It’s been a while since I last discussed a new position. That is mostly due to the fact that I have made few changes. In the past couple of months I have mostly bought a little more of some existing positions and sold a few positions that moved up in price. Things are starting to look more interesting recently with the correction in the Chinese stock market. Some stocks in Hong Kong and Singapore have become a lot cheaper very quickly, but I have not bought anything new there yet.
One market where I have been on somewhat of a buying spree in the last few weeks is Australia. I’m finding a bunch of cheap small caps there and I’ve bought a few. One company that I bought and found very interesting is CMI Limited (ASX:CMI).
CMI Ltd (company website) is a company with a turbulent history. I will not go into too much detail in this post about all the things that have happened at this company over the last decade, but when I had read a few annual reports I was surprised about the number of events and incidents that have occurred. When you glance at the company’s results in this period you’re therefore likely to dismiss it as an investment candidate. However, today CMI is in a very different position than it was in the past. I think the important issues have been resolved and the company is now left with one high quality subsidiary.
For years CMI Ltd was something of a mini-conglomerate. The company had a financial services division that provided chattel finance to consumer and commercial borrowers, there was an engineering division and a subsidiary called TJM that manufactured and sold vehicle accessories for the 4WD and SUV markets. The finance division was sold in 2008. The engineering division was sold to an insider in 2009. In this last transaction the company provided a $17m loan to the insider who defaulted on the loan payments not much later. There were two large impairments a few years ago as it became clear that the company would not receive the repayments. This bad loan is one of the incidents that have affected the company’s financial results in the recent past.
Australian entrepreneur Ray Catelan was a major shareholder of CMI Ltd and was managing director from 2007 until 2011. He owned about 37% of the shares. Mr. Catelan passed away in 2011. Not long after, CMI was sued by an investment fund called Trojan Equity, which had a large holding in the Class A shares of the company. CMI had stopped paying dividends on the Class A shares even though is was required to do so. The management wanted to save cash to fund acquisitions. There was also controversy around a cash gift made by Mr. Catelan to his daughter Leanne that was subsequently used by her to buy a block of shares of CMI. Some discussion about this legal case can be found here. In fiscal 2012 CMI bought back the A shares for $26m.
This background story is a bit complex, but I felt it was important to add to this write-up because Leanne Catelan is today the major shareholder of the company and holds 38% of the shares outstanding. I hope this post will still be easier to understand than a Valeant 10-K.
After CMI got rid of the finance and engineering divisions it still had one other problem child on its hands: TJM. This was TJM’s EBIT from 2010-2014:
Management had been trying for years to turn things around, but it never became a consistent earner for the company, losing money most years. This obscured the profitability of the company’s crown jewel: the electrical division.
I became really interested in CMI recently when I revisited the company and read that they managed to sell TJM to Aeroklas, a subsidiary of a company from Thailand called Eastern Polymer Group for $22.2 million. This was just above the book value of the TJM assets. The sale was completed on March 2, 2015. Given the performance of TJM under CMI’s ownership I think this was a great result for the shareholders.
That means that today CMI Ltd is left with one remaining division CMI Electrical (company website). CMI Electrical specializes in the design and manufacture of flameproof plugs and couplers for underground coal mining plus specialty electrical cables, sourcing and supply of niche electrical cables, high voltage cables and flexible cables. The revenue from this division comes from the mining, industrial and construction sectors. The coal mining products have the best margins, but the revenue split between these three sectors was not mentioned in the reports.
I have an old analyst report that says Minto Industrial Products has a ~70% market share. Coal prices have been falling for a while, coal mining activity has subsequently declined and the industrial and construction sectors have also slowed down. This has had an effect on CMI Electrical’s revenues and profits:
The sale of TJM has left CMI with a very large cash position. Let’s take a look at some financial data as of June 30, 2015:
Current share price: $1.65
Outstanding shares: 34,552,634
Market cap: $57.0m AUD
Book value: $60.6m
Total liabilities: $6.2m
Goodwill & Intangibles: $9.2m
Net income: $5.5m
Adjusted net income: $4.3m
Adjusted P/E: 13.3x
P/E excl. excess cash: 8.1x
I have made a few adjustments to the reported net income. I excluded the recovery of the impaired CMI Industrial loan ($0.87m), I’m not sure if the gain on disposal of TJM ($0.47m) is already excluded from the “Profit from continuing operations”, I think they are. My math skills are very limited in any case so I might have made a few mistakes.
