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Tight Knit

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It’s unlikely that investors would imagine the U.S. textiles industry as fertile ground for potential opportunity. Which is exactly why North Carolina synthetic-yarn producer Unifi Inc. may be worth trying on for size.

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Green Shoots Rising

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Unifi Shares Worth $38.72, Trading at a 39% Discount

We like to go into the fields before sunrise. Carry a little lantern and spade, poke around for green shoots while others are fast asleep…

One of our recent discoveries is Unifi, Inc. Founded in 1971 as a publicly-traded company (NYSE: UFI), it became the dominant synthetic yarn producer in the U.S. by the 1980s, forming the backbone of the now long-forgotten U.S. synthetic textiles industry. By 1992, the company was generating $1.3 billion in annual sales.

Everything looked pretty good. Consumer spending was on the rise. And synthetic goods were overtaking those made from natural fibers. Riding those secular tailwinds, Unifi continued to innovate and prosper. By 1997, revenues had surpassed $1.7 billion.

Then someone moved the company’s cheese. The devaluation of the Chinese Yuan in 1997 – followed by other Asian currencies – set off a series of devastating ripple effects on the U.S. textiles industry, making easy pickings for new low-cost Chinese (and other Asian) producers. Yarn production flew offshore almost overnight. By 2002, Unifi’s revenues had plunged below $1 billion. The pain persisted. In 2005, the World Trade Organization abolished global textile quotas, adding insult to injury. By 2007, revenues had fallen below the $700 million mark, a level not consistently seen since the 1980s. To make matters worse, Unifi’s gross margins had collapsed from the high teens into single digits. Yarn had become an Asian commodity.

Detroit Lions quarterback Matthew Stafford and other NFL players recently sported green jerseys made from Repreve fiber.
Detroit Lions quarterback Matthew Stafford and other NFL players recently sported green jerseys made from Unifi’s Repreve fiber.

Arguably it should have been “lights out” at Unifi.  Not so fast. Unifi took a stand. The board (seasoned industry leaders and notable investor Ken Langone) recruited a new CEO, Bill Jasper in 2007. Under Bill’s leadership, the Unifi team was focused and persistent. First, they stabilized the company through rigorous cost control, process management and a focus on the growing Central American region. They then found ways to adapt and innovate. To plant seeds. To once again dream big dreams.

Drawing on decades of expertise, Unifi found opportunity through innovation – the creation of a new product line of clearly differentiated yarns. Those new products – known as PVA products (premium value added yarns) – improved the company’s cash flow and margins.  PVA products are important to consumers because they can be utilized in unique ways to improve comfort, appearance, support, durability, sustainability, and more.

Unifi’s most important PVA product is the branded yarn Repreve, a polyester yarn produced from recycled plastic bottles and post-industrial plastic waste. Think pure sustainability. Repreve has been a significant contributor to PVA product growth over the last six years. It’s done so well that Unifi is banking on it vertically, spending $85 million to expand its Repreve manufacturing capabilities and backward integrate into recycling and used plastic bottle processing. Once complete, Unifi will have one of the most advanced recycling facilities in the world. This will create exciting supply chain efficiencies. Most importantly, it will strengthen Unifi’s competitive advantage.

As of the most recent quarter, PVA sales accounted for 33% of revenues, compared to only 16% back in 2009. And momentum is on their side, driven by increasing adoption by consumer powerhouses, including Ford, Nike, NorthFace, Patagonia and Target. Unifi’s PVAs have clearly “crossed the chasm” and are beginning to gain mass-market acceptance. Although the company does not break out PVA gross margins, we estimate they command 3-4x those of commodity yarns.

As a result, PVA sales are steadily driving increases in cash flow, which will only accelerate once Unifi completes its heightened fiscal (June 30 FYE) ’16 and ’17 capital expenditures. Based upon our projections, Unifi’s free cash flow should more than double to $2.60 per share in ‘17 and rise again by around 37% to $3.55 per share in ‘18. Green shoots rising. Table 1 below summarizes our view.

Unifi

Note that our projections assume 10% EBITDA growth rates in fiscal ’17 and ’18, which we believe reflects a relatively low achievement bar once the Repreve expansion has been completed. Mid-to-high teen growth rates should be achievable as the demand for PVA products increases and Unifi gains more operating leverage through supply chain efficiencies.

As Table 2 below shows, a 10x multiple of ’16 projected EBITDA results in an enterprise value of $675 million and equity value of $555 million, or $29.78 per share. The current share price of $23.50 represents a 21% discount to value.

