HNFSA/HNFSB - Hanover Foods

[oddballstocks]

I did two posts detailing Hanover Foods a vertically integrated frozen food company located in Pennsylvania. 

 

The company is family owned and controlled and unlisted.  I figured I'd get that out there early so 98% of this message board can click away now.  If you're still reading here are some highlights:

 

The company went dark in 2004 paying shareholders $131/share for their A shares, at the time the A shares were trading in the same range they are now ($80/sh range), a considerable premium.  During the going private transaction a valuation was completed which pegged the fair market value of the A shares at $131 and the B shares at $138.  At the time of going dark the book value of Hanover Foods was $99/sh.  Fast forward to today:

 

Earned $16.24/sh in 2011 has a current P/E of 5

Grew book value from $137/sh in 2004 to $250/sh in 2011

Liquidation value of $99.39/sh

The company has an outstanding offer to buy employee owned shares purchased before 1988 at $150/sh.

$37.89/sh of cash from operations for a P/CF of 2.16

FCF of $23.79/sh for a P/FCF of 3.44

EV/EBIT of 4.45 and EV/FCF of 4.59

 

Using a range of values from earnings power, book value, and appraised value I came up with a IV range of $150-250 a share for Hanover Foods.  This is double or more than today's share price.

 

I go into more detail on the posts, but would be interested in this board's thoughts.  I have a position in the B shares.

 

Here are the two posts:

http://www.oddballstocks.com/2012/04/hanover-foods-part-1-story.html

http://www.oddballstocks.com/2012/04/hanover-foods-part-2-figures.html

 

Nate

[Kraven]

Very interesting.  Thanks for posting it.

[nkp007]

Just bought some. Not really sure what to expect, but it's fundamentally very cheap and been around for a while. Obviously not a concentrated position because of lack of transparency...but would love to discuss with people who are also invested.

[Hielko]

Do you have the financials? Would like to take a look at this :)

[nkp007]

Do you have the financials? Would like to take a look at this :)

 

Check out Oddball's part 2 post. It has the important numbers (except for depreciation!).

 

I don't have the financials yet.

[Olmsted]

Doesn't Nate run a website for unlisted financials?  I'm sure that Hanover is in there, and I'm sure there is a link to it on his blog.

[ScottHall]

Just bought some. Not really sure what to expect, but it's fundamentally very cheap and been around for a while. Obviously not a concentrated position because of lack of transparency...but would love to discuss with people who are also invested.

 

I own this. The annual report isn't really very detailed so there's not a lot to talk about.

[oddballstocks]

My ears were burning, so I figured I'd respond.  Yes, I own it and like the company, and yes the financials appear on my unlistedstock.net site as well.

 

I'm in a generous mood tonight so I posted the 2012 annual report.  As ScottHall mentioned, not much additional information available beyond what I'd posted in the blog.

 

The interesting pieces of information with this company come from on the ground sources.  A friend of a friend talks to Michael Warehime occasionally and had some insight.  Apparently most of the shares coming onto the market are Michael's shares, he hates his brother and regularly donates his Hanover shares to a few local charities.  The local charities sell the shares for cash, that's the source of what we're seeing out there.

 

John Warehime has been acceptable at running the company, he's been a pretty decent capital allocator by purchasing up other brands and bolting them onto Hanover.  In the 2012 report there are signs the company is at work acquiring another company though a joint venture.

 

I've debated driving out to Hanover a few times just to check things out, if I get the chance I might.

hnfsa.2012.annual.report.pdf

[ScottHall]

Anyone care to speculate what will happen to Hanover after John Warehime kicks the bucket?

[Green King]

Oddball thanks

Can i have some more please?:) I think I need at least 5 years to have an opinion.

 

Thanks

 

GK

[Hielko]

Thanks Nate for the annual report. Just wondering: do they hold annual shareholder meetings?

[oddballstocks]

Oddball thanks

Can i have some more please?:) I think I need at least 5 years to have an opinion.

 

Thanks

 

GK

 

That's tough, I don't have five years.  I do have some data going back to 2007, they went dark in 2004.  But honestly you don't need that hole, the results are pretty linear, from 2004 forward to now they're pretty linear as well.  Sales have been growing at a steady pace, earnings, cash flow and book value as well. 

 

Without looking I seem to remember book value has grown at 8% over the past 10+ years, and buying at 30% of book value means they're compounding at 27% on your investment.  Not bad to take that and wait it out, so this is one of those things I don't mind holding and waiting for years.

 

They pay a $1 per year dividend.

 

As for what happens when John dies?  That's anyone's guess, but Michael doesn't have a big stake, all of the grandkids only own 3k shares each.  It wouldn't surprise me if the company is sold, none of the kids are in managing roles, the only way they can monetize their inheritance is to either kick out bigger dividends or to sell and take the cash. 

[Green King]

Oddball thanks

Can i have some more please?:) I think I need at least 5 years to have an opinion.

