying debt. Would you pay $4000 for this business because it's a triple when car prices go back to it's pre-crisis level?

 

Wouldn't it make a lot more sense to just buy a new car at the new depressed price level?

[ukvalueinvestment]

I don't understand where $4000 comes from or the final sentence.  I'm just saying the value of the assets only matters when you have to sell them.

 

My bet is that the company will be able to generate more cash flows from the assets in the future and that the supply/demand imbalance should be less in the future.

 

Many companies were "fair value" based on massively depressed asset prices in 2009.  But if one held the assets, they reverted to something more "normal"

[SpecOps]

That relies on a recovery in the global mining sector. What if China or another big economy has a bit of a wobble and mining continues to be poor? This sector tends to have cycles that last a decade or more and we've just been through a huge bull lasting about 15 years.

 

I don't know what the future looks like but if the downside isn't protected it doesn't really strike me as a safe investment anymore. In Indonesia its utilisation rates fell to almost 0%, so clearly worst case scenarios can happen.

[writser]

I don't understand where $4000 comes from or the final sentence.  I'm just saying the value of the assets only matters when you have to sell them.

 

You don't think that the current market prices of mining equipment imply something about their earning power? To get back to the car example: you buy a car for $25000 and expect to earn $2500 / year by renting it out. Now the market value of your car suddenly declines to $4000 (arbitrary number) but that's no problem because you don't sell it and it will still earn $2500 / year? Doesn't really make sense, everybody would start buying $4000 cars.

[ukvalueinvestment]

But if $4000 is below replacement value, then we will run out of these cars eventually as they get scrapped.  We are forced to replace them with new cars above replacement value, and are industry is forced to charge more.  So earnings power goes up as supply glut works out of the system.

[yadayada]

I dont think all their assets will sell at 50% discounts. People forget taht they had to write off parts and other equipment for closer to 100%, and it might have been old and v large trucks. It makes sense that they would send their older equipment to indonesia, because that was a higher risk area that probably didnt have standards as high as a more first world country like Australia.

 

In 2009, they sold equipment at a much lower discount. And it seems the smaller equipment can be used for a lot of other things besides mining, so they hold their value much better. So to compare this thing to a car rental commpany doesn't make sense imo. With cars, models change, and that is much less relevant here. Also cars are not almost purely priced on utility. And it is much harder to make money on a car then it is on a dump truck.  It is just a different type of asset.

 

That said, their equipment is used for operations in mines and for building them. But most of it is operating them. So there is less risk in that area . Also closing of Indonesia had political reasons, and looking at the losses in form of bad debts and damage to equipment, it wasnt a v good area to operate in.

 

I think the building boom will end soon, so that will take a bite out of revenue. But the operating part of it will go on. More then half is energy, and coal and oil demand will only go up in the future. Im starting to like this one less tho. Im not sure what the upside is now if they cant get back to their old levels. I dont like this one if upside is only a 100%, with the risk you potentially take with management that doesnt really have same incentives as share holders. 

[writser]

Yeah, but in the meantime profits will get squeezed and your company isn't exactly in the best position to wait for 'eventually' because you have to pay $1250 interest annually. If your competitor buys a couple $4000 cars and rents them out for $1000 you are in big trouble.

 

I dont think all their assets will sell at 50% discounts. People forget taht they had to write off parts and other equipment for closer to 100%, and it might have been old and v large trucks. It makes sense that they would send their older equipment to indonesia, because that was a higher risk area that probably didnt have standards as high as a more first world country like Australia.

 

You could very well be right, but that's all just speculation. Facts are the company sold huge chunk of equipment (internationally) at 50% of book value because of a 'global slump in value'.

[ukvalueinvestment]

The company more than twice covers interest at the absolute worst time in terms of the bubble bursting and over capacity.  While I'm not claiming Emeco has some amazing moat, you can't enter the market all that quickly.  If nothing else you need tens of millions of capital at minimum.  Who's gonna raise that?

 

 

[writser]

The company more than twice covers interest at the absolute worst time in terms of the bubble bursting and over capacity.  While I'm not claiming Emeco has some amazing moat, you can't enter the market all that quickly.  If nothing else you need tens of millions of capital at minimum.  Who's gonna raise that?

 

1. I don't know that this is the absolute worst time in mining history. I have no clue about these cycles. Two times interest coverage isn't that much.

2. Companies with a solid balance sheet don't have to raise capital, they can simply charge lower prices and that would kill Emeco. Not to mention that big mining companies could buy the equipment themselves or whatever.

