Value Investors Club / Excelsior Capital (CMI)

Description

change the name of the company from CMI Limited to Excelsior Capital Limited. The name

change may not yet be reflected depending on where investors get their quotes.

Excelsior Capital has been written up twice on VIC (under the former name – CMI Limited).

Once by MPK391 back in December 2008 and again by VI4Life in March 2013. Both reports are

well done and provide additional background.

Over the past year and a half I have spent a significant amount of time studying the business

and getting to know the management team. I also traveled to Sydney, Australia in the fall of

2018 to attend the annual meeting and spend a day at headquarters meeting with the

management team.

Business:

Excelsior Capital is an industrial business based in Meadowbank, Australia that manufactures

and supplies equipment for the underground coal mining industry primarily in Australia.

Excelsior Capital’s electrical business has two divisions. 1) Minto Industrial Products which

manufactures and supplies couplers and connecters to the underground coal mining sector in

Australia. 2) A cable distribution and installation business that sells products under the XLPE,

AFLEX and Hartland brand names.

Minto Division

Although Excelsior Capital does not break out separate financials between Minto and the cable

division, my research suggests that Minto contributes 85% of operating profits. Minto is a high

quality business that exhibits a number of mental models that I look for in businesses:

High switching costs and a sticky customer base: Once a new mine selects Minto

products they are unlikely to switch suppliers for the remainder of the life of the mine.

Mines typically do not dual source and once they source with one brand of couplers and

connecters, they stick with that brand because the switching costs are significant. There

are substantial costs associated with retraining employees to use a different brand.

Given the small cost of this equipment relative to overall operations, a mine would never

risk miners safety and incur the cost to retrain workers to save an insignificant amount of

money.

Mission critical product: Coal mines contain gases (methane being the most dangerous)

and one spark could ignite and cause an explosion. Couplers and connecters are

mission critical safety equipment with very strict government regulations. From people I

have spoken to in the industry, mines prefer Minto because of their reputation for quality

and Minto has grown their market share in low voltage underground couplers to 85%. If

this $3,000 piece of equipment breaks, a billion dollar mine would grind to a halt costing

the owner a considerable amount in lost productivity. As a result of both the mission

critical nature of the equipment and strict government regulation, buyers are price

inelastic allowing Minto to earn high margins on these products.

Recurring and counter cyclical revenue stream from replacement parts: Every 5 years

couplers are required to undergo an extensive safety check and this typically requires

replacement parts or a new coupler. This revenue is counter cyclical and creates a

steady base of recurring revenue regardless of whether new mines are opening or

expanding. As a result, Minto is very resilient through the cycle. Today, over 50% of

Minto’s revenue is either replacement couplers or parts. The replacement parts garner

much higher margins than the original coupler sale.

Strong barriers to entry: There are four companies (including Minto) that control the

market for couplers in Australia. Foreign competition is nonexistent. Minto dominates the

market for low voltage underground couplers with 85% market share in this area. Minto

currently does not compete in high voltage or open pit mines.

To protect workers safety, the Australian government has ratcheted up regulations and it

is very hard for a new entrant to get approval. A new entrant would then need to spend

significant sums to open a facility in Australia to avoid long lead times associated with

importing. As described earlier, mines stick with one supplier and thus, a new entrant

would only have the opportunity to gain share when new mines open and that is very

infrequent. All of these hurdles would have to be overcome just to enter a market that is

only $32 million in total sales. The business case simply is not there. As a result, there

have been no new competitors in the past few decades. The barriers to entry in this

business are quite high and that will remain the case. In the past few years a new

entrant attempted to enter the market and gave up after spending $13 million and getting

only 4 products approved by the Australian government (Minto has over 100 approved

products).

Minto is a good business and has a strong brand image in the industry. My research indicates

Minto customers are willing to pay 20% more on average for Minto products because of their

safety reputation and strong customer service.

