Blount represents an attractive long at $13.89 with upside potential of roughly 45% to fair value of $20.

The Business

Blount’s business is comprised of the following segments:

FLAG (Forestry, Lawn, and Garden) represents 70% of total sales.  This is their core saw chain and guide bar business.  It’s essentially a duopoly with Stihl so pricing is rational and it has been a 20%+ EBITDA margin business for the past 10 years except 2008/2009 where margins dipped into the high-teens.  Their customer mix here is 60% pro loggers and 40% consumer.  Demand is driven by wear and tear/replacement.  Geographically it breaks up as roughly 30% NA, 35% Europe, 35% rest of world.

FRAG (Farm, Ranch, and Agriculture) represents 28% of total sales:  This a collection of businesses BLT has acquired over the past two years.  65% of this segment is Woods/Tisco which makes attachments (think mowers, backhoes, etc) and replacement parts for agricultural equipment.  The other 35% is SpeeCo which makes log splitters and replacement tractor parts.   Demand is tied to farming activity (literally activity/usage, not farmer income).  90% of this segment’s revenues come from North America.

CCF (Concrete Cutting and Finishing) represents 2% of sales: Too small to talk about but its saw chain that can cut through basically anything.

Thesis

Blount has been left in the dust among a peer group that has been on fire over the past 18 months due to macro pressure in Europe, the drought of 2012 impacting farming activity, and acquisition integration issues.  Not only that, but in February they announced their largest customer, Husqvarna, was going to produce its own saw chain starting in 2015…..what else could go wrong???

The answer is not much.......and the reasons to own Blount from here are:

1)Business in Europe appears to be bottoming

• Their direct to end user business was up 10% in Q1, while there is always a 3-4 month lag management feels this is a leading indicator for their distributors needing to restock inventories
• In 2012 Europe was (11.8%) organically, in Q1 2013 it was (5.5%).  Again, this is a relatively steady replacement business, the dealer channel can only let its inventory get so low….

2)A rebound in US housing starts from the current 900k-1M run rate to a more normalized 1.4-1.5M will be a boon to their North American business

• Pretty self-explanatory, more starts = more lumber = more logging = more saw chain

3)The 2012 drought hurt FRAG, not only has this created an easy comp but 2013 looks great on an absolute basis

• Last year the drought hit yields hard, this meant farmers logged less hours on their tractors and burned through less replacement parts.  The wet and prolonged spring of 2013 has also had a negative impact (a $5M push, as stated on the conference call, this is material for a $60-65M/qtr business)
• However, due to the high grain prices the drought created the USDA is projecting a record planting of 174.4M acres of corn and soybeans.  This will be a big tailwind, especially later in the year.

4)To date management has botched the integration of its FRAG segment acquisitions and as a result it is under-earning in a big way right now.  

• TTM EBITDA margins are roughly 4%, for perspective this is what the businesses looked like when acquired
  • SpeeCo, July 2010—TTM revenues of $77M, EBITDA of $12.5M (16.2% margin)
  • Woods/TISCO, September 2011—TTM revenues $164M, EBITDA $20.3 (12.4% margin)
  • The real culprit was SpeeCo, in 2011/12 they had major issues integrating it into their Kansas City plant which resulted in both incremental spending and lost orders.  They also faced a small product recall in Q4 2012. 
  • Management has guided to this being a $300M+ revenue business with 15% EBITDA margins within 2-3 years

5)FCF is temporarily being depressed by higher than normal capex spend            

• Due the build out of their plant in Fuzhou, China, which started in late 2011 and spending on integration and facilities for the Woods/TISCO/SpeeCo acquisitions capex was elevated in 2012 at $50M.  It will come down to $45M in 2013 and management has stated that it will decline further in 2014.  They have pegged a normalized level at $30-35M ($20M maintenance + $10-15M growth)

A note on Husqvarna

On February 13^th BLT declined almost 18% on the news that their largest customer, Husqvarna, would be building their own saw chain capacity starting in 2015.  They represent 8% (roughly $80M) of total company sales.  While this is definitely bad news the reaction is way overdone and the situation is manageable.  Here are some details around the relationship:

• Of the $80M, only ½ the business is saw chain
• BLT is currently Husqvarna’s sole supplier of saw chain.  They provide them with 38M feet of chain.  The mix is roughly 1/3 Original Equipment (OE) and 2/3 aftermarket.  This is important, because BLT already competes with Husqvarna in aftermarket, sounds dumb, but they sell them chain and then watch Husqvarna fight them with price at retail.  So really they will likely lose the $13M of OE business starting in 2015 and have to compete at retail (like they already are) for the other $37M
• According to management you need 15-20M feet of capacity to scale and break even (so max of ½ the saw chain business with BLT currently), they believe it is going to be very tight to build that out within the next 18 months, and if they do get it done it will be high cost product, so their ability to come in and price aggressively seems limited

A negative, but I peg the impact to 2015 at $20M if they get 20M feet of capacity online, that will represent a 2% headwind and BLT have a year and a half to align their capacity appropriately so utilization/margins don’t get whacked.

Valuation

BLT doesn’t scream cheap at first glance, but as highlighted above, they are currently coming out of a tough 18 month stretch and sales/profitability are troughing.  I believe my numbers are conservative and can get close to $2.00 in earning power a few years out once they find their stride and start using the FCF to pay down debt.  Its tough to find a pure comp for BLT, but I’d look to TTC/SMG/Husqvarna and 12x the out year earnings number looks reasonable, this brings me to a $20 target.