Delta SBD – A recent float with promise and a macro tailwind (DSB)

This is what an underground longwall operation looks like

Whenever I run a value filter it will spit out 50-70 stocks on the ASX which meet my criteria, and most of them are either garbage (easy to bin) or marginal (much more difficult to separate and easy to make a mistake with that costs you lots – VMG looked good at 35c in January despite a quite high debt load, until the belly fell out of their project pipeline and they nearly breached banking covenants.  The share price closed on Friday at 4.5c)

After exhaustive analysis one hopes to find a few companies who have the right metrics in growing industries, with sound management and no major problems.  One example in 2011 is SNL, whose share price has risen 75% along with 5c in dividends.

Delta SBD is a mining services business which specialises in outsourced underground coal mining relocation projects and ongoing operations.  DSB has 3 big things going for it: It’s priced well, It’s generating solid cash, and it has a healthy macro tailwind.  The CEO also owns 1/3 of the company.

This blog is supposed to be about value investing, so I’ll begin with value.

DSB floated at $1.00 in December last year and since then has bounced off a low of 55c to the 70c-75c range.  Based on Friday’s close of 68.5c, the company’s numbers look like this:

Market Cap: $30m

P/E: 6.2

P/Book: 0.62

Debt/Equity: 13%

Giving us a business with moderate debt selling for less than 7 times earnings and 2/3rds book.  So if the underlying business is sound, this stock looks like it has a reasonable margin of safety.  The $8.85m operating cashflow and $3.59m net cashflow is also a nice figure for a company supposedly worth only $30m.

 

As of 30 June 2011, Delta SBD has $9.9M cash, and $6.2m Debt.  In FY11 they earned $4.75m on revenues of $83m and EBITDA of $9.4M.  Cashflow was $3.6m.

The forward looking order book is also positive, with FY12 orders of $98m, FY13 orders of $93m, and FY14 orders of $69m.  With another $348m in the pipeline, you can see why Delta’s committed to another $15m worth of new equipment.

Delta SBD generally works as a Subcontractor to other mine operators working on behalf of end customers like Anglo Coal and Xstrata.  Importantly, the only full outsource job is for Boral: most of the projects Delta engages in are things like secondary support and longwall moves.

Turning to the macro level, despite rumblings in China and India, I am very bullish about both Thermal and Coking Coal this century.  The massive investment currently underway (in Queensland particularly) in new export capacity means that additional mines will be coming online to take advantage of this capacity.   And new projects means more work for Delta.

A new market to soon open up is the Surat Basin (reliant on the Southern Missing Link and 3 separate coal export terminals currently under development around Gladstone) which mainly consists of underground longwall projects, a niche in which Delta has plenty of references.

 

Despite all the good news, it’s important to review the vulnerabilities, and so far I’ve counted three:

Contract expiry: Delta doesn’t have long-term contracts, and all current contracts appear to expire in 2013.  The mine lives are generally 20 years+ and the forward order book is strong, so this is not a great concern.  What would set off alarm bells would be contracts for ongoing work not being re-signed, which would indicate business lost to competitors.

Human Resource: Probably the biggest challenge I see Delta facing is recruiting skilled operators.  Delta aren’t sitting on their hands though, and there is a level of skills transfer between projects.  With things like employee share plans and traineeship alliances in place to drive recruitment and retention, Delta can hopefully keep the right people on board to continue their success.

Plant and Equipment: With plenty of equipment to service new and existing contracts, Delta has some level of vulnerability to equipment obsolescence and redundancy when existing contracts expire.  Delta may also encounter difficulties obtaining the necessary equipment to fulfil future contracts if demand for certain equipment exceeds supply.

 

DSB’s main competition is Mastermyne, another mining services company which while it isn’t selling for the same bargain price, does appear to be a reasonable business based on an initial inspection.  While I’m not currently comfortable buying into DSB I intend to continue researching this industry to increase my knowledge and hopefully avoid a potential “gotcha”.  I’m perfectly fine with a missed opportunity, rather than getting into a hastily-researched mess which results in losses. My background in telecommunications doesn’t translate well into the contract services business, so it’s important that I recognise my limitations.

Colorpak – About as exciting as a trip to the box factory (CKL)

 

You know an industry is boring when its dullness used in a Simpsons episode
You know an industry is boring when its dullness used as a plot device in a Simpsons episode

Colorpak was the first company I ever profiled on this blog, and nearly a year later the share price has barely moved on almost non-existent volume.  You’ll see from my original post that I’m hanging around for the FY12 results which should reflect some success at Colorpak’s integration of the Carter Holt Harvey business.  I couldn’t help noticing that another small packaging business on my radar, Pro-Pac (PPG) was bought out for 45c per share – a 50% premium to their average price around the 30c mark.  I even drafted a post back in May (never published) outlining PPG’s potential.  The company was just emerging from a disastrous 2008 and had a less healthy NPAT margin.  Will the boring and pedestrian Pro-Pac end up being the longer-term winner?

 

Reviewing the FY11 figures shows that revenue is up from $80m to $125m, EBITDA margin has fallen from 18% to 12%, but EBITDA and NPAT have both shown a modest increase, even when accounting for the acquisition costs.  With further integration costs to be realised in FY12, Colorpak won’t really see the light at the end of the tunnel until FY13, when integration costs and other expenses of approx $15m are realised  in FY12.  Given that only 4 months of CHH contribution has been accounted for, we can expect further erosion to group margins in FY12.

 

One of the ways Carter Holt Harvey polluted the rest of the ~$600m packaging market was their low pricing, which is why CKL were able to buy $120m worth of revenue for $5m – the EBITDA of $4m show the narrow margins CHH were operating on.  CKL should show significant improvement to this, and with a presumably more disciplined pricing approach should improve margins over the coming years.

 

You can also read broker reports which Colorpak post on the Investor section of their website.  Both the Merrill Lynch and Pegasus Securities reports have rated CKL for share price appreciation, targeting 89c and 83c respectively (Please note however the bias that any broker covering CKL is likely to be rating it as a buy).  The reports are better used to learn information not normally disclosed through the regular shareholder channels (including industry intelligence).

 

Despite the big costs CKL is facing shorter-term, I’m positive about Colorpak’s longer-term prospects and will continue to hold through to the end of FY13.  Barring share price appreciation to the point of over-valuation, CKL will be another forever stock for me.