DNOW - DistributionNow

[KCLarkin]

I looked at the various companies in the distribution/supply chain management space and 6% seems reasonable to me. I think part of the thesis here is that Peter Miller can get that margin up to 8% and maybe even higher. For a conservative approach 6% might be on the high side, but not out of the ball park.

 

With operating leverage, I wouldn't recommend applying a flat rate. It would be better to build a P&L using your estimates for fixed costs. I haven't done the work, but it might look like this:

 

$2.5B - 0-3%

$3.5B - 3 - 5%

$4B - 6%

$5B - 8%

 

If revenue was to drop permanently to $2.5B, they might be able to cut enough fixed costs to get 6% margins but that isn't the current plan.

[valuedontlie]

I am not sure 6% margin on 2.5-3.5b revenue is realistic, given the operating leverage.

 

what do you think is a reasonable range?

 

2015 consensus EBITDA is ~$65m on $3.1bn in sales so around 2% margins. As mentioned earlier, operating leverage will cut into 2015/2016. Fixed costs can cause large upswings in margins as they are spread over more sales and consequently cause large downswings when sales drop as is the case herein.

[RadMan24]

There is a pretty good short thesis on Value investors club, its worth a read over if you are thinking of going long.  Also, the companies revenues are heavily tied to rig count.  Rigs are down tremendously, which may explain the 8% drop the other day when reports came on how many rigs are being pulled.

[philly value]

There is a pretty good short thesis on Value investors club, its worth a read over if you are thinking of going long.  Also, the companies revenues are heavily tied to rig count.  Rigs are down tremendously, which may explain the 8% drop the other day when reports came on how many rigs are being pulled.

 

Yeah, I got interested when seeing Mecham buying in at higher prices, but my own (admittedly very brief) analysis and the VIC pitch make it hard on a valuation basis. Can anyone long present their idea of a fair valuation? You are paying a little over $2B TEV for the aforementioned $65M expected EBITDA. I get on a qualitative basis that you are buying what looks to be a decent business with good management and with a very strong balance sheet, and this may allow them to make some accretive deals of weaker players. And the EBITDA figure can significantly improve with a rebound given op leverage. But it seems that you are really paying a decent amount towards that upside and if the deals don't happen / rig activity doesn't recover soon, you have a lot to lose.

[KCLarkin]

Sadly, I think the short thesis on VIC is now the bull case. It seems fairly priced at $20 but there is still significant downside risk.

[RadMan24]

Sadly, I think the short thesis on VIC is now the bull case. It seems fairly priced at $20 but there is still significant downside risk.

 

That's what I have been thinking, despite the obvious decline in revenues and earnings, the cash flow is still pretty strong.  Growth through bolt on expansions is not a bad idea.  No debt yet, may acquire more as they scale, current market would be good conditions to do so if they get attractive offers.  The two catalysts to this investment are fairly simple. 1.) Improve margins 2.) Scale business to gain market share.  The risks are that they continue to have small or stagnant margins, take on too much leverage and don't integrate acquired businesses well, and if a Amazon enters the business.  They seem to have a pretty solid track record of integrating businesses while under the NOV umbrella and are quite aware of the downside risks of cutting expenses and offices at the expense of meeting quarterly goals (recent conference call mentioned previous owners thought short term and caused longterm pains when markets rebounded). Therefore, it is feasible that bolt on acquisitions, at a good price, are likely to occur first.  Then as things work themselves out, over the next couple of years, margins should improve.  Expecting a quick rebound to 6-8% pretax earnings EBIDTA (no/min debt) is why this stock sold at high 30s in addition to the expectation of very accretive acquisitions, which would have been done at much higher enterprise valuations, which in effect would have generated lower returns.

[kab60]

I made it a big position. I think it's a good way to play the oil downturn. Management seems very competent, company is unlevered, it's trading a bit above book value (a bit more above tangible book value) and even though it might drop more, I think that might even play to their advantage, as levered competitors will drop even more - paving the way for some nice M&A options. I have no idea how long oil will stay around $40-45, or whether it will go lower og higher, but I think their balance sheet puts them in a pretty unique position to take advantage of the turmoil.

[Guest notorious546]

Sadly, I think the short thesis on VIC is now the bull case. It seems fairly priced at $20 but there is still significant downside risk.

