Higher margin business masked by legacy business

So just a quick overview on UNIFI. UNIFI is the maker of REPREVE, fiber/textile manufacturer with operations in North/Central/South America and Asia. North comprises the United States, Central comprises El Salvador, South America comprises Colombia and Brazil. These are consolidated as The Americas, Brazil, and the other is Asia. The past few years they have been hit hard. Revenues down from all-time highs from 2022 with revenues up as much as $800m. Now revenues latest FY was around $650m. A big contributor to this was super high inventory level at the retail level in apparel which is their main sales channel coupled with increased imported goods into the Americas and Brazil which has been a big contributor to the decrease in margins in the past 2 years. The lower volume, specifically in America, caused weak fixed cost absorption as they are asset heavy in this region. Volume is a key driver for this investment.

Why the investment will yield a positive return.

The company is priced very low due to the weak economic environment in a commoditized industry. What people fail to realize is the upside the company has in leveraging their REPREVE brand to enter new markets beyond apparel. First off, as consumers become more conscious of the impact apparel has on greenhouse emissions and the overall health of the planet, demand for REPREVE is going to keep increasing as the years go by. It’s a matter of time for consumers to be educated on this topic and brands are forced by regulations and consumer demand for recycled products. Repreve has an extensive brand reputation and sophisticated tracking system that serves as an advantage for their brand partners. Their brand partners will benefit from REPREVE by having a certificated and trackable fabric that eases the consumers mind on its authenticity. Second of all, REPREVE is able to expand into new markets, “beyond apparel”, which is margin accretive and orders and interest are starting to come in FY24. Demand for REPREVE will always be there, it’s just a matter of time recycled products become the norm. Repreve is a higher margin business and it still has not penetrated the Brazil market. Plenty of upside in Brazil with the adoption of REPREVE. Local advertising is taking place to increase awareness of REPREVE fibers.

Inventory levels looks like it has bottomed and is set for a rise as retailers will start purchasing again in the next calendar year 2024. However, I do expect retailers to purchase more slowly as they made big mistakes with inventory management the last few years due to supply chain issues. They saw they overstocked, and it became a big problem paired with weak consumer spending and created huge drags on cash flows for them. I see that easing in the near future based on management’s comments and industry trends. 

Americas set for an uptick in volumes

Biggest competitor in the US exited the market, leaving UNIFI with the majority of the business left. Around $30m worth of business they are confident they will capture. This should improve volumes and fixed cost absorption in the Americas and be margin accretive coupled with general increase in demand from decreased inventory levels and resuming of inventory purchases. Volume is extra important for the Americas as its asset base is very heavy and needs increased volume to absorb all this overhead. The last 2 years the Americas had negative gross margin due to weak volume caused by dumping of imports. 

Last quarter, Q1 2024, Americas operations posted negative gross margins not due to volumes, but due to lower selling prices caused by lower input costs coupled with increased imports. Now with increased volume from business revamp and the capture of market share, they should be able to pump those margins back up by year end. 

Brazil Operations

Brazil is one of their segment/geographies with the most potential for growth excluding Asia. The thing with Brazil is that a small number of sales are REPREVE, so REPREVE has not penetrated that market and Brazil has higher margins without the REPREVE mix. They are getting REPREVE out there, advertising it to gain traction in that area as it is a growing segment and REPREVE would expand margins even further. Plus, investments in equipment have been made for efficiency and cost savings so that should drive margins even further there. The roll out of REPREVE in Brazil will be a part of the growth story of the company and part of the margin accretion as well.

In Brazil, volume remained strong with 90%+ capacity utilization in Q1 24. However, sales decreased due to extreme competitive pricing caused by dumping imports from China which caused the Brazil segment to lower its prices and cause revenue decrease. Margins suffered greatly as well. As the Asian market improves, they see imports from China in Brazil decreasing which should help Brazil operations improve margins and grow revenues. 

Asia Operations

The Asian operations are different from the other geographies. This one operates on an asset light model which has benefited them greatly as they don’t have to rely on volumes to absorb fixed costs and margins are relatively stable when sales decrease. This is a big part of the REPREVE business as they sell their recycled products to manufacturers that manufacture for these big brands all over the world. The growth of the Asian market is essential for UNIFI’s growth, they have been experiencing increased interest in REPREVE and their “textile take back” program. Management have said that they plan to copy the Asia operations business model and apply them to other markets like in Europe, India, and Africa.

In Asia, Q1 volumes were significantly down, the Chinese economy has been weak and most of the REPREVE sales demand is from Asia. However, margins were able to increase due to increase in prices.

Capital Allocation

Capital spending has been paused due to an uncertain economy which I think was smart from management. Why invest in growth when there is no growth, and it is very foggy looking forward because no one can predict when the economy will improve. They also focused on working capital management and cost control, implementing activity-based costing to find true unit costs. These initiatives generated positive cash flows in the last quarter during a really tough environment. So props to them. They also have $38m remaining on their share repurchase program, however they should prioritize debt service, especially in this environment. But the buyback program should be a catalyst in the long term as right now that buyback program if executed would remove 34% of the shares outstandings. That is a significant reduction, especially for a business of this size.

One of the board of directors, Kenneth Langone, increased his position in the company from 10% to 13% in December. He was the co-founder of Home Depot. The board of directors is also composed of very good businessmen. The former CEO of PepsiCo is on the board of directors.