Unifi

Arguably, it looks compelling, but in today’s volatile markets, you might think better buys could be found, until you realize you’ve missed something.  That something has a name: Parkdale.  Parkdale is the world’s leading (primarily cotton) yarn spinner. It’s privately owned, well capitalized (we assume zero net debt) and generates around $70 million of EBITDA on revenues of $850 million. Unifi just happens to own 34% of Parkdale.

As Table 3 below shows, we value Unifi’s interest at $8.94 per Unifi share, based on a 7x EBITDA multiple, after applying a 30% liquidity haircut, despite the fact that Parkdale is a larger company.

Unifi

Table 4 on the following page displays the combined equity values of Unifi and its interest in Parkdale – $38.72 per share. By that measure, Unifi’s shares are currently trading at a 39% discount. Now that’s a bargain!

Unifi

And who knows, Unifi might one day monetize their stake in Parkdale. Unifi’s ownership is carried on the books at around $110 million and, in our opinion, clearly is worth more than $150 million. If Unifi were to sell its stake, it could use the cash to do lots of things: pay down debt, accelerate strategic initiatives and so forth. That could be an interesting turn of events.

And there’s even more value to unpack north of $38.72 per share. Three identifiable catalysts (more green shoots) could significantly increase Unifi’s shareholder value above our estimate.

  • The Grass. Years ago, Unifi bought a 60% stake in a company which has the licensing rights to a biomass plant, the Freedom Giant Miscanthus (let’s call it “Grass” just for kicks). As it turns out, the Grass has lots of uses such as poultry bedding, biopower, and perhaps even biofuels. Nowadays, they are selling all the Grass they can grow into the poultry industry. And they also have a contract to provide the feed to the University of Iowa’s biopower generation project. The licensing rights could be worth a fortune.
  • Survival of the fittest, Brazilian style. Unifi is a major player in the Brazilian textile industry. Brazil has become an economic mess, which has amplified competitive pressures and forced many smaller textiles players out of business. Unifi, in contrast, has been able to use its market leadership position to strengthen its competitive position. The Brazilian economy will eventually reverse course. Once that begins to happen, Unifi will be standing tall, driving significant increases in revenues and profitability.
  • Spinning yarn into brand demand. Today, Unifi is underfollowed and valued merely as a synthetic yarn producer. However, the Company is rapidly gaining brand awareness for sustainability and innovation, especially among millennials. As PVA products continue to gain popularity, Unifi’s growth and profitability should accelerate. As this unfolds, Unifi should attract broader equity coverage, rising demand from investors, and likely, a sustainably higher multiple.

With these catalysts in place, one could easily see Unifi’s share price accelerating beyond the $50 mark within the next few years.

The eastern skyline is beginning to warm with light as we make our way back in from the fields. We found lots of green shoots rising at Unifi. And we can’t wait for the masses to wake up and discover what we stumbled upon in the wee hours.

A Winnebago Moment?

Ever hear a star athlete – think Federer – refer to being “in the moment.” A mysterious mental state of calmness, clarity and conviction. Unless you’ve been there before, it might sound like a lot of hocus-pocus. But when you watch them perform, again and again – in that moment, at that almost superhuman, Zen-like level of play – the Federers of the world can smash our notions of what’s possible.

It’s not possible to sniff out “the moment” like it’s a cookie baking in the oven. It’s not possible to force it to happen, or even beat it into submission.

But when it happens, anything’s possible.

Now turn to the world of investing. Everyone is searching for an edge. Anywhere, even for just a nanosecond. Through speed, discovery, scale, cleverness, or simple brute force (yes, bullies often prosper). Or with good old-fashioned wealth, power and influence.

But one could argue that the power of recognizing and harnessing the moment – and the discipline to avoid other temptations – is superior to any of these other advantages when grounded in careful fundamental analysis. In fact, it’s an unbeatable pathway to success, regardless of strategy, asset class or market cycle. And it absolutely confounds the competition.

In the moment, it’s possible to turn a losing tennis game around. In the moment, it’s possible to find opportunity in chaos – to put the pieces of a scattered puzzle together to form a meaningful mosaic. To crystallize the future.

How can you tell if you’re in the moment? Simple. You’ll know when you’re there. Otherwise, you’re not. Just be ready to take action when you are. A good friend often said his definition of luck was the intersection of preparation and opportunity. He was always prepared, patiently awaiting the moment to pounce.

Here’s an example of a recent moment when everything came together:

All alone in the little-known town of Forest City, Iowa, sits one of the world’s most iconic brands – Winnebago. Inarguably a household name (see, I haven’t even told you what the company does). A rock-solid balance sheet. Spot-on product innovation for decades. A winning culture. Solid bench strength and governance. Durable distribution channels. Cash flows on the rise. A clear leader in a growth market (the cycle is nowhere close to topping). Favorable demographics and secular trends. But its stock is down 12% this year, and way off its 52-week high. Now trading at 7.2x cash flow and 2.5x tangible book value (46% and 24% below the respective 10-year averages). And getting cheaper thus more interesting every day.

