MCCK - Mestek

[KJP]

Mestek is a family-controlled, OTC-listed manufacturer of HVAC equipment, metalforming equipment and architectural products.  It currently trades at an EV/EBIT of around 5.4.

 

Mestek is levered to commercial and industrial construction, as evidenced by its annual revenues from current business lines:

     

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

329 356 372 385 378 373 288 280 304 299 331 345

 

Beginning in 2005, the company undertook a multi-year restructuring of its manufacturing operations.  The restructuring resulted in a very profitable and cash-generative business, even at the bottom of the downturn in 2009-10.  In addition, in 2011, Mestek shutdown a money-losing subsidiary pursuing an unrelated line of business.  All of these efforts combined to produce very strong results over the last four years:

 

Year 2011 2012 2013 2014 Q1 2015

Revenue 304 299 331 345 82.7

Gross Profit 91.4 90.6 107.1 111.7 26.9

Gross Profit Margin 30.07% 30.30% 32.36% 32.38% 32.53%

Operating Profit 21.7 19.6 27.8 27.9 6.5

OP Margin 7.14% 6.56% 8.40% 8.09% 7.86%

FCF 21.2 16.5 29.9 17.2

Invested Capital 105.28 112.7 109.7 113.8

Pre-Tax ROIC 20.61% 17.39% 25.34% 24.52%

 

Mestek has used its ample free cash flow to pay down debt, pay a large one-time dividend in 2012, make a few small acquisitions, and accumulate about $40 million in excess cash:

 

(in millions) 2009 2010 2011 2012 2013 2014

Cash at year end 1.8 1.8 22 7.8 36.5 54.4

Debt at year end 26.47 13.01 11.777 12.035 10.575 10.375

Cash Paid for Acquisitions 0 0 0 9 0.5 0

Dividends 0 0 0 22.5 0 0

 

Assuming the company needs about $7 million (2% of sales) to run the business, the company’s current enterprise multiple looks like this:

 

Market Cap @ 23.31/share 175

Less Excess Cash -43

Less DTAs -3

Plus Enviro Reserves 7.7

Plus Debt 10.3

Plus Warranty Reserve 3.4

Enterprise Value 150.4

EBIT (2014) 27.9

EV/EBIT 5.39

 

About 5.5x EBIT seems cheap if:  (i) 2013/14 don’t represent peak earnings; and (ii) management can be trusted to allocate sensibly the excess capital the company currently has and will generate in the future.

 

Regarding the cycle, Mestek’s revenue numbers show that we’re a few years away from the trough, but I’m not sure how to gauge whether we’re close to a peak.  Any insights on this issue would be much appreciated.

 

Regarding capital allocation, the company is majority-owned by the CEO and the estate of the CEO’s father.  So, the key decision maker on capital allocation questions appears to be aligned with shareholders.  The 2014 annual report also includes a lengthy and candid discussion of the company’s capital allocation philosophy and prior M&A record, including an admission that its prior foray into an unrelated business (the money-losing subsidiary discussed above) was a “disastrous strikeout with the bases loaded.”  http://www.otcmarkets.com/financialReportViewer?symbol=MCCK&id=138702 

 

It appears that that the CEO has learned his lesson and will focus on tuck-in acquisitions at reasonable prices.  It remains to be seen whether he can successfully execute that strategy. 

 

Overall, I think Mestek’s overcapitalized balance sheet makes it a relatively safe investment that has a decent chance of producing mid-teens compound returns over time.  I’d be happy to hear any contrary views. 

 

 

 

[DeepSouth]

The CEO pens solid shareholder letters. Themes regularly discussed: Capital allocation, decentralized organization, return on capital, shareholder return, tax avoidance.

[KJP]

The CEO pens solid shareholder letters. Themes regularly discussed: Capital allocation, decentralized organization, return on capital, shareholder return, tax avoidance.

 

Agreed.  There's a clear Berkshire influence in the content of the letters, and the CEO says the right things.  If he is able to execute, I think the investment will do well.  In short, good upside, with not too much downside risk.

[Jurgis]

Right. My question was: he's can write, but can he execute? :)

 

When I look at 10 years of revenues going nowhere, I start to doubt whether eloquence means results...

[DeepSouth]

As he is clearly holding himself to a "growth" standard, negative topline growth since 2007 looks pretty weak, but non-res construction spend is still well off of 2007-8 levels (but trending right way). There are plenty of housing related companies with revs off their 2006 peaks that are stronger than ever (HD revs just 5% over 2007 highs). With GMs rising, I'd imagine they're staying competitive.

 

https://research.stlouisfed.org/fred2/series/TLNRESCONS#

 

ROE as high as it has ever been ~11% over last 3 years, even with the growing drag from excess cash as GM has grown 250bps since 2010. Trading at 1.1X BV

 

Reasonably interesting.

[MrB]

Right. My question was: he's can write, but can he execute? :)

 

When I look at 10 years of revenues going nowhere, I start to doubt whether eloquence means results...

Yes, zhe can write and zhe can execute, but with no growth and no liqweedity the price is crazee.

[capitalg]

In their 12/31/2019 financial statements posted to the OTC Markets website on 6/25/2020, their investment footnote reads:

 

"The Company maintains a brokerage account for speculative commodities purchases and related investments which is included in Other Current Assets in the accompanying consolidated balance sheets. These investments carry market risk and are classified as trading and are recorded at their fair values using the specific identification method. The investments include actual physical quantities of precious metals maintained in the broker’s name at financial institutions by an established commodities broker. The cumulative results for these activities in 2019 and 2018 were a pretax gain of $21,386,000 and $2,695,000, respectively, primarily related to long positions on various commodities, respectively. Since these investments do not qualify as effective hedges for accounting purposes, the unrealized holding gains or losses on any investments are included in Hedging and Other - net in the accompanying consolidated statements of income."

 

The 2019 gain is pretty significant...is this effectively a commodity "hedge" that just doesn't directly qualify for hedge accounting?  I don't see the usual letter attached to the report that was posted, so no real context to the numbers.

[bizaro86]

In their 12/31/2019 financial statements posted to the OTC Markets website on 6/25/2020, their investment footnote reads:

 

"The Company maintains a brokerage account for speculative commodities purchases and related investments which is included in Other Current Assets in the accompanying consolidated balance sheets. These investments carry market risk and are classified as trading and are recorded at their fair values using the specific identification method. The investments include actual physical quantities of precious metals maintained in the broker’s name at financial institutions by an established commodities broker. The cumulative results for these activities in 2019 and 2018 were a pretax gain of $21,386,000 and $2,695,000, respectively, primarily related to long positions on various commodities, respectively. Since these investments do not qualify as effective hedges for accounting purposes, the unrealized holding gains or losses on any investments are included in Hedging and Other - net in the accompanying consolidated statements of income."

 

The 2019 gain is pretty significant...is this effectively a commodity "hedge" that just doesn't directly qualify for hedge accounting?  I don't see the usual letter attached to the report that was posted, so no real context to the numbers.

 

IIRC this is the one where the CEO is a big believer in platinum and had a big position as an inflation hedge. Given platinum was way up in 2019 that would fit.

[DeepSouth]

He's a hard money loon. Disappointing as a casual perusal of supply and demand characteristics of PGMs in the mid 2010s would have pushed you to long palladium instead of platinum.