Cable Division

The cable division supplies imported cable to the construction, building and mining

industry under the XPLE brand name. Hartland and Aflex perform custom cable

installation jobs. Unlike Minto, the cable business is a mediocre business with low

margins and no barriers to entry. However, this business does have a positive outlook

and is likely to continue to grow. Additionally, mines prefer to buy cable and couplers

together which gives Minto an additional edge to differentiate themselves from

competitors. Although Excelsior Capital doesn’t break out separate financials between

the cable and Minto division, my research suggests that the cable business contributes

only 15% of profits.

New Management Team

Excelsior’s management team are the largest shareholders and they have consistently acted in

shareholders best interests. Long time board member Leanne Catalan owns 48% of the

company. Additionally, over the past year the Chairman has purchased a meaningful amount of

shares in the open market. I have closely studied management’s decisions over time and they

have a consistent history of doing what is right for shareholders. Over time they have returned

the majority of free cash flow to shareholders either through dividends or opportunistic share

buybacks. Over the past 4 years, Excelsior Capital has returned $16.15 million back to

shareholders through dividends and share buybacks. With management’s large ownership, their

interests are aligned with shareholders.

In December of 2016, Michael Glennon joined the company as Chairman. I have had the

opportunity to get to know Glennon well over the past year and a half and I am very impressed

by him. I also traveled to Sydney, Australia to spend time with Glennon and the rest of the

management team in the fall on 2018. Glennon is the founder of Glennon Capital, an investment

firm that focuses on small capitalization equities in Australia. He has started and sold a couple

of businesses successfully in the past. Glennon runs Excelsior Capital with an owners mentality

and has made several very positive operational improvements at the company since he became

Chairman.

Shortly after Glennon became Chairman he hired a new president of CMI Electrical. The prior

management team had become complacent and the quality of their customer service declined.

James (Jim) Johnson was hired in January of 2017. I spent an entire day with Jim in the fall of

2018. I think highly of him and he is very ambitious about growing the business.

Excelsior Capital partnered with Michael Glennon to create an asset management firm called

Excelsior Asset Management which is being lead by Paul Bolinowsky. Paul has quite an

impressive resume. His previous roles have included Country Head (Australia) of Pioneer

Global Investments, CEO and subsequent Head of Distribution at UBS Global Asset

Management Australia, Head of Distribution at AllianceBernstein Investments Australia and

CEO of Zurich Scudder Investments Australia. Excelsior Capital owns 40% of the venture.

Excelsior Capital has a significant amount of cash on the balance sheet that is being invested

by Glennon through Excelsior Asset Management. Both Paul Bolinowsky and Michael Glennon

have big ambitions for the asset management business. I see this venture as a free option and if

it is successful, the value of Excelsior Capital’s interest in Excelsior Asset Management could be

worth multiples of the current share price.

Valuation

Share price	$1.41
Market capitalization:	$40.9 million
Net cash and investments (adjusted for buyback):	$21.3 million
Value of tax losses at 30% tax rate:	$9 million
Annualized free cash flow (FCF) of the underlying business:	$4.5 million
Net current asset value + securities (adjusted for buyback):	$37.1 million

At today’s market price of $1.41, Excelsior has an enterprise value of $19.65 million and the

underlying business is producing $4.5 million in annual FCF. Excelsior Capital is a quality

business and is worth far more than 4.4 times FCF.

I believe Excelsior Capital’s electrical components business is worth at least $55 million or

$1.90 per share, a multiple of 12 times FCF. Excelsior Capital also has net cash and securities

worth $21.3 million or $.73 per share. In aggregate, I believe Excelsior Capital is worth $2.63

per share today. This excludes any value for the tax losses that will reduce Excelsior Capital’s

tax liabilities going forward. In addition, while we wait for the market to recognize this bargain,

Excelsior Capital is producing annualized FCF of $.16 per share, a FCF yield of 11% based on

today’s price.