But then you notice some faint discolorations. The company has exhausted the Forest City labor pool just to keep up with current production, much less grow faster than the industry. And it’s a hard place to attract new workers. The company’s leadership has always risen from within, and had a good track record with it. But on August 6, CEO Randy Potts suddenly retired. Why? Bob Olson (the former CEO) stepped back in (out of retirement) to serve as interim CEO until a permanent replacement could be found. Winnebago clearly has internal talent that could rise to the occasion. Then in early September, Olson announced he would step down as of the 24th, regardless of whether a new CEO had been announced. So what’s really happening out there? Why the rapid changes? Where is this heading?

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Pick your flavor, like ordering a scoop at Baskin Robbins. Major fundamental issues? Highly unlikely. Internal discord? Doubtful. Dissension between the Board and CEO over strategy? Possibly with Potts, far less likely with Olson. Misfiring on crucial acquisition opportunities? Or, more likely, maybe the company is firing on all cylinders, Olson’s tour has served its purpose and all that’s required is a little patience. And so on.

Until you have a moment – see it from a different angle – and a mosaic comes into focus:

Winnebago is arguably an underutilized asset – the company can’t really grow without access to more resources (labor). And because it’s in the middle of Iowa and cannot grow, it’s really hard to attract a seasoned CEO from the outside. Granted, an internal candidate could surface, but that seems less likely with each passing day. And a strategic shift appears necessary – most of the natural skilled resources are over in places like Elkhart, Indiana, or down in Alabama. So, the company appears to be stuck, at least temporarily.

Then imagine this conundrum triggers the board (very good, smart folks) to review broader “strategic alternatives.” And in due course, some equally smart PE (private equity) firm takes a look and thinks it sees a new winning strategy for the company. The PE firm has their own “moment,” which goes something like this:

Buy an iconic brand at a reasonable price. Put in a turnaround CEO (possibly a former McKinsey star) to outsource production, tighten up overhead and get the growth engine ginned back up. Set the stage to “unlock the value,” one might say. The PE firm could see a clear pathway to double cash flow over the next 3-5 years, and then flip it to a strategic (Berkshire, Thor, Ford, or so on) at maybe a 50% higher multiple? Simple. Just attract a growth multiple to an iconic brand. That means the PE firm could buy it for $100 (in normalized terms) and sell it for a 3x return ($300/$100) in a few years. Not too shabby. We should all be so lucky.

Then the PE firm sees even more potential – zero debt and solid cash flow, which looks great to banks with money to lend. So the PE firm can juice the returns by levering up the investment. Assume half of the initial $100 is borrowed. In simple terms, the expected return goes from 3x to 5x ($250/$50). Still a $200 gain, but on half the invested capital. Granted, this is simple math, but it’s always “better to be generally right than specifically wrong.”

At this stage, the PE firm could be all lathered up. Hubris might have snuck in. The only issue would be price. Care to wager a guess? $28/share?

Then again, it’s just a mosaic, something from a moment of clarity. Or a mirage, maybe from too much creative thinking. Take your pick. Time will tell.

Regardless of the mosaic, the clarity of the moment is undeniable. A great American brand on firm footing in a growth market. Strong management, just momentarily lacking a visionary leader in the top role. And trading at under $20/share, Winnebago is a bargain for investors, a PE firm or strategic acquirer. Unless, however, one’s frontal lobe has been skewered by fears of China’s slowing economy, the U.S. rate environment, the recent VW diesel scandal, or a host of other issues, which are real, but highly unlikely to deter Winnebago’s progress. The downside appears limited, and the upside potential is north of $30 over the next couple of years.

We look forward to seeing how the future unfolds.

“The Art of Disciplined Judgment”

Buy low, sell high. Simple, right? In truth, it takes discipline to do it consistently. Fortunately, Anchor Capital has a simple and effective approach. Take a moment to consider the following illustration:

Price and value are different animals. Price changes daily. Value tends to be relatively stable. The former reflects the market’s perceptions. The latter represents what something is worth. So here is our approach:

  1. Understand value. Most investors glaze over value and rely on broad diversification for protection. In contrast, we invest the time and energy to clearly gauge a company’s value from the bottom up. This way we actually know at which prices to invest and harvest.
  2. Invest with a wide margin of safety and significant upside potential. We continually seek stocks trading at 50% below our estimates of value. Volatility and market inefficiencies create plenty of these opportunities.
  3. Harvest at reasonable gains. We harvest or trim at a 25% gain, take everything off the table at a 50% gain. Although we may leave upside on the table, this mitigates market risk – Newton’s Law is always lurking in the shadows. What about a loss of value? The liquidity of public markets offers us the ability to quickly cut losses and run.