In conclusion, you are buying this stock at a market cap of $113m, at cyclical lows when no one is watching it due to negative earnings while the environment is improving coupled with a good business inside of its ecosystem that will help the company move into a higher margin norm as volume on that business increases. Also worth reemphasizing, they were able to generate positive cash flows in horrible operating conditions. It also has downside protection with it trading at 40% of tangible book value, so margin of safety is very wide.

Disclaimer: This is not investment advice

A deep value play

Overview

Sigmatron International (SGMA) is a tiny $19m company. It is an EMS company that is being priced as if it was going bankrupt. SGMA has been beaten down lately due to interest rates rising, wiping profits and also due to a significant loss on the WAGZ investment that pointed to bad capital allocation from management. For the ones that dont know about WAGZ, it is a pet tech company the company acquired for around $23m issuing stock and debt to fund them. WAGZ did not even have $500k in revenue but somehow management found it attractive? That is the worst capital allocation and value destructive transaction I have seen in a while. Long story short, 2 years later they defaulted on their debt and the creditors told them that the default could be waived IF they sold WAGZ. So they sold WAGZ for $1 to the owner and gave 81% ownership and now they only own 19% of WAGZ. They are no longer required to fund WAGZ operations. As a result, they are 100% focused on the core business, EMS.  

Debt

One of the main reasons the stock is trading for so low is due to its rising debt and interest rates. Since 2021, debt has increased from $42m in FY 2021 to a high of $102m in Q3 2023. With this increase in debt comes an increase in interest rates. Now interest rates go for SOFR+Applicable Margin. The TCW Term Loan has an Applicable Margin of 7.5% and the JPM Revolving Facility has an Applicable Margin of 2.5% currently (depends on revolver availability). This is a concerning amount, however, they have been paying down debt principal in FY24. One of the covenants for the TCW loan requires them to pay $250,000 per quarter towards the principal amount and also has to pay 50% of excess cash flow at year end. So its $1m decrease in principal + the 50% of excess cash flow per year. And yes, they generate positive cash flow. However, to my surprise, they have been paying down the JPM which has no requirements on payments and has a lower interest rate. As of Q2 FY 24 ending Oct 31, the company has repaid 13% of debt principal from Q4. I expect the trend to continue as they keep selling off inventory, generating cash to deleverage. Management is focused on reducing inventory for FY24 and inventory will start picking up as backlog builds up for FY25. Another tailwind is the FED announced rate cuts coming in FY24. In my assumptions I still have the SOFR at 5.32% to be conservative. If the FED cuts rates, interest rates (SOFR on debt) will decrease resulting in an increase in profits. I believe debt will decrease the coming quarters at a fast pace and interest will decrease showing the true earnings power of the business.

Competition

The EMS industry is very competitive in nature. The main differentiator I believe it to be scale, as economies of scale and operating leverage are crucial in this industry to provide lower cost solutions to customers and increase profits. Before 2022, the company earned gross margins of 8.5%-9% and operating margins of less than 1.7%. As revenues increased in 2022, gross margins shot up to the 12% range and operating margins shot up to the 6% range, having a real effect on operating profits, making them the highest it’s ever been. After 2022, margins have cooled down but still remain higher than pre 2022 and I believe it will stay that way because they reached economies of scale. As long as they maintain revenues above 2021, assuming SG&A is fixed and COGS will hover around 88%-90%, they will be generating substantial operating income well above pre 2022 levels, and factoring in interest expense decreasing, net margins will also increase. As a reference, KTCC, the closest competitor in market cap ($44.7m), has gross margins FY23 of 8.1% vs 12% for SGMA and operating margins of 2% vs 6% for SGMA. Another thing is that KTCC never reached that economies of scale. Despite tremendous revenue growth comparable with SGMA’s, margins stayed relatively flat. I believe there is no significant difference in services offered between SGMA and KTCC, there is a qualititative factor that separates both of them besides the margins. Return on Invested Capital for SGMA after reaching economies of scale and operating leverage was reached, was 11% vs 3.8% for KTCC. It is also a more efficient collector of accounts receivables as DSO is a around 40 days and KTCC is above 80 days. However, SGMA also has its negatives as any other company in the world. SGMA ‘s inventory days and turnover are not good compared to KTCC. It is a liability for SGMA as the cash generation cycle doubles in time compared to KTCC minus the DSO. SGMA’s inventory turnover averages 2.5x while KTCC averages 3.5x. Days Inventory Outstanding SGMA averages 155 days while KTCC averages 100 days. In general, SGMA is a superior company to KTCC as SGMA yields a higher margin and reached economies of scale and operating leverage, it also trades at half the value of KTCC.

Expansion

Covid initiated a surge in demand in the EMS industry which caused an increase in capital expenditures among the players to expand facilities to be able to meet the demand. While good, they also got the bad, which was supply chain issues due to component shortages. SGMA has a manufacturing footprint in China, Vietnam, Mexico, US, and a procurement office in Taiwan. They expanded every facility investing in equipment to serve the high demand, the investments were very successful. However, due to the high demand there were component shortages that impacted the company’s ability to ship products and that is still going on today and is one of the main issues with the lower revenue growth the past quarters and decrease in operating income as they have had to absorb all the overhead with lower volumes. That problem with the supply chain is subsiding slowly but it is still expected to impact the industry going forward to FY25. 