Excelsior Capital is mispriced based on the current state of the business alone. Going forward, I

believe earnings are likely to grow for both Minto and the cable business:

• The replacement cycle is just beginning. Mines that purchased couplers during the

mining industry boom a few years ago now need to replace the equipment or purchase

replacement parts. Minto’s replacement orders are likely to grow in the years to come

as the mining industry enters a replacement cycle and I believe this will add a few

million in annual sales in the next few years. Replacement parts carry much higher

margins than the original coupler sale.

• Minto currently dominates the market for low voltage underground couplers. The

company is introducing products to address the segment of the of the couplers market

they do not currently compete in. The R&D costs associated with these new products

have been an ongoing expense in the income statement and this could be a meaningful

sales opportunity when the new products pass certification.

• Minto has begun selling their products internationally and the results thus far are quite

promising. They began supplying to a massive mine in Mongolia which I believe to be

Rio Tinto’s Oyu Tolgoi mine in the Gobi Desert. It will be one of the largest mines in the

world and the scale is truly massive with over 200 kilometers of tunnels planned once it

is fully built out. This mine will last over 50 years and I believe this will lead to a few

million in sales growth annually for Minto (which did $16 million in sales last year). In

conversations with management they plan to expand to other countries as well. The

growth opportunity to sell their products abroad is substantial and they have only just

begun to tap this opportunity.

• If new mines begin opening again in Australia or existing mines begin expanding this

would lead to a substantial increase in earnings at Minto. Minto’s earnings are far below

their cyclical peak. In fiscal 2018, Excelsior Capital’s electrical division produced a pre-

tax profit of $7 million. The electrical division peaked at $21.5 million in pre-tax earnings

during the mining boom in 2012. This opportunity is not contemplated in my numbers

below.

Over the next several years I believe both sales and profits will rise significantly at Excelsior

Capital as a result of three separate opportunities: 1) the replacement cycle begins to ramp up,

2) new products are introduced to address the segments of the coupler market they don’t

currently compete in and, 3) sales to Rio Tinto’s massive new Oyu Tolgoi mine increase as that

mine moves towards full production in 2020. As a result of these growth opportunities, I believe

Excelsior Capital’s electrical business will grow annual sales from $52 million today to over $70

million by 2021 and annual operating earnings from $7 million today to over $10 million by 2021.

This would result in annual FCF at Excelsior Capital growing from $4.5 million today to $6.6

million in 2021. Valuing the business at 12 times 2021 earnings and adding net cash and

securities results in a valuation of $100 million or $4.63 per share compared to today’s price of

$1.41.

Disclosure

This has been prepared solely for informational purposes. Information herein is not intended to

be complete, and such information is qualified in its entirety. This is not an offering or the

solicitation of an offer to purchase an interest in any fund, and it is not an offer to buy or sell or a

solicitation of an offer to buy or sell any security. Nothing herein should be construed as

investment advice, an opinion regarding the appropriateness or suitability of any investment, on

an investment recommendation. No representation is made that the objectives or goals of any

investment or strategy will be met or that an investment or strategy will be profitable or will not

incur losses. Past performance is no guarantee of future results. Reliable methods were used to

obtain information for this presentation but the information herein cannot be guaranteed for

accuracy or reliability; the information in this presentation may be out of date or inaccurate. The

information contained in this summary is and may not be distributed without permission.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1. Significant earnings growth potential becomes evident to the market

2. Management continuing to do the right thing for shareholders - opportunistic share buybacks, higher dividends etc.

3. Greater awareness by the investment community of the quality of this business as well as the extreme mispricing at the current share price.

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			2018	2019
Price:	1.41	EPS	.1353	.16
Shares Out. (in M):	29	P/E	10.4	8.9
Market Cap (in $M):	41	P/FCF	9.1	8.2
Net Debt (in $M):	-21	EBIT	6	6
TEV (in $M):	20	TEV/EBIT	3.4	3.07