by Travis Johnson, Stock Gumshoe | September 7, 2012 9:08 pm
I do have a quick teaser unveiling to share with you for today’s Friday File, but I want to start with a look at a stock that I own and that I suggested to the Irregulars several years ago, Sprott Resource Corp. (SCP in Canada, SCPZF on the pink sheets)
Why? Because they just agreed to sell one of their major divisions for more than twice the value it was carrying on their books, and more than I thought it would be worth, and the acquirer’s stock went up as a result … and Sprott Resource Corp shares were relatively unchanged despite anticipating a profit on this one sale that equates to more than 10% of the share price.
Sprott Resource Corp is an investment company, it basically acts like a venture capital firm in the natural resources space, building up and trading companies and trying to buy firms in depressed sectors and sell them when the sector and the stock recovers … and they’re managed by a team from Sprott, Inc., some of the best commodities investors around. They pay Sprott Consulting, which is effectively their corporate head office and management team, the hedge fund standard-ish 2/20 (2% of assets as a management fee each year, 20% of earnings above the benchmark).
And I’ve always valued them using a “sum of the parts” look at their major assets, since they tend to be very concentrated in just a few big investments, so now that they’ve made this deal — which I think is their second most profitable “exit” of an investment, depending on how you count — let’s take a look at how much the company is worth today.
Right now they have two assets that are easy to value — they own 73,971 ounces of gold, which as of today is worth $128.7 million; and they have large holdings in two publicly traded Canadian energy companies that they are combining into one: Westfire Energy and Guide Energy, which, if we assume the deal goes through and we use the price of Westfire today, are together worth $138.13 million at the current share price of $3.88. They couldn’t liquidate those Westfire shares right away at that price, but the company is depressed because of weak natural gas prices and I think the combined group should do well over time. So if we take them at their face value that gets us to a valuation of $267 million. Both Westfire and Guide would, I think, be considered contrarian investments in the energy space by most investors right now and are worth probably less than half as much as they would have been a couple years ago (Westfire was created out of Sprott’s controlled Orion Oil and Gas, which alone was worth well over $200 million on Sprott’s books just a couple years back).
What else do they own? Well, they have substantial stakes in two farming companies — One Earth Farms, which they started and control, and which is becoming the biggest farmer and cattle producer in Canada. One Earth should be an excellent long-term growth story if agricultural inflation continues … and I’d bet that they will be looking to bring One Earth Farms public in an IPO or otherwise unlock the value over the next two or three years — particularly if we hit another stretch of public mania for agriculture investing as we did a couple years ago, when everyone started to fret that the world would starve (in part because of ethanol) and food prices brought social unrest in many countries. They carry the company at a book value of $46 million or so right now, and I think that substantially understates the value but I’ll use it as a base case.
And the other one is a large stake in Union Agriculture Group, a massive Uruguayan farming operation that’s been rolling up smaller farms in that country — they missed their window for an IPO back when George Soros and everyone else was talking up Agriculture over the last couple years, but they’re still looking to go public when the market’s ready for them. UAG is carried at the price of their last financing of $13.44, which is the low end of where the company was hoping to go public last Summer before they pulled back. I’ll discount that to be $10 a share instead just because I haven’t heard any chatter at all about UAG getting that IPO restarted, but I think that’s probably a low number — at $10 SRC’s stake is worth $34 million. So that’s $80 million from their two major farming investments, which brings our total value now up to $347 million.
Sprott also just started a drilling company, trying to capitalize on demand for high-spec shale drilling rigs in North America — they value it at $48.8 million, which is slightly less than the $50 million they put into the company earlier this year and is probably reasonable, Independent Contract Drilling will start generating meaningful revenue now with their second and third rigs starting up operations this quarter but I assume that it will take more than that to make them profitable, but they do have a good start-up investment now and plan to have 25 rigs by the end of next year and 40 by the end of 2013. At that valuation, we’re up to just under $396 million in asset value.