 

That's what I have been thinking, despite the obvious decline in revenues and earnings, the cash flow is still pretty strong.  Growth through bolt on expansions is not a bad idea.  No debt yet, may acquire more as they scale, current market would be good conditions to do so if they get attractive offers.  The two catalysts to this investment are fairly simple. 1.) Improve margins 2.) Scale business to gain market share.  The risks are that they continue to have small or stagnant margins, take on too much leverage and don't integrate acquired businesses well, and if a Amazon enters the business.  They seem to have a pretty solid track record of integrating businesses while under the NOV umbrella and are quite aware of the downside risks of cutting expenses and offices at the expense of meeting quarterly goals (recent conference call mentioned previous owners thought short term and caused longterm pains when markets rebounded). Therefore, it is feasible that bolt on acquisitions, at a good price, are likely to occur first.  Then as things work themselves out, over the next couple of years, margins should improve.  Expecting a quick rebound to 6-8% pretax earnings EBIDTA (no/min debt) is why this stock sold at high 30s in addition to the expectation of very accretive acquisitions, which would have been done at much higher enterprise valuations, which in effect would have generated lower returns.

 

attached the short thesis if anyone is interested.

Value_Investors_Club___NOW_Inc.pdf

[MrB]

Sadly, I think the short thesis on VIC is now the bull case. It seems fairly priced at $20 but there is still significant downside risk.

 

That's what I have been thinking, despite the obvious decline in revenues and earnings, the cash flow is still pretty strong.  Growth through bolt on expansions is not a bad idea.  No debt yet, may acquire more as they scale, current market would be good conditions to do so if they get attractive offers.  The two catalysts to this investment are fairly simple. 1.) Improve margins 2.) Scale business to gain market share.  The risks are that they continue to have small or stagnant margins, take on too much leverage and don't integrate acquired businesses well, and if a Amazon enters the business.  They seem to have a pretty solid track record of integrating businesses while under the NOV umbrella and are quite aware of the downside risks of cutting expenses and offices at the expense of meeting quarterly goals (recent conference call mentioned previous owners thought short term and caused longterm pains when markets rebounded). Therefore, it is feasible that bolt on acquisitions, at a good price, are likely to occur first.  Then as things work themselves out, over the next couple of years, margins should improve.  Expecting a quick rebound to 6-8% pretax earnings EBIDTA (no/min debt) is why this stock sold at high 30s in addition to the expectation of very accretive acquisitions, which would have been done at much higher enterprise valuations, which in effect would have generated lower returns.

 

Broadly agree with the above and RadMan24's analysis. To highlight the VIC analysis; I think it was spot on. It was written about one year ago and we are roughly at the author's $19 target, which is food for thought for the long thesis.

Only comment I can add is that the tougher it gets for the industry the better it is for the consolidator. So there is an element of the worse it gets, the better it gets for DNOW.

[kab60]

Sadly, I think the short thesis on VIC is now the bull case. It seems fairly priced at $20 but there is still significant downside risk.

 

That's what I have been thinking, despite the obvious decline in revenues and earnings, the cash flow is still pretty strong.  Growth through bolt on expansions is not a bad idea.  No debt yet, may acquire more as they scale, current market would be good conditions to do so if they get attractive offers.  The two catalysts to this investment are fairly simple. 1.) Improve margins 2.) Scale business to gain market share.  The risks are that they continue to have small or stagnant margins, take on too much leverage and don't integrate acquired businesses well, and if a Amazon enters the business.  They seem to have a pretty solid track record of integrating businesses while under the NOV umbrella and are quite aware of the downside risks of cutting expenses and offices at the expense of meeting quarterly goals (recent conference call mentioned previous owners thought short term and caused longterm pains when markets rebounded). Therefore, it is feasible that bolt on acquisitions, at a good price, are likely to occur first.  Then as things work themselves out, over the next couple of years, margins should improve.  Expecting a quick rebound to 6-8% pretax earnings EBIDTA (no/min debt) is why this stock sold at high 30s in addition to the expectation of very accretive acquisitions, which would have been done at much higher enterprise valuations, which in effect would have generated lower returns.

 

attached the short thesis if anyone is interested.

Thanks. I think the author raises some very valid points, but the price has pretty much come down to his price target and it's trading only a bit above BV which mainly consists of inventory, receivables and cash. I think that offers downside protection unless they have to write down receivables due to bankruptcies in the sector. Do you think that is too optismistic? (ie, that the company should be worth atleast TBV?)