The China-US trade war has caused customers in the EMS industry to shift manufacturing outside of China into Vietnam, Mexico, and US. Although the company barely commented on this issue because they dont do earnings call, all the competitors are seeing a shift to manufacturing to the US which benefits the industry as it will get more customers and also higher margins. I believe SGMA to be prepared for an increase in demand for US manufacturing as the previous investments in the US facilities blossom. An alternative option to China that customers have is also shifting to Vietnam manufacturing, they commented on this matter on the newsletter in their website, “Certain customers also benefit from VN as an alternative option amid continuing Section 301 Tariffs on Chinese exports by the U.S.”. 

Industry Tailwinds

With rate cuts and consumer confidence gaining traction, a lot of markets the EMS companies serve are seeing tailwinds that will increase demand for EMS.

For example, the auto industry will likely increase production and increase demand for EMS. Now, SGMA is prepared to handle that demand as they expande the Mexico facility and equipments to assemble the PCB more efficiently and cleaner as auto customers are demanding cleaner and more customized PCB. Other companies in the EMS are seeing the same trend. Jabil, one of the biggest players in the EMS industry is seeing an increase in auto projects related to EV specifically. Kimball Electronics (KE) is seeing the same trend. Another market the company is seeing that is improving and getting a lot of demand from is renewables, and KE is seeing that too. As the component shortage eases, it will get easier for EMS companies, especially SGMA to ship out products.

Outlook

SGMA announced Q3 being soft as customers reduce their inventories going into year end and expect demand to pick back up in Q4. They also said they won new business and programs  that will kick in Q1 FY25, and as the supply chain issues eases, I expect margins to gradually increase or stay flat. I do not see them falling further. I also expect debt principal payment at FY24 to total $22.76m, which reduces the debt outstanding from $92m in FY23 to $69.2M in FY24 and interest expense to total around $9.53m, net income of $3.41m. This would mean that the company would trade at 5.68x FY24 earnings (This does not factor in the 50% of excess cf paid towards the TCW loan). 

The company is not being valued properly. Interest rates are masking their true earnings power,  investors are discounting the company due to WAGZ, which created a debt burden for them but are correcting it as 100% of their focus is towards the EMS. They are trading at a 50% discount to its closest competitor that trades at 10.3x earnings. SGMA also trades at 28% of its tangible book value.  Higher ROIC than competitors will differentiate SGMA and outperform in the long term.

A Great Opportunity

Jewett-Cameron (JCTCF) is involved in the business of industrial wood distribution products (Greenwood), pet and fencing (JCC) and seed processing (JCSC, which was shut down recently).  Jewett-Cameron has been a successful growing company in the early 2000s but lately it has been well under the radar and for valid reasons. The company the last 2 years have seen depressed prices on their stock due to Covid 19 and its effects on the business. JCTCF has been struggling with decreasing margins due to increase in costs from supply chain disruptions the past years and therefore the company is carrying inventory at a high cost which is hurting margins as they are selling off their higher cost inventory. As said by management, in Q4 they will likely be done with selling their high cost inventory and margins should be seen improving over the next quarters. 

JCSC was also a drag on JCTCF’s profitability as they were recording loss after loss and making a negative impact on the bottom line of the company. JCSC has recently been shut down due to equipment coming to the end of its useful life and management thought that replacing the equipment will be a low return on their investment as JCSC is a drag for the company. The management is focused on selling remaining inventory at JCSC around $600-800k so  an increase in cash flows could be expected from this liquidation and an increase in profits should be seen over the next few quarters once the operations are completely shut down.“Nearly half of the seed inventory held at the time of the closure announcement has already been sold, as well as some of the equipment, which has exceeded management’s expectations. The end of operations and full closure of the facility is expected to be completed by the end of calendar 2023. 

Also, JCSC has some valuable assets, they own a 105,000 sq ft building in Hillsboro, Oregon. “JCSC owns 11.7 acres of land and 105,000 square feet of buildings in Hillsboro, Oregon. The ultimate disposition of these assets has not been determined and will be evaluated by the Board.” They state they own 11.7 acres of land AND 105,000 sq ft building in Hillsboro, Oregon. However, when we go to the asset section of JCSC, it only states a value of around $740,000. So I believe the building is close to being fully depreciated as the company was acquired back in 2000 for $1.5m. And from research on the properties near Hillsboro, Oregon, we have 2 buildings listed, one building is listed for $989,000 with 7,500 sq ft and the other building is listed for $1.1m at 6,600 sq ft. Now, JCSC building is 15x the size of that and with an avg price of $80 per sq ft, the building is valued at $8.4m. I don’t know how they value the buildings up there but I’m certain that with a conservative price per sq ft of $80, the building is understated in the company’s balance sheet and a sale of it would be huge for the company’s cash position. I do think $80 per sq ft is too low because the other two buildings I mentioned were selling the building at an avg price per sq ft of $137-$150. 

“Management believes there is significant value in the Company’s real estate, as the 2018 Market Value Tax Opinion from Washington County (excluding the Manning property) was $6,804,940 compared to the book value as of May 31, 2019 of $2,520,366.” This was a statement from management in the 10-Q from 2019 on its property book value. 

The company has a lot of tailwinds coming in Q4. JCTCF signed a new sales agreement with a major lumber retailer that will increase revenues and will also provide the company with a more predictable stream. However, this agreement does require the company to have a higher inventory level on their fencing products, so therefore the inventory levels will be higher compared to historical levels, good news as they earn an increase in revenue. They also signed a new exclusive distribution agreement with the SECOS Group in Australia for the distribution of MYECOWORLD products in the US. In Q3 they did a soft rollout, but in Q4 they are making the full product rollout into retail channels and with the agreement comes a minimum sales requirement to maintain exclusivity and that number is $2.8m by March 31, 2024. That should add to sales in the near future.