They have a handful of smaller investments, including a stake in Stonegate Agricom, a company they’ve already generated large capital returns from as they took it public and gradually selled down their holding, a small oil and gas junior called One Earth Oil and Gas, which is drilling but tiny and unprofitable, and holdings in Potash Ridge and VA Uranium. All told, these are carried on Sprott’s books at adjusted book value or “last financing” value or some similar estimate, and Sprotte gives them a combined value of about $55 million. I think that valuation is actually reasonable, and they’ve certainly booked impairments on some of these and larger investments that have declined in value, but I’m going to discount it by 25% just because these are either tiny or early or more speculative investments — so we’ll call it $41 million. Which brings us to $437 million.
And the current market cap of Sprott Resource Corp is $439 million. So I think we can argue that it’s reasonable to own the shares here, certainly, and based on that and the quality of their performance over the years I’d actually say that I think it’s an easy buy here if you’re a long term investor — but we haven’t gotten to the interesting news that made me take another look at Sprott. Their last major investment that I haven’t mentioned thus far is Waseca, a heavy oil producer in Saskatchewan … and they just agreed to sell it.
Waseca had been in a “looking for solutions” phase for quite a while, with Sprott thinking it was time to monetize the investment to unlock some of the money they had put into it over the years. No news came out of that initial search for buyers, but this week they announced that Waseca was being sold to a larger (still small at $500 million) Canadian high-yielding energy company called Twin Butte (TBE in Canada, TBTEF on the pinks). Twin Butte also announced that this and another heavy oil investment would allow them to increase their dividend, so the stock actually rose following the announcement (which is good, because part of the deal is in stock).
Sprott had carried Waseca on their books at $46.2 million, and this deal has them selling it for an enterprise value of $127 million, which is an estimated $99.2 million to Sprott Resource Corp (they owned a bit over 80% of Waseca) — a tremendous return on Sprott’s investment in building the company and financing them through to their current level of production. The deal is about 30% in cash, depending on what shareholders want, and the rest on Twin Butte shares, but it is notable that Twin Butte shares didn’t drop on the news and thereby lower the value of the deal. In the end, Sprott thinks they’ll end up with about 9% of Twin Butte (which pays a dividend of about 7%), and the rest in cash.
Their net cash position is negative, with a margin account and some receivables and farm inventory, I’m going to say that the combined “real” liabilities are probably around $25 million after you net out the cash and the vacillations in the values of their harvest and farm production (One Earth Farms, as a controlled subsidiary, throws all kinds of agricultural complication into their quarterly balance sheets and income statements). So if you combine $99 million in value from Waseca and these liabilities of $25 million, you get to my adjusted asset value for Sprott Resource Corp. of $511 million. At 111 million shares outstanding as of the last quarter (they’ve been buying back shares pretty rapidly, and just authorized buybacks of another eight million or so shares), that’s an asset value per share of $4.60.
There’s clearly some fudging in here, both in guesses about valuation and in currency translation (I didn’t bother converting CAD to USD and back for each asset — the two are too close now to be a major impact), and I did not account for the 20% incentive that Sprott Consulting will earn on their realized profits, but I think I’ve been relatively conservative as long as you’re not looking to trade in and quickly out of the shares. So I think SCP still represents a very good value below that asset value, they bought back shares pretty aggressively when it was lingering just below $4 and it’s now at $4.05 so the downside for long term investors should be quite limited … unless you think that oil, gas, and agricultural products will be worth less in a few years than they are today.
I’d still be comfortable buying SCP up into the $4.25-$4.50 range, this management team has now made three substantial and profitable exits or partial exits from investments and I think that they’re a great group of nimble and contrarian natural resource investors for some commodities exposure in my portfolio .. but my position is already relatively large (it’s in my top five individual stock holdings) so I’m not so overwhelmed with the discount that I feel compelled to add to my Sprott Resource Corp shares. It’s likely that they will trade at a more notable discount to reported book value per share as of their next quarter thanks to the Waseca deal, but fluctuations in the shares of Westfire or other news could also certainly impact their underlying asset value during that time, too.