[KCLarkin]

I calculate $1.4B in net equity that is "near cash" (receivables, inventory, cash) so the downside protection is pretty strong. I could see it drifting to $15 but not much lower.

[philly value]

I calculate $1.4B in net equity that is "near cash" (receivables, inventory, cash) so the downside protection is pretty strong. I could see it drifting to $15 but not much lower.

 

My thinking, though, would be that things like receivables and inventory could take a hit in a true downside scenario - if both customer solvency and the value of inventory is decently correlated with the strength of the energy market, and the value of DNOW as a going concern is itself very much correlated with the strength of the energy market, then I'm not sure it's a great downside protection.

[KCLarkin]

I calculate $1.4B in net equity that is "near cash" (receivables, inventory, cash) so the downside protection is pretty strong. I could see it drifting to $15 but not much lower.

 

My thinking, though, would be that things like receivables and inventory could take a hit in a true downside scenario - if both customer solvency and the value of inventory is decently correlated with the strength of the energy market, and the value of DNOW as a going concern is itself very much correlated with the strength of the energy market, then I'm not sure it's a great downside protection.

 

Possibly but I think you would need to see a much sharper, deeper drop in oil prices. The nice thing about their inventory is that it holds value well. They aren't holding miniskirts, fruit, or computer chips. Receivables could be a problem but we havent really seen any distress yet. They should be able to manage the quality of their credits. Everyone knows which companies are highly levered.

[MrB]

I calculate $1.4B in net equity that is "near cash" (receivables, inventory, cash) so the downside protection is pretty strong. I could see it drifting to $15 but not much lower.

 

My thinking, though, would be that things like receivables and inventory could take a hit in a true downside scenario - if both customer solvency and the value of inventory is decently correlated with the strength of the energy market, and the value of DNOW as a going concern is itself very much correlated with the strength of the energy market, then I'm not sure it's a great downside protection.

 

Possibly but I think you would need to see a much sharper, deeper drop in oil prices. The nice thing about their inventory is that it holds value well. They aren't holding miniskirts, fruit, or computer chips. Receivables could be a problem but we havent really seen any distress yet. They should be able to manage the quality of their credits. Everyone knows which companies are highly levered.

 

Distributors release working capital during a downturn.

[Guest notorious546]

dnow's q1 results included ebitda of 4 million, 10 million dollar loss, ebitda margins were down to 0.5% from last year at 6.1%. overall, the business is being negatively impacted by the lower global rig count and demand for it's products.

 

management highlighted the company's margins held in better than they thought and they completed three acquisitions in the first quarter. from a strategic viewpoint the company's roll-up strategy is being executed well, and the company still has cash on the balance sheet  (122 million), and limited long term debt (135 million).

 

i missed the conference call and am waiting for a cleaned up transcript. will post notes after.

 

In the first quarter of 2015 the Company completed the acquisition of John MacLean & Sons Electrical (“MacLean”), a UK based distributor of marine and industrial electrical products, lighting systems and cables for renewable-energy, petrochemical, process, marine, industrial, infrastructure and onshore and offshore energy applications worldwide. The Company believes that MacLean’s international presence and IEC product line will strengthen its electrical product offering. MacLean has over 225 employees and 12 locations across four countries.

 

The Company also completed the acquisition of Machine Tools Supply (“MTS”) in the first quarter of 2015. MTS, based in the United States, is a cutting tool and machine shop specialist providing comprehensive inventory management programs to the industrial and aerospace markets. MTS enhances our Supply Chain solutions international reach in the UK, Mexico and the Philippines. MTS has over 150 employees operating in ten locations providing supply chain solutions to over 70 customer sites across four countries.

 

The Company’s third acquisition of the quarter aligns with the three deals completed in the fourth quarter of 2014, and the Company’s most recently completed deal in the second quarter of 2015 of a European-based company, building on the Company’s product line and growth strategies in valve automation, pipe, valves, fittings, artificial lift in the U.S., personal protective equipment in the UK and electrical products in Europe. We believe these acquisitions will further support our industrial, midstream and upstream markets. Combined, the seven acquisitions the Company has completed since its spin-off in 2014 have added over 450 employees to the Company.

