Wednesday, December 5, 2007

I may be the "greater fool" sellers are waiting for

This position started as a hedge to my MLM puts. The thought process was that if construction materials rallied and my puts lost value, then the RMIX position gains would minimize my pain. Luckily I did well on MLM and didn’t need the hedge. But, I fell in love with this little company and it has been a rocky relationship. The stock has dropped steadily and now resides at about $3.50, down considerably from where I entered the position. I’ve averaged down some, but those purchases are also underwater.

I think this company is too cheap. I don’t think it is a world class outfit and it doesn’t have a pristine balance sheet. Earnings have ben erratic and a significant portion of its business is tied to residential construction. It won’t dramatically improve margins and growth next quarter, or the one after. But it has been hammered worse than homebuilders!
So why do I like this little company and stay with a losing position? I ask myself the same question every day it retreats. It’s time to put the reasons to paper again and see if they still are valid.

First, I recognize that they are consolidators and as such have lots of goodwill on the balance sheet and around half of their capitalization is long term debt. So far I think they have done okay with their purchases. The last two have been bought for 1Xs and that isn’t astronomical. In the process they’ve bought market leading positions in the Bay Area of Ca, Sacramento, Detroit, West Texas, Dallas, and New Jersey.If add-on acquisitions are worth 1 X sales, then market leading positions have much more value.

They will make $.35 for 2007 and analysts say $.41 next year. So they make money, but not tons. They do throw off decent cashflow. Free cashflow after capital expenditures and debt service will be $20MM per the CFO. That means that as the debt has been serviced, the $140MM market cap earned $20MM and all the equipment was maintained. That 14% return looks good to me. They can control their cap-ex since they don’t need to replace as many trucks if they aren’t delivering as much concrete, so sell more and buy more mixers or sell less and you don’t wear out the fleet.

As I said, RMIX has bought two companies recently at one times sales. You can buy US Concrete today for about 1/2 sales. You won’t be able to, but the market has priced the stock that way. Take the value up to the $850MM sales volume and you need a stock price of near $10. An acquirer would get market leading positions in 6 markets, an up-to-date plant and equipment, and be able to get a market cap boost of their own stock since VMC, MLM, CX, CRH all are valued at much higher than 1 X sales. I like $10 much better than $3.50!
Finally, the CFO recently bought 15,000 shares with his own money and I’ve listened to him on presentations and he seems very competent.

Since the company is connected to homebuilding, it could continue to decline along with housing headline risk, but there isn’t a whole lot of downside left and if I have concluded correctly there is much more upside. I plan to continue to add to my position.

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