 

Still, you're probably right but part of my (your?) initial thesis was that you bought at .35x tangible book, giving this investment a margin of safety and that assumption simply doesn't hold anymore if you take a conservative approach.

[Hielko]

I don't understand where $4000 comes from or the final sentence.  I'm just saying the value of the assets only matters when you have to sell them.

It's a bit of an arbitrary number, but it is to represent that you pay a significant premium above the current market value of the equipment as an option to participate in a possible future recovery. That is basically what you buy with Emeco right now.

 

My bet is that the company will be able to generate more cash flows from the assets in the future and that the supply/demand imbalance should be less in the future.

Yes, but how much and how fast? And what is already priced in at the current level? Remember that this is a company paying 10% on their debt! The return on their equity must almost certainly be significantly more to just get a fair risk adjusted return. I doubt that they will generate $15 million in FCF in a steady-state scenario with todays revenue (adjusting for all the one-time events of this year)

 

Many companies were "fair value" based on massively depressed asset prices in 2009.  But if one held the assets, they reverted to something more "normal"

Sure, and it's certainly possible that Emeco will prove to be a good bet. But instead of buying assets at "fair value" and hoping on price appreciation I prefer to buy them at a big discount with possible appreciation as a bonus. That's what value investing is all about imo, and 2009 also offered plenty of opportunities like that.

[yadayada]

Please actually study this thing and read all comments in this thread before making these claims.

 

These guys have more then 50% marketshare. You honestly think they could do that if they were a commodity business like a car rental?

 

There are safety issues, and there is an advantage in having a large amount of equipment and a large distribution network.

 

Also these things cost a lot of money and you need scale to compete. Some other guy can't just randomly buy up a few trucks, undercut them and expect to make money.

 

Second it is not speculation that not all equipment in Indonesia was heavy earthmoving equipment. It says so in the statement, Most of it was heavy earthmoving equipment. Someo f it was inventory, office equipment etc. 

 

Third, there is a difference in the very heavy equipment and smaller equipment. That is a fact. The larger stuff doesn't hold its value as well because market is smaller and more volatile. in 2013, they sold 46 million$ and had to write off 400k$. the market in this type of equipment is not this volatile to lose this much value over 1 year.

 

And the car rental comparison just doesnt make any sense, it is a different type of asset, and a different business alltogehter. you honestly cant compare a 3 million$ dump truck to a 30k$ car. I can start a car business with 10 million, but i cant start a 3 million$ dump truck rental business with the same amount of money.

[xxx1313]

I do not understand why there seems to be a huge disconnect between the prices of used mining equipment (that Emeco sold up to 50 % below book value) and new mining equipment, that is sold by the market leader Caterpillar, for example. Sales and profits for Caterpillar are going to rise this and next year, as far as analyst consensus is concerned. Can anybody try to explain this different development?

[ukvalueinvestment]

Caterpillar has two lines, I think: construction and mining.  Construction is recovering eg because of highe US sales.  Mining was down 50% yoy at the last quarter. 

[writser]

Second it is not speculation that not all equipment in Indonesia was heavy earthmoving equipment. It says so in the statement, Most of it was heavy earthmoving equipment. Someo f it was inventory, office equipment etc. 

 

That's not what I mean. You make the assumption that Indonesia was a one-off and that they had worthless equipment there. That's not a fact and some of us simply choose to make another assumption: i.e. we assume these discounts hold for their entire fleet. In that case your margin of safety is no more. Anyway, you win the discussion. You're getting a bit rude and I have already convinced myself to sell. I sincerely hope you make a lot of money.

[Hielko]

Caterpillar has two lines, I think: construction and mining.  Construction is recovering eg because of highe US sales.  Mining was down 50% yoy at the last quarter.

Yes, and gross margins at the resource segment are also going down rapidly at Caterpillar. So not only the value of old equipment is going down, so is the value of new equipment.

 

These guys have more then 50% marketshare. You honestly think they could do that if they were a commodity business like a car rental?

These guys are minuscule. Caterpillar sold $13 billion worth of equipment to just the resource sector last year (and that was a bad year). That's 20x the (book) value of Emeco's fleet. Emeco occupies a small niche, and what they provide is just a commodity were customers have many substitutes available such as buying/leasing from Caterpillar or acquiring equipment on the second hand market. Just because there isn't another big player in the rental category doesn't mean that Emeco doesn't face big (and well capitalized) competitors. At the same time Emeco's customers are often multi-billion dollar mining companies. They can find an alternative if renting is not attractive: Emeco is facing a lot of indirect competition!