[Guest notorious546]

In Q1/15, alan mecham continued to add to his stake which now stands at ~12.70% of his total portfolio. Robert olstein added to his position as well, his overall portfolio concentration is low so not much to read into their position, ~1.0% of total portfolio. The rest of the value funds on dataroma didn't sell their position (including Berkshire)

 

http://www.dataroma.com/m/stock.php?sym=dnow

 

a bit late but Q1/15 conference call highlights include

 

• annualized revenue for the quarter, excluding acquisitions, was $1.097 million per average global operating rig, only down slightly from the $1.102 million produced in the prior quarter. The company’s decline in revenues was far less than the corresponding decline in the global rig count, the company is performing better than historical measures here. Q2 results won’t be nearly as good given breakup in Canada.

 

• The company has LOI’s for four company’s current; with aggregate revenues in the $300 million range (not completed no impact yet). With acquisitions, annualized revenue for the quarter was $1.107 million per average global operating rig, sequentially up nearly 6%. Revenue in the quarter from acquisitions was $54 million, up $49 million from the prior quarter. Annualized revenues from all the acquisitions since IPO is about 85 million with high single digit EBITDA margins

 

• SG&A costs have trended down from $69 million in Q4 to $57 million. Operating and warehousing costs were also reduced by $10 million sequentially. Headcount was reduced by just under 500 people in the quarter. Incentives at the branch level to find ways to earn incentives in a down market. I think this is a great sign, management has created a great incentivize system for employees to reduce costs.

 

• Longer term I think the company is better positioned that its key competitor MRC to consolidate the industry in today’s downturn. Cash flow generation remains relatively strong as balance sheet optimization has continued. Given low capital requirements for the business (ex-acquisitions) the company is well positioned to deliver strong returns on capital as it approaches its longer term EBITDA targets

 

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTgwMTcyfENoaWxkSUQ9Mjg1Mzk1fFR5cGU9MQ==&t=1

 

[kab60]

Thanks a lot. Do you have a transcript from Q1? It is getting beaten today on stronger dollar, weaker WTI for anyone else following Mecham closely.

[Guest notorious546]

Thanks a lot. Do you have a transcript from Q1? It is getting beaten today on stronger dollar, weaker WTI for anyone else following Mecham closely.

 

it's available on their website.

 

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTgxMzQwfENoaWxkSUQ9Mjg3MjA2fFR5cGU9MQ==&t=1

 

[Lowlight]

Thanks a lot. Do you have a transcript from Q1? It is getting beaten today on stronger dollar, weaker WTI for anyone else following Mecham closely.

 

it's available on their website.

 

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTgxMzQwfENoaWxkSUQ9Mjg3MjA2fFR5cGU9MQ==&t=1

 

The stock traded down below $21 at the end of the 1st quarter.  Wouldn't be surprised if he made a significant amount of his additions at these levels.  The company made significant strides in their M&A activity during the quarter at what appear to be reasonable prices.  It sounds like they think the back half of 2015 will present additional opportunities to deploy capital.  If they are successful in growing EBITDA margins to 8% while buying each sales dollar for $.50, DNOW shareholders will do extremely well. 

[kab60]

Thanks a lot. Do you have a transcript from Q1? It is getting beaten today on stronger dollar, weaker WTI for anyone else following Mecham closely.

 

it's available on their website.

 

Thanks. I really like the part where the CEO says they keep HQ costs down but don't send out emails firing people. Yet, more people were laid off than expected in Q1 because local management seems to have the fight incentives. It reminds me of the outsider CEOs with decentralized operations.

 

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTgxMzQwfENoaWxkSUQ9Mjg3MjA2fFR5cGU9MQ==&t=1

[AzCactus]

Based on everything I have read the management of this company seems both very capable and opportunistic.  The price is reasonable...Is anyone else thinking that at these levels DNOW is a bargain or am I missing something painfully obvious?

[kab60]

I made it a 12 percent position at these levels (don't think there is much to miss). You might wanna check the short thesis.

[RadMan24]

Read the short thesis and understand that the rig count is highly correlated to the company's operating performance. That's the main risk. Upside is consolidation and inorganic growth and improved operating margins.

[AzCactus]

The following line was from their q1 results.  See page 11 of attachment. 

 

Excluding acquisitions, sequential US revenues were down 14% compared with the US rig count decline of 28%

2015_q1_call.pdf

[AzCactus]

Read the short thesis and understand that the rig count is highly correlated to the company's operating performance. That's the main risk. Upside is consolidation and inorganic growth and improved operating margins.

 

I would say that when revenue declines at half the rate of rig count this would not really classify as highly correlated.  Also of importance is that you have first class management running this place and based on the growth and margins you mention above will lead to this possibly being a solid investment over time.