It is worth noting, if you haven’t already, that — thanks largely to their investments in now-depressed energy companies — Sprott Resource Corp. was also around $4 two years ago and has been almost completely unchanged since Thanksgiving … and, for that matter, the stock almost always trades at at least a small discount to their net asset value, so certainly more hard times for Westfire or a lack of enthusiasm for farm investments could mean the stock stays pretty boring. But in my opinion they’re trading at a discount to assets that are themselves discounted, and it would take some more substantial pain to drive the stock down more than 10% or so … and there’s also a good chance for a rapid rise if energy and agriculture catch our fancy again.
Heck, it’s been flat so long that it might even start to get exciting for technicians if it bumps up by another three or four cents and gets over that 200 day moving average.
And now, on to a quick look at a tease …
Jeff Opdyke of the Sovereign Society has been teasing a stock that he thinks can benefit from the “$2.4 Billion Weil Project,” and he refers to it as the “next fast food giant” … so who’s he talking about?
Well, he’d like to get you to sign up for a subscription to his Global Growth Strategist for the (special discount, naturally) low low price of $697 before he’ll tell you … so, let’s do what we do and undo the hullabaloo.
Here’s how he gets our attention:
“Will The $2.4 Billion ‘Weil Project’ Make This Stock Soar Too?
“One company, known to some as the “millionaire maker”, is quietly rolling out one of the most aggressive projects in its 57-year history of innovation…
“The project will bring cash to nearly every town in the U.S. and 117 countries (and counting) around the globe – and the company running this project has already seen profits jump more than 585%.
“But there’s another little–known stock that could be an even bigger winner as this project moves forward.”
Since I’ve already blathered on for so long about Sprott Resource Corp., I’ll spare you some of the hyperbole and buildup from Opdyke — the short answer is that the “Weil Project” is the massive international facelift that’s being given to almost every McDonald’s, which you’ve probably already noticed if you have any relatively new Mickey D’s around you … the McCafe, the dark wood and glass, the more glam and coffee shop-y look that McDonald’s is using as they rebrand their restaurants.
And yes, McDonald’s is often referred to as the “millionaire maker,” and is widely seen as creating more wealthy people in the US than any other company — that’s because of the rapid increase in value in the franchises owned by their thousands of millionaire franchise owners over the last few decades, though shareholders in McDonald’s have generally done just fine, too … particularly if you happened to buy in a few years back, when the company was in a bit of a rough patch, Supersize Me was making headlines, and folks thought that somehow kids would stop cajoling their parents into buying Happy Meals. Now McDonald’s is widely admired as a dividend grower and a successful rebrander and leading light in fast food again, thanks largely to their store makeovers, their promotion of somewhat healthier fare (though many dispute that), and their big success with new menu items and the big McCafe rollout of fancy and expensive Starbucksian beverages.
There was a good story about this McDonald’s makeover in Fast Company about two years ago, if you’re curious about those details — and yes, the “project” was really given the code name “Switzerland” … and Denis Weil, a McDonald’s executive, led the charge.
But Opdyke is clearly not teasing McDonald’s here (though he does say he still thinks it’s a “good buy”) — and indeed, many folks think it’s gotten quite pricey over the past year and pretty high expectations are still built in, so it might continue to be a very solid investment but it’s unlikely to surprise anyone with a quadrupling in value over the next several years as it did in climbing out of its 2004 trough. So who’s he teasing?
Well, it’s clearly a related company … here’s a bit more of the tease:
“as I’ll show you in just a minute, we think there’s a better way to play the next phase of the project rollout.
“Because, as many as 32,000 project centers worldwide could institute the new project protocols. And if the revenue growth continues as it has in the early testing, then this could create a massive windfall for the company… and for investors who know where to invest.