The company does not look very cheap when you see an adjusted P/E of 13 and the stock selling just marginally below book value. But there are two things that are important to consider:
- At least $22.2m of the cash can be considered excess
- The current operating environment, specifically the low coal prices and decreased mining activity
After the sale of TJM the company mentioned that it was looking for suitable acquisitions that were complementary to the CMI Electrical division. In the latest annual report the current chairman Mr. Buckley mentioned that the company has not succeeded yet in finding an acquisition candidate and that CMI is now considering returning the proceeds of the TJM sale to shareholders:
“The Board notes that suitable acquisitions with synergies with the existing business have as yet not been identified and as a result the Board is considering the potential of a capital return of up to $22.2m (the proceeds from the TJM sale). The Board is seeking a tax ruling in this regard.”
So I think at least $22.2m of the current cash balance of $34.2m can be considered excess. When we exclude this amount from the current market cap it means we are paying just $34.8m for the remaining business that generated adjusted net income of $4.3m in fiscal 2015: an adjusted P/E of only 8.1x.
What is a normal operating environment?
I’m not a coal mining expert and know little about economic cycles in general. I do know that the current operating environment in Australia and other countries that rely on mining and natural resources is very depressed. At some point things will probably pick up a little, even though it will probably not be anywhere near the levels seen when the Chinese economy was booming. CMI Electrical’s EBIT was north of $20m in 2012, in 2015 it was $8.1m. It is impossible for me to say whether the bottom has been reached.
Business does appear to have stabilized somewhat. Another quote from Mr. Buckley in the latest annual report:
“Lack of capital investment in new coal projects has continued to impact sales from the division’s mining product range. This has been compounded by a lack of new infrastructure projects which has kept revenue from the building and construction product range down. Overall revenues are 12% down but activity levels have been consistent with the second half of 2014FY indicating that sales activity has not decreased further in the course of 2015FY.
Noting that revenue has stabilised, the Board’s view is that the outlook for the business in the medium term remains positive, with an expected improvement in the market over the next couple of years. Revenue from new initiatives including Flameproof and some new product distribution opportunities will begin to flow during the 2016FY. The Board continues to look for more synergistic acquisitions and organic opportunities to grow this division.”
I think CMI is a nice vehicle for investing in a mining recovery. The upside is much less dramatic than investing in some of the companies directly involved in the field, but your downside protection is much stronger with CMI. CMI has more than half its market cap in cash, no debt and a business that is pretty lean in terms of working capital requirements and capital expenditures.
I don’t know what the operating environment for CMI Electrical will look like a few years from now, but I do think it is likely to be better than today. Meanwhile CMI will pay a nice dividend if it can: the company has just declared a $0.06 dividend with a record date of September 4, 2015 and a payable date of September 18. The fact that the company is willing to return cash is positive on two levels. It gives an indication that minority shareholders will be treated fairly, something I was a bit doubtful about after reading about the lawsuit by Trojan Equity and the purchase of a block of shares by Leanne Catelan. It is also something of a vote of confidence by the management about the near term future of the business: if they were worried about revenues dropping strongly from here and the company losing money, they would probably hold on to all the cash. Instead they are considering returning a substantial part of it.
I have not discussed the historical results of CMI Electrical in this post much. The older annual reports do show segmental information of TJM and CMI Electrical in the footnotes. It shows quite clearly that CMI Electrical was by far the better business and that their capital expenditures have been quite low: in 2014 and 2013 just $800k and $443k respectively (page 67 of the 2014 AR). I do think you should add some capitalized product development expense to this amount, but I think that total capex will not be more than $1m – $1.5m per year on average. The electrical business looks to be very cash generative. In a business environment that is less depressed and without the anchor of TJM dragging down the results the quality of CMI’s current business should become clearer in future reports.
Edit Sept. 3: Just found a few old write-ups of CMI Ltd on VIC that provide much more detail about their mining products:
- Dec. 2008: http://valueinvestorsclub.com/idea/CMI_Limited/3531
- Mar. 2013: http://valueinvestorsclub.com/idea/CMI_Ltd/92085
Disclosure: long CMI Ltd (ASX:CMI)