I expect cash flows to come back to the positive side the next few years now that inflation related costs have come down and higher cost inventory will have gotten rid of in Q4, JCSC will have been shut down so no longer a drag in the company’s profitability, increase in sales due to new sales agreement and distribution agreement and inventory coming back to normalized levels. Capital expenditures are basically non existent so free cash flow will likely equal to operating cash flow and minimal SBC. So owners earnings can be calculated as FCF. Over the past 10 years the company has generated an average FCF of $360k. Now if we limit it to pre 2020, we have avg fcf of $2.1m and the reason why we limit it to pre 2020 is because increasing costs really made an impact in the operations of JCTCF as they had to increase their inventory significantly which was a drag to cash flows and I believe that those years should be excluded because those years are not indicative of future results as they are already past that. However, earnings over the past 10 years are an average of $2.4m.

Lastly, in the near future they should receive a sum of cash from pending legal victory. In 2021 they were being sued by a former distributor for the company and JCTCF was able to win the battle and now are seeking cash from damages and I expect it to be around the $400k area as their SG&A had an increase of around $400k in their income statement due to legal fees so that is my estimate of what they are receiving. I might be way off but that’s something that will add to cash no matter the amount.

However this investment does not come without risk. One of the downsides is their customer concentration. The top 10 customers were responsible for 84% of sales in 2022. So a loss of one of those customers could have a huge blow on the financial conditions of the company. However, that is nothing that they can’t handle because they have been operating with this concentration forever and have dealt in the early 2000s with a loss of a customer that accounted for 30% of its revenues. They were able to offset revenue loss to only 19%.

They also have no product differentiation that sets them apart from competition besides their patented products. They are working into putting another patent in to keep the product well protected.

I believe this company has a sizable discrepancy between value and price. The company has understated assets and strong earnings power, even more now that tailwinds are ahead and no longer headwinds. They are able to generate positive FCF, and have bought back shares in the past so it is a possibility that they resume the buy back program they had. Management is not value destructive as they have shown to shut down operations when they have to and not bleed cash consistently.

*Not Investment Advice*

TableTrac develops and designs Casino Management Systems (CMS) for small-mid sized casino operators around the United States and internationally. They currently have their systems installed in over 265 casinos all around the world. They first had Table Trac which was the system designed for the table games at the casinos, i.e. poker, blackjack, etc. They started expanding their offerings into marketing, analytics, accounting/auditing, security, and became what it is today, CasinoTrac. Their system, as stated above, provides information for management on the table games, slot machines, marketing, accounting/auditing, player reward program/loyalty program, analytics, etc. 

The current CEO of the company founded the company in 1998 and patented the product. The same founder/CEO is the 26% owner of the business.

Thesis

The company is very close to reaching operating leverage and has the upside of being a very high margin business with recurring revenues. The company has substantial upside as when it reaches operating leverage, maintenance revenue will cover all fixed costs and then the profits of the new installments of systems will drop straight to the bottom line and the earnings are going to increase and so will the cash flow. They can also operate their business without the addition of new systems and still break-even. The recession will not kill them as casino operators will have to find ways to cut costs during the economic downturn and TableTrac’s CMS is the cheapest option they will have with similar or better functionalities than other expensive CMS. At today’s price, I believe the company is a bargain and has a promising future on its back that should bring the stock increased attention.

Recurring Revenue/High Margin Business

 TableTrac sells systems. They earn revenue in 3 ways; installing the system, maintenance fees, and licensing fees. They earn RECURRING revenue. They earn monthly maintenance revenue from already installed systems. This is a very high margin business at about 79% gross margin. The recurring revenues are so advantageous in the way that it provides stability. These recurring revenues will also be able to help achieve operating leverage so with any additional system installed profitability can scale in huge amounts. The benefits of recurring revenues also comes with not having to acquire additional customers. The company can almost operate with only receiving the maintenance fees revenue and almost break even with it. It is also easier to forecast revenues and profits in the future if outside forces don’t influence much in operations. 

Cash Cow 

Another reason why this company is top quality is it is not capital intensive. They can grow significantly without having to pour tremendous amounts of capital into the business. I mean, they have averaged $25,007 in capital expenditures the last 5 years. The business is an absolute cash cow and with future growth making that cash flow run, the company at these multiples is a bargain all day. Cash flow generation is essential in a company. It is what keeps the engine running. A negative cash flow business has its days counted, while a cash flow generating business is better every day. If I would buy a business in its entirety it would be a company with the same characteristics as this one; not capital intensive and with the ability to increase its cash flows throughout the years. The company is essentially a cash cow and has yet to reach operating leverage. When it does, the company will be able to generate tons of cash and optimally, return it to shareholders.

