Description

Chase Corp is a better-than-average company at a below-average valuation. Although the sticker price of 7.6x LTM EBITDA/8.6x EBIT is probably compelling value in and of itself in the current market, CCF’s trading valuation pro forma for a recent acquisition, excess owned real estate holdings, and excess compensation for the former CEO is closer to 6.3x EBITDA/7.2x EBIT, representing a 9.2% NOPAT yield.

There is not any specific predetermined catalyst here, other than continuing compounding of value and earnings, and good performance. However, this is probably an activist target for an investor not afraid of what could be a difficult fight, as the company is operated like a family business despite having 75% non-family ownership.

I.                    Business Description

Chase Corp, headquartered in Bridgewater, MA, operates under two segments:

The Industrial Materials segment (76% 2014 sales, 83% EBT) manufactures highly engineered tapes, coatings, and other insulating/conducting materials sold to the electronics and telecommunications industries. These materials are used primarily to manufacture, transport, install, protect, and repair wires and cables. These products generally are either (i) specified into an OEM product or (ii) used for maintenance purposes, both of which are high quality/recurring revenue streams.

The Construction Materials segment (24% LTM sales, 17% EBT) manufactures highly engineered tapes, coatings, waterproofing products (sealants, membranes, additives, linings), and related accessories. CM products are primarily oriented towards waterproofing and corrosion protection for a wide array of construction-related applications, primarily in global infrastructure (bridges, airports, ramps, roads, racetracks, marine, water management) and energy (oil & gas, particularly pipelines and utilities).

II.                  Investment Thesis

High quality business with high (17%) sustainable ROIC, significant recurring revenues, GDP+ growth, trading at an ostensible multiple of 8.6x EBIT, but an adjusted multiple of 7.2x EBIT after adjusting for a recent acquisition, excess real estate holdings, and excess executive comp that should start rolling off this year.

III.                Capitalization and Summary Valuation Statistics:

Here is the unadjusted capitalization:

Stock Price: $36.06
Basic Shares Outstanding: 9.2 (9.183 basic, 0.03 ITM options and RSUs)
Market Capitalization: $332.4

Add LT Debt: $57.3
Add Pension Obligation: $10.6
Less Cash: $17.4
Less Options Proceeds: $0.8
Enterprise Value: $382.0

LTM EBITDA (Feb-15): $50.123
LTM EBIT (Feb-15): $44.391

EV/LTM EBITDA: 7.6x
EV/LTM EBIT: 8.6x (7.6% NOPAT yield)

A 7.6% yield for a quality business with GDP+ growth is a compelling buy in the current market, particularly in an industry where peers and potential suitors (MMM, DHR, etc) trade well into the double digits. However, I think the underlying economic reality is quite a bit better than the sticker price, as per the following adjustments.

IV.                Recent Acquisition

CCF completed a $33.285 million acquisition of two product lines from Henkel which closed on January 30, 2015. CCF paid all cash. The product lines had combined revenue of >$20 million suggesting a minimum EBITDA (at CCF’s margin) of ~$4.5 million, therefore implying a sticker purchase price of ~7.5x. This was an asset purchase in which $25.24 million of the purchase price is amortizable for tax purposes over 7-8 years. Assuming a 35% tax rate, I calculate an NPV to that tax shield at a 10% WACC of $5.9 million, suggesting an adjusted purchase price of ~$27.4 million or ~6.1x EBITDA.

Ultimately I am content in the assumption that this acquisition at the very least did not destroy value, and is in fact most likely marginally accretive. To keep it simple, I treat the gross consideration paid as cash, which reduces CCF’s implied Enterprise Value to $348.8, or 7.0x LTM Adj EBITDA and 7.9x LTM Adj EBIT (~8.3% NOPAT yield).

V. Real Estate Monetization

CCF also owns about 814k ft2 of industrial real estate, on which the implied unlevered return is perhaps mid-single digits (compared to 17% consolidated ROIC, including the capital invested in real estate). Some of these assets are not even being used for core operations of the business, but are instead being used as excess warehouse space or even leased out to tenants. I have zero expectations that this real estate will actually be sold, but the value is inherent in the stock, so I include this value in my spreadsheet math as follows:

The company’s owned real estate assets (land and buildings) are held on its balance sheet at a gross book value of $30.029 million. I went through property by property and checked out market comps, and it looks like the market value of this real estate is ~$25 - $35 million, so to keep it simple I just assume that gross book value is a fair assessment of the market value (and also CCF’s tax basis in the properties). I spoke to a national industrial CRE broker who indicated that CCF’s properties would likely go for a 6-cap in a sale-leaseback in the current market given its credit worthiness, suggesting that CCF could sell its real estate for net proceeds of ~16.7x EBITDA.

Pro forma for a real estate monetization, CCF’s enterprise value would be $315.7 million, and new EBITDA/EBIT would be $48.1m and $42.4m respectively, suggesting pro forma multiples of 6.5x and 7.4x (8.7% NOPAT yield).

V.                  Excess compensation

The Chase family is currently transitioning the leadership of CCF to its fourth generation, with Peter Chase (age 66) transitioning from CEO to Executive Chairman in February of 2015, and Adam Chase (his son) assuming the CEO title. Interestingly, Peter Chase made $4.9 million in total compensation in 2014, of which $2.5 million was ‘change in pension value and nonqualified deferred compensation earnings,’ which I do not believe runs through the income statement on a 1-for-1 basis from an accounting standpoint (please correct me if I’m wrong).

CCF has not made any disclosure regarding changes in compensation for Peter, but presumably some or all of his comp will go away over time, some sooner rather than later. Let’s assume at the very least that Peter’s $1.7 million of non-equity incentive plan comp goes away forthwith, such that pro forma EBITDA/EBIT increase to $49.8 million and $44.1 million, respectively.

VI.                Adjusted Capitalization/Valuation

To put it all together, the pro forma capitalization and valuation metrics are as follows:

Stock Price: $36.06
Basic Shares Outstanding: 9.2 (9.183 basic, 0.03 ITM options and RSUs)
Market Capitalization: $332.4

Add LT Debt: $57.3
Add Pension Obligation: $10.6
Less Cash: $17.4
Less Options Proceeds: $0.8
Less Sale-Leaseback Proceeds: $33.029
Less Henkel Acq price: $33.285
Adjusted Enterprise Value: $315.735

LTM EBITDA (Feb-15), Adjusted for RE Monetization and Outgoing CEO's Excess Comp: $49.8
LTM EBIT (Feb-15) as Adj: $44.1

EV/LTM EBITDA: 6.3x
EV/LTM EBIT: 7.2x (9.1% NOPAT yield)

This is among the highest NOPAT/UFCF yields I am aware of in the North American small cap market, especially after jettisoning those stocks that lack consistent/growing earnings streams, and thus I am long the stock.

Catalyst

Continuing compounding of value/earnings; probably an activist target (though none currently in the name)