 

Thanks

 

GK

 

That's tough, I don't have five years.  I do have some data going back to 2007, they went dark in 2004.  But honestly you don't need that hole, the results are pretty linear, from 2004 forward to now they're pretty linear as well.  Sales have been growing at a steady pace, earnings, cash flow and book value as well. 

 

Without looking I seem to remember book value has grown at 8% over the past 10+ years, and buying at 30% of book value means they're compounding at 27% on your investment.  Not bad to take that and wait it out, so this is one of those things I don't mind holding and waiting for years.

 

They pay a $1 per year dividend.

 

As for what happens when John dies?  That's anyone's guess, but Michael doesn't have a big stake, all of the grandkids only own 3k shares each.  It wouldn't surprise me if the company is sold, none of the kids are in managing roles, the only way they can monetize their inheritance is to either kick out bigger dividends or to sell and take the cash.

 

where did you get 30%? the annual report says 200 m in shareholder equity? But i trust your work are right but for me to buy anything i have to see it for myself. Do you have more than one year of annual report? I can't do anything with that big of a gap.

[wknecht]

Thanks for the very interesting idea! Not sure how I missed this when you posted it back in April. Please help me understand the capital structure though. Based on the annual report posted:

• Class A: 349,453,000
  
• Class B: 850,572,000
  
• Series A & B convertible dilution: 1,326
  
• Series C convertible dilution: 10,000
  
• Treasury Stock: 147,453,000
  
• Held in ESOT: 340,119,000
  

My understanding of the shares held by the ESOT are that they currently unallocated to individual employees, but are earmarked to meet the demand created by the 2005 Option Plan and the ESOP. Since they are unallocated, they are effectively held by the company and should be treated similar to treasury stock. What's a little more confusing is in some of their SEC filings, the company included the shares issued to the ESOT in their outstanding count - really not sure why they did this.

 

Additionally we have:

• 2005 Option Plan: 215,000 options granted, of which 126,044 still outstanding
  
• ESOP: shares are transferred to the ESOP when earned and allocated to individual employees accounts; currently 17,730 such shares in the Class B count above
  

Per the treasury method, the options in the 2005 Option Plan are out of the money so no dilution. But these are pretty close to the money so might have a delta of a little less than 0.5 and hence very rough dilution of 63,022. Granted they will receive cash so effective dilution would be lower depending on what the stock price does.

 

Following this reasoning, I come to a diluted share count of around 786,800 (=349,453+850,572+1+10-147,453-340,119+63). But I was having trouble reconciling the share count numbers in their old SEC filings so part of my reasoning here is probably faulty or I'm missing something.

[oddballstocks]

Oddball thanks

Can i have some more please?:) I think I need at least 5 years to have an opinion.

 

Thanks

 

GK

 

That's tough, I don't have five years.  I do have some data going back to 2007, they went dark in 2004.  But honestly you don't need that hole, the results are pretty linear, from 2004 forward to now they're pretty linear as well.  Sales have been growing at a steady pace, earnings, cash flow and book value as well. 

 

Without looking I seem to remember book value has grown at 8% over the past 10+ years, and buying at 30% of book value means they're compounding at 27% on your investment.  Not bad to take that and wait it out, so this is one of those things I don't mind holding and waiting for years.

 

They pay a $1 per year dividend.

 

As for what happens when John dies?  That's anyone's guess, but Michael doesn't have a big stake, all of the grandkids only own 3k shares each.  It wouldn't surprise me if the company is sold, none of the kids are in managing roles, the only way they can monetize their inheritance is to either kick out bigger dividends or to sell and take the cash.

 

where did you get 30%? the annual report says 200 m in shareholder equity? But i trust your work are right but for me to buy anything i have to see it for myself. Do you have more than one year of annual report? I can't do anything with that big of a gap.

 

I just took the market cap of $78m divided by equity of $200m, so 39%. The stock is thin and I've seen trades recently in the low 90s which is closer to 30%. I guess the 30% of BV number stuck from when I purchased in the low 80s.

 

In terms of shares it is tricky. I've seen numbers from 730-780. The most solid number I've heard is closer to 730. This was confirmed by a friend of a friend who talked to the auditor.

[Hielko]

Per the treasury method, the options in the 2005 Option Plan are out of the money so no dilution. But these are pretty close to the money so might have a delta of a little less than 0.5 and hence very rough dilution of 63,022. Granted they will receive cash so effective dilution would be lower depending on what the stock price does.

I don't know when they expire, but looking at the delta as a way to figure out the dilution doesn't really work I think. What matters is the probability that they will expire in the money and how big the gap between the current price and intrinsic value is (if there is no gap dilution doesn't hurt).

 

Lets say that there is a 50% probability of the options getting in the money (reasonable for an at the money option). Lets say that intrinsic value is twice the current market price. If price goes to IV at some point in the future two options basically bought one free share. So i'd say that the expected dilution from the options is ~32,000 shares and less if the price stays below IV.