Cheapest CMS Provider

 The company offers the cheapest CMS out there in the market. In the 2008 10-K, the management team said this regarding the pricing of their systems “At the same time, Table Trac feels that it can still claim their system’s sales price is “half-price”, compared to Nevada competitors.” I know this is an old 10-K and one would imagine that is not the case anymore, but it is still the case. According to Zippy Research, Seeking Alpha author, he talked with a small casino about TableTrac’s CMS regarding the pricing of its system and they said “ According to the company, the CasinoTrac suite is 30-50% cheaper than the big player alternatives, but offers similar (or better) functionality. In addition, TBTC does not charge for software upgrades. I was able to confirm these assertions after an interview with a director at a small commercial casino.” As a result, in the risk of recession they don’t have to worry about churn rates or losing customers because they are already the low cost provider which is what casino’s need when dollars need to be stretched as far as possible. The only risk they run is basically if their customers go bankrupt. I don’t know the probabilities of that happening but we can get an estimate or a more accurate picture by seeing the trend in bankruptcy during recessions. However, they will likely not lose customers during a recession, but will be harder to gain more customers but easier than other CMS providers as casinos start looking for a more affordable system provider like TableTrac. They have also said this in the past, around 2009, they said a recession might actually benefit them as casinos will start looking to cut down costs and since TableTrac provides a cheap system with similar or better functionality as the most expensive ones, they are able to put their name out there during a recession and gain customers in the recession and coming out of the recession. Plus they don’t charge for upgrades which I think is an advantage and are able to personalize the software to the casino’s needs. According to Zippy Research, a casino operator had to say this about the company’s software customization “ A director at a small commercial casino told me that TBTC “was able to do some very specific things for us that were not available with larger offerings”. He noted that: “Technology, operations, and marketing all have to go hand in hand, and [CasinoTrac was] able to make all of the changes and integrations we required ”. This is an additional advantage TableTrac has over their competitors.

Pristine Balance Sheet

The company has virtually no debt. The reason is they don’t require capital to grow, so issuing debt makes no sense. Going hand in hand, they also don’t have to raise equity due to the fact that they are self-sustaining and don’t need outside resources to operate profitably. Companies like these have huge advantages over companies that don’t, they have huge flexibility and are more likely to perform better than companies with a not-so-flexible balance sheet during an economic downturn. It was seen back in 09’ where they said that they did way better than competitors during that downturn due to the fact that their balance sheet was so strong. They also have the advantage that if they want to issue debt at a lower rate, they will be able to do so because their financial position is so strong. As a result, they have a strong capital structure.

Operating Leverage

I think I have mentioned this point enough but we have to keep emphasizing because of how important it is. We are also going to take a deeper dive into what operating leverage is and how this might affect the company’s profits. Operating leverage occurs when a company’s fixed costs are completely covered and any additional unit sold will drop straight to the bottom line. Operating leverage happens where fixed costs are the majority of the costs such as manufacturing companies. Companies with low operating leverage are those such as retail which contain a lot of variable costs. There are advantages and disadvantages of owning a company with high operating leverage. The advantages are profits are going to rise exponentially as revenue rises during good periods. A disadvantage is when for example, a company is experiencing seasonality, so sales volume is low, they will struggle to cover their fixed costs and profitability will be low. However, in companies with low operating leverage, they barely have fixed costs so they can still be profitable during low volume quarters since they are mostly variable. TableTrac’s main expenses are SG&A, and sure it does increase with sales volume but it doesn’t grow by the same magnitude as sales does. So that is why I consider SG&A to be a fixed cost for TableTrac even though accountants might not agree with me. To support my view, in 2014 SG&A was $2,854,759 and Revenue was $3,478,580. In 2021, SG&A was $3,562,003 and Revenue was $6,966,683. SG&A grew 25% while total Revenues grew 100%.  To put it in perspective, TableTrac in 2014 generated $1,339,829 in maintenance revenue. SG&A was $2,865,759. This brings revenues covering 47% of SG&A (fixed costs). In 2021, TableTrac generated $3,121,283 in maintenance revenue. SG&A was $3,562,003. This brings revenues covering 88% of SG&A (fixed costs), really close to reaching operating leverage and substantially expanding the profit potential. To conclude, the company is very close to achieving operating leverage and once it does every single dime from new installments will drop straight to the bottom line helping the earnings and free cash flow of the company to increase in a substantial and material amount. In addition, the continued installations of new systems will increase maintenance revenue. The company can operate without having to add new systems and still break-even.

OTC & Illiquidity

TableTrac has traded on the OTC market for a long period of time. Buying a company in the OTC has risks. For example, illiquidity is a big risk when you buy a company in the OTC as these tend to be overlooked companies as everyone has their attention on the NASDAQ and NYSE. Let’s say for example you want to enter a position, it will take you a long time to get to your desired allocation since shares are barely traded in the market. It will also affect you when you want to get out, it will take time and it will hurt more when you know you were wrong and are selling at a loss as it will take time and be a slow-painful death. 

Now a positive is, barely any people are watching these companies. No analyst coverage and no institutional ownership. This can cause mispricings in the securities since no one is paying attention to them. You have an advantage among other people since you are finding a bargain in the market earlier than everyone.

Competition

The company unfortunately competes against big players in the Casino industry. Among them, the biggest competitors are Konami, International Game Technology (IGT), Aristocrat Technologies. These players have way more financial resources than Casino Trac and way more customers.

Valuation

At the moment the company trades at the most recent years P/FCF of 6.5 and FCF yield of 15.3%. Best part, they haven’t reached operating leverage still. They only have to generate $400k more in maintenance revenue and it will reach operating leverage. Also, if they are able to make maintenance revenue overpass their fixed costs, its game over. Profitability should skyrocket and so should cash flow generation and what you are buying today for a P/FCF of 6.5 is a steal in every sense of the word. I’m not able to put a definitive fair value on the stock, but what I can tell you is it is very undervalued at today’s price, and should be trading above what it currently is at. No company with these qualities should be trading so low. It is understandable the fear of a recession, but as mentioned above, TableTrac can come out of a recession as a better and improved company relative to competitors if they are able to get their name out there.

