Description

This is an illiquid PA idea. All figures are in CAD. You can download an excel file with historicals here.

Hammond is a nano-cap Canadian manufacturer trading for 6x EPS and 65% of tangible book value (which approximates IFRS book value). The company makes industrial enclosures and racks, primarily used to house electronic components of various sorts. The end markets are widely diversified. If you want to know more, the company website has a lot of information about hundreds of its products.

Hammond’s products are essentially commodities. The company earns a ~30% gross margin, a 5-8% EBITDA margin, and a 6-7% return on equity over the cycle. Hammond has compounded revenue annually at roughly 5% and book value per share at 7% over the last decade without acquisitions.

Hammond is located in Guelph, Ontario, which sits roughly between Detroit and Buffalo. HSales to the US and other non-Canadian regions are about 60% of revenue, while the large majority of the company’s fixed costs are denominated in CAD. So a strong dollar is great for Hammond.

The benefit is already showing up in the financials—but the effect on income is being obscured by non-cash mark-to-market losses on USD-denominated intercompany loans. The total effect on EPS has been $0.07 over the last twelve months. Not insignificant on a ~$2 stock. Profits are surging, but the growth is being partially masked:

Hammond’s annual normalized EPS (before FX and non-operating costs) has increased from its post-crisis average of ~$0.20, up to ~$0.40 on an LTM basis.

If the CAD remains weak compared to the USD, I think the company can continue earning double-digit ROEs for at least a few more years, until its production cost advantage eventually gets competed away. On the other hand, if the CAD strengthens you as an investor have a hedge, since your investment in Hammond is denominated in CAD.

Now for the risk: Hammond’s board recently approved a plan to spend approximately $20M between 2015 and 2018 to expand plant capacity. For Hammond this is not a small amount of money; $20M is 150% of current PP&E. The primary cost will be a new factory with a modern paint line, focusing on the racks side of the business. The factory will be large and will free up space for modernization and optimization at the existing factory. The cost will be financed with bank debt and a $1.5M grant from the local government. Hammond isn’t a business with backlog or contracted orders, so the company will quickly need to find new business to utilize the added capacity. Obviously management believes it can.

Robert Hammond, the CEO and Chairman, owns 1.4M Class A shares (1 vote each) and 2.8M Class B shares (4 votes each), giving him a 37% economic interest in the company and a 63% voting interest. So you are truly a passive minority investor. With that said, I do not see anything untoward going on at the company. The three named executives combined make about $700K per year (Mr. Hammond makes about $300K), and total board compensation is only $65K. Hammond is audited by KPMG. The company does not hold earnings calls or provide any investor information beyond what is required, but management is accessible and responsive to investors.

The company owns a 50% interest in an unused property currently under environmental remediation. The company is spending about $100K per year on remediation and other property expenses (I lump this in with FX as a non-operating cost). The property is carried on the books at $1M, and management estimates its fair value in filings at $1.25M.

For the last five years Hammond has paid a $0.02+ special dividend each year. The company is neither a purchaser nor an issuer of its shares; the diluted share count is unchanged since 2008. For the foreseeable future I would expect the new factory expansion to be the company’s sole capital allocation priority.

Frankly I have no idea what the “right” value is for this company. 100% of book value seems fair to me, in which case you’re looking at ~$3.50 today and maybe $4.50 three years from now based on retained earnings. The company traded at book leading up the GFC, but has consistently traded at a significant discount since then.

Catalyst

Increased EPS as FX charges roll off

Increased earnings from new factory