[Olmsted]

I would approach the share count vis-a-vis the employee stock options slightly differently for a small, illiquid company than I would for a mid-cap or something.  The key assumption for employee options on a larger company are that, upon expiration, the employee can choose to exercise options or to buy an equivalent number of shares on the open market at the prevailing price that day.  If they can buy shares cheaper than their option strike, options are worthless and they do not get executed, keeping share count the same.

 

For something like this, though, that assumption does not hold.  There is not unlimited liquidity at the last-trade-price.  The employee likely cannot buy as many shares on the market as he has options.  Therefore, an option - even if it is above the last price - has value and will be exercised as long as the employee feels the strike price is an attractive price for shares.  In this case, I would fully dilute any options that are even reasonably close to the current market price - maybe even any options under book value.

[Packer16]

I think you understanding of the ESOT shares is not correct.  For an employee owned ownership plan, the plan buys the shares for the participants and holds them in trust.  They do not belong to the company but the individuals represented by the trust.  If there is a sale, the trust will get its pro-rata share of the proceeds and as a minority shareholder you will not share in the ESOT proceeds.  Thus you need to include these shares in your fully diluted calculation.

 

Packer

[oddballstocks]

I think you understanding of the ESOT shares is not correct.  For an employee owned ownership plan, the plan buys the shares for the participants and holds them in trust.  They do not belong to the company but the individuals represented by the trust.  If there is a sale, the trust will get its pro-rata share of the proceeds and as a minority shareholder you will not share in the ESOT proceeds.  Thus you need to include these shares in your fully diluted calculation.

 

Packer

 

That's correct for a normal ESOP but these trust shares do not technically exist. They are voting only, no economic interest. If the company were to dissolve those shares get zero.

 

Google Hanover Warehime trust and you'll find a lot of court documentation surrounding this. Also Tim Erickson on this board is a good resource, or call the company. One of their filings in 2003 I think had an extended discourse on the shares.

 

What I know is the auditors have said in a sale the ESOT shares are not counted. But for a vote they absolutely count.

[Packer16]

From what I see in the financials the reason why the shares are not counted in the financial statements is the ESOP is consolidated for financial reporting purposes but I could not find where these shares would have no value economically.  Typically, shares can be redeemed by participants at the latest determined valuation so I would think at a minimum participants would re-sell the company before the sale.  In addition, there are specific DOL regulations regulating ESOPs due to in part the tax benefits they are given.  It is hard for me to believe that the case where Hanover gets taken over and the shares receive nothing would be allowed as an ESOP because the contributions are tax deductible under the premise that the employees are getting a benefit not just a vote.  It may be set up this way but I think there would be some litigation around providing only a vote to the employees via the ESOP versus a economic interest.

 

Packer

[oddballstocks]

Packer,

 

In all the reading I've done I've come to the conclusion that John Warehime is surfing as close to the boundary of the law as possible if not over the line.

 

Here is a cour document that sheds some light: http://caselaw.findlaw.com/pa-superior-court/1456446.html

 

The trust is very complicated, this investment would be simple if it weren't for the shares outstanding issue. I've heard of some investors just throwing up heir hands and using the 1m share figure, but I think it's more nuanced then that.

 

750k shares, 1m shares, either way this is still cheap. 

[Packer16]

The key issue you bring up is it is still cheap.  One issue given the history of litigation, how do think you will be treated in a take-over?  Has he ever tried to "take-under" the company?  It appears from the case that he feels the company is his fiefdom to do with as he pleases.  Have you found other instances of this or this just bad blood in the family?  Thanks for interesting idea.

 

Packer

[Packer16]

I talked to one of my partners about Hanover and he used to work on the audit.  He said the family is highly disfunctional and had a "Helmsley" complex in a blue-collar company.  One portion of the business that has done quite well is the Synder snack foods which was seperated from Hanover in one of the family feuds.  He also had done quite a few ESOPs and said it is quite common for the financial reporting to consolidate the ESOP trust so if you look at the financial statements it appears that the shares are not there but the economics of the situation are they are there and they will either get a payout upon sale or their pro-rata share of the merger consideration.  This situation may be unique but I would not rely on the financial reporting to provide you a clear view of what is going on with the shares.

 

Packer

[wknecht]

I talked to one of my partners about Hanover and he used to work on the audit.  He said the family is highly disfunctional and had a "Helmsley" complex in a blue-collar company.  One portion of the business that has done quite well is the Synder snack foods which was seperated from Hanover in one of the family feuds.  He also had done quite a few ESOPs and said it is quite common for the financial reporting to consolidate the ESOP trust so if you look at the financial statements it appears that the shares are not there but the economics of the situation are they are there and they will either get a payout upon sale or their pro-rata share of the merger consideration.  This situation may be unique but I would not rely on the financial reporting to provide you a clear view of what is going on with the shares.

 

Packer

Does he know why clean opinions were given? Audit partner had a different view?

[Packer16]

Clean opinions were given becasue that is what the GAAP rules are not what is economically happening in the allocation of potential proceeds.  This happens in certain areas other areas of accounting.

 

Packer