Pretty interesting

You are probably tired of me coming in with the same idea. I know it’s tiring but somehow I keep finding these ideas. Props to Twitter. Twitter is actually amazing for finding new investment ideas, but there are also dumb ideas which I’m not going to mention. For example, Tesla. But I’m not going to rant about how overvalued these folks are. Today I bring to you Insignia Systems. Again, deep value + special situation. This is similar to GigaMedia (GIGM) and Allied Esports (AESE). Though, it’s a bit different. The difference is that Insignia has activist investors involved to unlock shareholder value.

Let me give you an intro into what Insignia Systems is. Insignia Systems is an in-store advertising service company that offers advertising services to multiple brands, either big or small to showcase their products at retail locations. Nothing special, just boring. The case is, their main revenue source was the Point of Purchase Services or POPS, which was essentially a big display with signs that were shown before you entered the aisle where the product is in order for you, the consumer, to keep the product in mind when you go through the aisle and essentially make you impulse buy. So they have been discontinuing this segment and focusing more on non-POPS services which are essentially On-Brand services and Merchandising services. Non-POPS revenue has been growing significantly the past year and now into 2022. Last FY if i’m not wrong it grew about 61% vs 2020 and 1Q 2022 it grew 48%. Offsetting this, the POPS segment has been declining significantly and now only contributes to 4% of revenue when it used to contribute 44% of revenue in 2020. 

So that was a small summary of the business. Now into steps taken by management in order to better run operations. Management ran a cost cutting program that reduced their staff by 19%, they moved operations and headquarters into smaller, more efficient buildings saving a lot on lease expenses that essentially dropped to the bottom line. These cost reduction initiatives are expected to bring about $500,000 annually in cost savings which should dramatically improve the company’s overall profitability. In response, the company posted its first profitable quarter after losing millions in operating income every quarter. It seems that the cost reduction program is working and now positively impacting the bottom line.

From a first glance, if you read the company’s balance sheet you won’t find any value. They don’t have enough cash to be a deep value play. That’s when Twitter comes into play, to feed me ideas that a screener does not see. This company just got into a settlement and is being awarded $20m. Keep in mind this company sells for $15m. So you already have more cash than the whole value of the business which is a step in the right direction. In a balance sheet you also won’t find the amount of Net Operating Loss carry forwards (NOLs) they own. The company owns $9.7/share in NOLs or $17.5m. NOLs are a great way to value creation as once the entity becomes profitable, you can reduce substantially the amount of tax you have to pay. This amount of NOL’s make this company a perfect candidate for an acquisition or merger. That is why reading the 10-k is so essential and necessary in order to make sound investment decisions. The company currently has a $4m book value, but when that cash comes in, it will be $24m in book value or Net Current Asset Value (NCAV). 

The company recently announced that they will seek strategic alternatives in order to maximize shareholder value and appointed an investment banking firm to assist them in the process. This is a huge catalyst for the business and shareholders as this is a great way to maximize the value for shareholders.

Another positive is the appointment of an activist investor into the board of directors and now serving as chairman of the board. Nick Swen, CEO of Air T and several investment funds own approximately 50% of the shares outstanding of Insignia Systems. That’s a big amount of control in a company. He knows shareholder value can be unlocked and he is here to do it. The company also announced another activist investor, David E. Lazar announced a 5.1% position in the company. These two people, I believe, will help the company choose the best option possible to maximize shareholder value as they have their own money in it and they depend on the success of the company in order for them to make money for them and their partners.

If a strategic alternative is not found, then a special dividend is likely to be announced as they stated in their 10-K  “We may consider special dividends in the future depending on outcomes of actions such as legal proceedings.”  

In any case, your downside is limited by the amount of cash the company is holding. I always try to focus more on the downside than on the upside, as a company can have a lot of upside, but also a lot of downside. But a company with no downside can only go up or sideways which avoids permanent loss of capital, and that is what we try to avoid in order to get the best returns possible.

Deep Value Investment Opportunity

Allied Esports owns an Esports business that engages in the hosting of in-person and online events to gather around hundreds and thousands of fans and gamers into one place for competition. They previously owned World Poker Tour (WPT). They lease space in their flagship property Hyperx in Las Vegas Stripe. They own TWO 18-Wheeler Trucks, one in Germany and one in the US.

Allied Esports, as stated above, owned WPT. In 2021, they sold it for a total of $106m in cash which was added to their balance sheet. Now the corporate balance sheet stands with $94m in cash and no debt. Essentially, they are a holding company with a business with high cash burn rate. While I’m not here for the Esports business, I am here for the HoldCo which is trading below Net Current Asset Value (NCAV) or below Net Cash Value (NCV). The company previously announced their intent to sell the Op Co for cash and complete a merger or acquisition to maximize shareholder value and grow the company. With the proceeds from the sale of WPT they plan to acquire a well managed company with long term growth potential and use the remaining cash to grow the company. Now, you are protected on the downside since there is a set floor with all the cash the company has but that protection is limited as the operating company has a high cash burn rate. So the thing in question is time. How fast can the company realize a sale of the Op Co? If they sell the Op Co there will not be any more cash burn and they can peacefully look for a possible merger or acquisition that fit their description of value. If no sale is realized quickly, cash burn will continue and will remove the buying power from the holding company for the acquisition and will also dwarf your margin of safety. They can cease the esports operation but they won’t get any money from that as opposed to just selling it. Good news is, there is active discussions with interested potential buyers of the esports business. 