These disciplines reward and protect Anchor Capital’s investors not only from the rise and fall of markets, but our own judgment as well.

“When The Loons Rule The World”

Foreword

This isn’t about what you’re thinking. It’s about what you’re not thinking.

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Start with a definition, a prediction and a little-known fact:

Loon:

1. a large North American bird that eats fish and has a cry like a laugh
2. a silly or foolish person

Prediction:

By 2020, a new sixth species of loon might very well rule the world of communications, enabling billions of people to get online for the first time, thanks to Google X’s Project Loon.

Google is in the early stages of launching hundreds, soon to be thousands, of helium balloons (or “loons”) into the wind currents of the stratosphere, some 65,000 feet above the earth’s surface. These loons are outfitted with communications equipment that will enable online access for all the people below, whether in New Zealand, the Australian Outback or Times Square. This new species will span the globe and become a part of our everyday lives. Fascinating.

Google is in the early stages of helium balloons (or "loons") that will enable online access for all the people below.
Google is in the early stages of helium balloons (or “loons”) that will enable online access for all the people below.

We recently stumbled across a Popular Science interview with Mike Cassidy, leader of Google X’s Project Loon. What kind of technology makes this possible? In his words, “I believe we’re the first to have an altitude-control system that works on a steady basis. The balloons have solar panels for power, GPS so we know exactly where they are, Iridium antennas for communication, and onboard computers to receive commands…”

Whoa, Nellie! Something doesn’t add up. Until you realize you’ve just discovered…

This little-known fact:

He’s referring to Iridium Communications, Inc. Iridium failed as a Motorola satellite project back in the late 1990s. Today, it stands alone as a publicly-traded company under the symbol IRDM. Great management team and governance. Revenues and cash flows are growing. The company is leveraging its position into a growing base of subscribers and partners across numerous commercial and governmental markets. It’s the world’s only commercially-available satellite network with 100% global coverage. And within a few years, Iridium will have replaced its existing satellites with new ones, providing even faster transmission rates and tons of hosted payload space. Payload space for things such as global aviation communications, machine-to-machine interaction and so on.

Yet a quick Google search of the keywords “Google Loon” and “Iridium” returns some 395,000 results, the top 20+ of which portray Iridium as a tired old horse turned out to pasture, compared to Google X’s Project Loon as a rising force of nature. Nobody, other than Cassidy, seems to be talking about the fact that Project Loon’s success is dependent upon Iridium.

So are you thinking like a loon, or are you really thinking? Investors take note:

The space frontier is changing at a faster rate than we have seen in 15 years, driven in part by the insatiable demand for broadband. Consider the following: Cisco claims that mobile broadband connections in the developing world are growing faster than any other area (84% CAGR between 2007 and 2014), but still 3 billion people in the developing world have no access to the internet. Companies have been trying for years to connect these people cost effectively, but traditional methods that are based on equipment on the ground have been too expensive or difficult, so companies have been looking to the sky instead. Google in particular is looking for new customers (just about everyone who has access already is a customer), and has been looking to both the sky and space as a way to reach the whole world. Project Loon is indeed a rising force of nature.

But, alas, balloons rise, drift, and at times need to come back down for maintenance, or shift tack to avoid collisions with random pieces of atmospheric “junk.” Hence, they have to be controlled (as any loon should). Based on the Cassidy interview, that would appear to be where Iridium comes in – command and control. By providing real-time communications for the computers aboard the Loons to be controlled through the Iridium antennas. That would mean Iridium is a key technology partner in Project Loon, which stands in stark contrast to the general market’s perception. But it’s right there in print, and now you know where to find it. Nothing short of a ringing endorsement of Iridium’s value proposition.

Why Iridium? Certainly not the only possible satellite (or ground) solution around. The answer could be glaringly simple: only Iridium has uncompromising coverage of 100% of the world where the winds can blow these balloons, and each of them really needs to be under control at all times for this idea to work.

So let’s not be so quick to dismiss Iridium. After all, Google hasn’t; nor has Facebook, which recently called off plans for building its own satellite constellation once they figured out the real cost. The games are just beginning, and Iridium is a sphinx, not a loon.

We hope you have enjoyed this second in a series of case studies.