“The thing is, I believe the biggest gains won’t come from the same company, but from a smaller company that should benefit from the international rollout of the project.”
The tease then goes on to share the potential “triggers” for this pick:
“4 Growth Triggers That Will Practically Force the ‘Next Fast-Food Giant’ To Pour Cash Into Your Pocket ….
“These four triggers are very similar to what you would have found in the U.S. from about 1950 through 2000… the time when the original McDonald’s exploded into a worldwide brand and rewarded investors every step of the way. Turning modest investments into fortunes….
“Growth Trigger #1
“Latin America is expected to be one of the key growth centers of the world over the next decade. What you may not realize is how that affects even the most mundane aspects of life – eating.
“… the fast-food segment in Latin America grew at a 14.5% compound growth rate from 2004 to 2009, according to Euromonitor, which also estimated the fast-food segment in Latin America totaled $35 billion in 2010.
“And growth is projected to accelerate….
“The ‘Next Fast-Food Giant’ has already locked up exclusive rights in more than 20 Latin American and Caribbean countries and territories, from Argentina and Chile to Mexico, Panama and Brazil.”
Hmmm … so, the wording there is enough to make me pretty sure we’ve got the answer to hand already … but let’s sample the rest of the “Triggers” first …
“Growth Trigger #2
“The ‘Next Fast-Food Giant’s’ Philosophy is Part of The Recipe For Success…
“The Chairman of the board … worked directly with two of the biggest names in the food industry – McDonald’s and Coca-Cola. His experience with big brands is a key part of the company’s ability to create and sustain a very strong growth trend.
“The executive management team combined has more than 145 years’ experience with either McDonald’s or Coca-Cola – and the average is 20 years’ experience….
“Growth Trigger #3
“Burgers Are the Fastest Growing Segment of the Fast Food Industry in Latin America….
“… the ‘Next Fast-Food Giant’ already has established a market share larger than its next five competitors combined.
“That makes the barrier to entry high for anyone wanting to compete with this company….
“Growth Trigger #4
“Just the Beginning…
“Based on 2011 sales data, McDonald’s and its more-than 14,000 restaurants owns nearly 17 percent of the limited-service restaurant industry in the United States.
“The ‘Next Fast-Food Giant’ operates less than 1,800 stores, so it’s obvious this company has decades of growth in front of it. But – and this is important – it’s growing with all the advantages listed above… location, a wealth of experienced management, rising consumer demand, etc.
“Even though this is just the beginning for the ‘Next Fast-Food Giant’, it already controls over 10% of its markets, which is actually more than their next five competitors – including Burger King and Subway. And it’s seeing rapid sales growth of as much as 25% a year.”
So … yep, you guessed it, the “next McDonald’s” is … McDonald’s. Only it’s not quite McDonald’s, it’s a master franchise holder — Arcos Dorados (ARCO), the new company, fairly recently IPO’d, that owns the rights to McDonald’s in most of Latin America. Their tally has crossed over 1,800 restaurants now, but just barely, and their management does come from McDonald’s and Coca Cola, and they do have the largest business in their segment in Latin America (though it’s a very fragmented market), and, well, that’s your answer.
And though I haven’t personally owned this one, I did mention them a few weeks ago when I was following up on another South American burger place, Bob’s — I was starting to think that it might make sense to get out of Bobs (it’s actually called Brazil Fast Food, trades over the counter at BOBS), and get into Arcos Dorados, mostly because ARCO has a much bigger and more stable store base with some geographic diversification but the same basic underpinning of “rising lower-middle-class consumer fast food demand” … and, not incidentally, has seen its stock price get clobbered as they have had some growing pains as a newly public company, and some trouble in building the McDonald’s brand South of the Border to have the same allure as it does in much of the rest of the world.