If they sell the business they can also utilize the Net Operating Losses provided which they have about $57m in NOLs and they can offset the gains in the new profitable division of the company and make a huge impact on earnings.

I classify this investment as a special situation, sort of the same as Rubicon Technology which shareholders were offered a Tender Offer from another company to acquire a big stake in the company. Rubicon had the same characteristics, tons of cash, trading below NCAV, and cash burning op co. It went up 66% in one day following the news. Same could happen with AESE which has a greater margin of safety since it has more cash and a larger disparity between price and actual value.

2nd position (small in relativity)

GIGM owns FunTown, an entertainment platform that licenses and develops PC/Mobile games and serves as a social network as well in Taiwan and Hong Kong. People use their platform and communicate with their friends and play together. But I am not here for the operating company, I am here for the assets they own. The best kind of asset. CASH. They are trading disgustingly cheap and I think it is because first, they are a foreign company and US investors do not like to invest in foreign companies because they don’t trust the numbers. But they don’t have to be scared, the company changed their auditors into an international, well respected, and huge firm, KPMG to audit them in order to give confidence to US investors which I think is a great move to spark some trust. Second, they are burning cash. They are unprofitable and they won’t be profitable anytime soon in my opinion unless they start to cut costs aggressively or just grow revenues. Cash burn is a real problem. You have time working against you. The faster you burn cash, the more likely you are to get into trouble. If your cash burn is slow then you can get to think on how to solve the problem or how to enhance shareholder value. Third, they have an investment into a robotics company of $10,000,000. I believe it to be a gamble because they probably don’t have revenues generated yet and are still in the R&D stage. If this investment proves to be unsuccessful, we have $10,000,000 going down the drain.

GigaMedia is selling well below net cash and are also taking steps to gain trust from US investors by making them feel comfortable. They incorporated a US based auditing firm to audit their financials. “The change of auditors to KPMG is part of new management’s initiatives to enhance shareholder value. KPMG is registered with the PCAOB and is subject to periodic inspections by the PCAOB. Our annual audit is performed in compliance with the rules and regulations of the PCAOB, and we have cooperated fully with normal periodic information requests from the U.S. Securities and Exchange Commission (SEC) regarding our SEC filings.”They got rid of VIE’s because of the doubts people had about foreign companies and their accounting practices using the VIE’s which was one of the problems with the Enron scandal. And lastly, in the general meeting, it was voted in favor to allow the company to initiate stock repurchases.

Gigamedia is a dirt cheap company selling for below net cash value and the market should recognize how cheap it is. The company will probably authorize a buyback program since they need to substantially increase the stock price in order for them to not become a Passive Foreign Investment Company (PFIC) which is penalized by paying extra taxes in their country of incorporation, Singapore. If not by share buyback, the market should recognize how disgustingly cheap the company is and realize that they have a lot of years left until they run out of cash. Management is taking the right steps to enhance shareholder value which is rare in a foreign company nowadays.

Investment Opportunity

Taylor Devices designs, manufactures, and sells shock absorbers all around the world, their biggest market being the US. Taylor Devices specializes in various segments which include Industrials, Aerospace/Defense, and Structural. Structural is their biggest one accounting for 58% of sales, followed by Aerospace/Defense with 34% of sales, and then Industrial which is their smallest one.  

Taylor Devices have had contracts with NASA, where their business started. They were included in the NASA hall of fame for the impact they had on space exploration with their damper technology that has helped NASA’s spacecraft to function efficiently and minimize vibration and absorb shocks. They have had record-breaking contracts of $7.5m  to install dampers on the San Francisco Bay Bridge, which was outdated and had to replace previous dampers that were not as efficient as those of Taylor Devices. They also have had previous contracts with California hospitals of $3.2m to install dampers. Basically they are all over the country taking care of structures and saving lives with their technology. They also work internationally, in Japan, a place where seismic activity is prevalent. In Taiwan, China, all the places where seismic activities are prevalent that you can imagine, Taylor Devices will be there. “Mr. Schneider reported seismic sales in the United States are holding steady, while sales are increasing in other areas of the world such as Asia. He explained how new ordinances in California are emerging that could help overall seismic sales for the Company.” So as seismic sales remain slightly growing in the US, they are getting more and more opportunities in Asia and in California in regards to seismic activity. “Mr. Schneider elaborated on new and improved strategies for sales opportunities in the future. For example, Taylor Devices is actively pursuing the news that the Japanese government discovered a Japanese competitor was falsifying test data. This situation could possibly create more opportunities for Taylor Devices. Mr. Schneider then explained how Taylor Devices’ seismic damper design is more robust and consistent in design when compared to the competitor’s design. (2016)”  Taylor Devices will benefit from their brand recognition and trust that they provide to their customers + having a world class testing facility that facilitates the gain of trust from their customers all around the world.