“A ‘Concrete’ Example of Value Creation”

Foreword

USCR, or U.S. Concrete, Inc., is a leading U.S. construction materials company based in Euless, Texas. Its common stock is traded on the NASDAQ under the symbol USCR.

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The year was 1996. A seasoned entrepreneur embarked on a national roll-up of ready-mix concrete companies. Fast forward to 2007: Fueled by easy Wall Street financing, USCR was generating over $800M in revenues. But as the tide of economic expansion began to recede, something became painfully clear: the rollup strategy was seriously flawed. There were simply no “cost synergies” to be found. By 2010, the Company’s revenues had shrunk by 43% and it was hemorrhaging cash. Bankruptcy ensued, shareholders were wiped out and the Company was restructured by debt-holders.

In 2011, USCR recruited Bill Sandbrook as the new CEO. His turnaround strategy was sound. He knew that concrete is a local business, and that success would hinge upon:

  • Being #1 in each of its markets
  • Enabling decentralized decision making
  • Cultivating a winning culture

An outstanding CFO (Matt Brown) was recruited. Key operational changes were instituted. The Company shed unprofitable business lines, exited certain markets, and began strengthening its three key geographic markets.

His timing was impeccable. The strategy worked.

By year-end 2013, the Company’s revenues, margins and cash flows had been steadily rising for two years. The Company was growing organically and gaining additional market power by investing free cash flow and a new credit facility into small “tuck-in” and “bolt-on” acquisitions in primary markets. The Company’s share price began to respond positively.

Anchor Cap US Concrete
Word on the street is that USCR’s stock has “plenty of room to run.”

Nonetheless, the equity markets remained unconvinced (or unaware) of the Company’s long-term prospects. It didn’t help that USCR had no sell-side equity coverage.

But when USCR rose to the top of our quantitative screens in January 2014, we took a closer look. We liked what we saw. Financial condition? Solid. Insider ownership? High. Corporate governance? Sound. Attractive markets? Check. Business model? Simple. Intense rivalry? Absolutely. Fundamental value? Rising. Trading at a suppressed multiple? Yes indeed. A mosaic began taking shape.

That’s when our real homework began. Two of our partners had excellent contacts in the concrete industry and one knew the CEO. That quickly led us to on-site meetings with the Company. We completed our initial analysis, met with senior management, shared our findings and formed a solid relationship.

Next step, we toured operations in the Company’s two largest markets – California and Texas. Saw their systems in action. Had lunch with regional managers. Rode around on concrete delivery trucks. Learned more about the competition. And kicked the proverbial tires. What did we learn?

  • USCR was firing on all cylinders
  • The Company had great regional leadership
  • Its bargaining power was increasing
  • Demand was rising in its markets

None of these insights could have been gained without investing time on site. What else? Anchor Capital was apparently the only firm in years to conduct that type of “on the ground” due diligence!

After that initial round of meetings and site visits, we revised our analysis to accurately reflect our evolved understanding of the Company’s potential. Our resulting valuations (cash flow and comparables) showed a company worth at least $45/share, at a time when the stock was trading around $22. We tested our thesis with several analysts and institutional investors, and found no concrete reasons to invalidate our views or assumptions.

And so, after 60 days of intensive homework, we invested 15% of our capital into USCR. Then we began actively managing the investment. We kept in close touch with CEO Bill Sandbrook and CFO Matt Brown. Introduced them to regional concrete leaders we knew well in a strategically attractive market (our own back yard). Shouted the USCR story from the rooftops to sell-side analysts and institutional investors. Went back and toured operations again. And followed all the industry data and trends.

In March 2015, Bill Sandbrook addressed our partners at the Anchor Annual General Meeting. By that time, USCR’s stock was trading in the $33 range. Two equity analysts had initiated coverage with 12-month price targets of $42. By the end of the month, the stock crossed $36. The USCR story was just beginning to garner broader interest with institutional investors; meanwhile, our return on investment was already over 50%.

The Company’s stock price only went up from there. In our opinion, USCR has a bright future under Bill Sandbrook’s leadership. And word on the street (which we don’t doubt) is that USCR’s stock has “plenty of room to run.”

We hope you have enjoyed this first in a series of case studies.

Please contact us if you have any questions.

3105 Glenwood Avenue
Suite 101
Raleigh, NC 27612
Phone: 919.755.0602
Email: info@anchorcap.us

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Copyright © 2018 Anchor Capital. All Rights Reserved. Anchor Capital Management Company, LLC is a North Carolina Limited Liability Company.

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Copyright © 2015 Anchor Capital. All Rights Reserved. Anchor Capital Management Company, LLC is a North Carolina Limited Liability Company.