I was curious to see how their earnings would go, and … as they’ve done three of the last four quarters … they missed analyst estimates. The stock actually responded pretty well, briefly spiking on the news as it was “less bad” than the whisper numbers perhaps had suspected, but the stock has since come back down again, getting close to the all-time lows. There are several reasons for the weak stock performance … they’re reporting in a strong dollar but earning in weaker currencies in some countries, the opposite of their pre-IPO environment two or three years ago … their biggest Latin American market, Brazil, has been a challenge for them so far (and you can also throw in other concerns — inflation in both food and labor costs, notably).
They’re still growing revenues nicely, often posting double-digit comparable store sales growth, which is unusually excellent for a restaurateur (or anyone else, really), but expectations were very high that this would be a blockbuster IPO and, well, that’s not how it worked out and investors can be a bit petulant about accepting the “new reality” for a stock that they thought could only go up. The stock went public in early 2011 at around $20 (it was planned to price around $13-15, right where it is now, but immediately went far higher when it actually traded), spiked to $28 about a year ago, and has been dropping ever since.
And it’s still not cheap — not based on earnings, at least. Analysts have been dropping earnings estimates over the last few months, but now expect ARCO to earn 59 cents this year and 78 cents next year, which would mean a “current year” PE of 23 and a forward PE of 17. Pretty high, though reasonable if they really grow earnings by 30% plus (59 cents to 78 cents is pretty remarkable one-year growth of 32%) and can keep growing like that (or even anywhere near that fast) for a few more years.
Which is, of course, the rub — after falling far short of analyst expectations for several quarters no one really has any idea how much money they’re going to make anymore. I still think the big picture makes it worth considering ARCO — if currencies stabilize and Latin America remains a growth market with a rising middle class, then fast food is a logical growth sector, and it’s proven pretty short-sighted to bet against McDonald’s. The concept doesn’t lead the market in every country around the world (like in China, where KFC has been far more successful and aggressive), but they’ve managed to keep growing very well even when their brand wasn’t shining everywhere.
I think it was a wise move by McDonald’s to basically outsource their Latin American growth to a more focused and far smaller company in ARCO, but that doesn’t mean that it will magically “click” and work every time, in every country. It’s a great story and you can see why it has appeal — “miss McDonald’s stock a few years ago? Try McDonald’s, Jr … Latin America in many places is perhaps somewhat comparable to America in the 1960s, so maybe you can get in on the ground floor this time!” American culture is still a huge export, and McDonald’s is a substantial part of that, but that doesn’t mean those “glory days” of “you can buy exactly the same predictable food in every town in your country” are going to catch fire everywhere, or that McDonald’s franchises in Latin America will ever be local hotspots and millionaire-makers the way they were in the US for the second half of the last century. Maybe, and maybe the “makeover” for Mickey D’s that has taken hold in the US will help to boost sales and get ARCO closer to meeting expectations with their new stores … but stories are rarely that clean and predictable.
McDonald’s is a cheap meal here in the US and in many places around the world, but in some places — and Brazil is among them — it’s a pretty expensive luxury, one reason I’m holding on to the lower-price-point Bob’s instead of jumping into beaten down Mickey D’s with both feet right now. ARCO is still a franchisee, despite the fact that it’s also a master franchisor, so they still have to pay a stiff royalty and maintain the standards required by Momma MCD — so part of the plan requires them to find really high quality sub-franchise operators to push that growth plan forward and invest.
So personally I’m … well, I’m still waffling — I am still tempted to sell BOBS and buy ARCO instead, or perhaps to own both, but I haven’t done it. I like the fact that the shares are beaten down but that they clearly still have very high blue-sky potential given the expansion opportunities in their geographic area, and I like the solid dividend of almost two percent. The Motley Fool folks have covered ARCO perhaps more aggressively than anyone else in recent months (many other folks have been ignoring it since the IPO collapsed), and the PEG ratio is certainly very appealing (meaning it trades at a discount to its expected growth rate) … but again, that’s projecting future growth for a company that everyone thinks should grow but that hasn’t quite been able to put that performance together yet.
And that’s all the words in the tank today — we’ll refill and see you next week, have a wonderful weekend!
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