The company has spent a lot of money on commission to outsourced sales representatives that helped them get business contracts, but they have cut their reliance with independent sales representatives by adding staff to their business development and sales team, hence cutting costs.  These types of cost improvements are what is going to shape the company’s future and increase profitability and generate excess free cash flow. Now something to keep in mind, they do spend a lot in research and development and they are increasing the spending to accommodate for future growth in multiple sectors. But on the bright side, usually in the aerospace segment, their customers fund their R&D needs, so we have that going for them.

Now this is not your typical soggy cigar butt. This is a company with history, great technology, and acceptable management. Your typical cigar butt is either burning cash like there is no tomorrow, generating negative free cash flow, unprofitable, CEO salary takes all the profits, or all of their assets are tied up in inventory. Taylor Devices is different. They have a decent business with a small moat, their technology and brand recognition. Most of the things I look up on google about seismic dampers or what not, I always see Taylor Devices involved. They are not burning cash, they are profitable, and generate positive free cash flow with an average of $3.3m over the past 5 years. 44% of their assets are in cash, and during a downturn or a recession, that is what you want in a business. I believe this company to have a pristaline balance sheet with no debt and lots of assets which provide a large margin of safety + it enlarges it with the positive free cash flow it creates.  

The business is not great due to its dependence on the US economy, they have a positive relationship. If the US economic activity is up, the company is going to do great as infrastructure spending is likely to go up and defense spending will always be happening and contracts can be gained during these periods of time. “Mr. Metzger stated that the current administration indicates an increase in defense spending and that Taylor Devices is likely to benefit from the 2019 National Defense Authorization Act for $717 billion that was recently passed by Congress.” As evidence, defense spending was bound to increase in 2019 and management said they would benefit from the $700B being spent.  So as we go to a downturn in the economy, the same can be said. Economic activity will go down which will reduce the spending and ultimately hurt Taylor Devices top line and bottom line. To put it in perspective, the housing crisis that caused a US recession made Taylor Devices decrease sales and lower profits, same with the 1991 recession. The year following the recessions, they have grown revenues and profits subsequently. 

In 2019, the company made a change in management as the CEO, Douglas Taylor, was retiring. Alan R. Klembczyk, President, reported that the change in Management has been smooth and announced some new Company initiatives. These include new research & development efforts, hosting an International Sales Meeting for our representatives around the world, increasing our Lean Manufacturing efforts, initiating cost-savings efforts, establishing a marketing department, and hiring a new Western US Sales Manager.

Taylor Devices is financially sound with a pristaline balance sheet, positive cash flow generation, and profitable. The company has been profitable since inception, it has never lost money except for one year. The company holds 44% of its assets in cash, and only $4.5m in liabilities. The company for the majority of the time has been generating positive free cash flow even when they are very capital intensive, they invest a lot into new technologies and into their facilities.That has certainly paid off. One of my discomforts is that it is very capital intensive. But at least they generate positive FCF. Another thing that discomforts me is that shares outstanding are slowly increasing. That is value destructive and if they do not slow down or create a buy back program, the value will go down with time as they keep issuing.

The company has $21m in cash, $6.6m in receivables, and $6m in inventories. It is worth noting the working capital improvements that they’ve made. In 2019, accounts receivables were at $12m, it is now $6.6m. In 2020 the company had $11m in inventory, they cut that down in more than half. This all contributed to the vast amount of free cash flow they generated in 2021. They run a lean inventory as they don’t have much inventory ready for sale as soon as the customer orders. The company operates on an order to manufacturing basis, meaning that when the customer makes an order and signs a contract, that is when the company starts to manufacture the goods that it is going to provide to cut the risk of the inventory never selling. Taylor Devices only have $4.5m in liabilities. This brings the book value of the company to $41.6m or $10.6/share. The company currently trades at $34m or $8.76/share at the current time of writing. This represents a gap in value of 21%. The company also trades at a 5yr Avg 10x FCF. The company is very well financially and I expect them to keep their financials as they are or improve them over time.

Taylor Devices has a couple of catalysts. One of them being, like any cheap, small cap stock, a buyback program or dividend distribution. This will enhance shareholder value and increase the value of the business. The other one is an acquisition but it’s quite a long shot. An acquisition is unlikely but it is still possible by an engineering firm or some construction company or someone in the defense sector. Another catalyst is to see increasing seismic activity which will shift engineers to demand Taylor Device’s products to protect buildings and what not. We know seismic activity is prevalent in Japan, Taiwan, California, etc. If these locations experience more seismic activity, demand for Taylor’s products will increase and will cause a positive reaction into the top line and bottom line. Going hand in hand, a more strict building code will increase the demand for Taylor’s product as buildings will have to be retrofitted and everyone will be going to Taylor Devices for new and restructured buildings and bridges and what not. As we said earlier, if the economy enters a bull period and starts spending on infrastructure and defense and Taylor Devices is able to attract new contracts for new bridges and buildings, that will drive the price up. And ultimately, which is not really a catalyst but can attribute to price appreciation, is people realizing they are worth much more than what they are worth right now.

This investment is basically a bet on the US economy with the optimistic assumption that the US economy will be able to recover and thrive as it always does and that Taylor Devices will continue to seek opportunities as the US economy regains traction. On the other hand, the stock is cheap. Simple as that. They have no debt, they have tons of cash, selling below tangible book value and are cash flow positive. A large margin of safety is present in this company and if you lose, you won’t lose much. I will wait for the price to go down further as I don’t find the current price as attractive as it would be if it gets lower. I want to expand my margin of safety as much as possible. Don’t get me wrong, it is an attractive investment opportunity, but I want a larger margin of safety.