2010 | 2011 | ||||||
Price: | 18.40 | EPS | $1.80 | $2.00 | |||
Shares Out. (in M): | 165 | P/E | 10.0x | 9.0x | |||
Market Cap (in $M): | 3,030 | P/FCF | 10.0x | 9.0x | |||
Net Debt (in $M): | 530 | EBIT | 450 | 500 | |||
TEV (in $M): | 2,500 | TEV/EBIT | 5.5x | 5.0x |
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I believe an investment in Ingram Micro represents an asymmetric risk/reward opportunity. The company trades at 1x tangible book value, 5.5x estimated 2010 EBIT and 5.0x estimated 2011 EBIT - well below historical averages and any reasonable assessment of fair value. I think upside is likely around 50% over the next year and downside appears extremely low given the company holds almost 20% of its market cap in net cash, trades at less than 90% of forward tangible book value (which consists mainly of cash and high quality receivables and inventory) and has a stable, leading market position.
Ingram Micro is the largest wholesale distributor of technology products in the world, selling around $30 billion of products worldwide. From September 2008 to September 2009, Ingram Micro saw its revenues decrease by 18% as worldwide demand for technology products declined sharply. The company maintained solid profitability through the downturn and turned its focus to rationalizing its workforce and reducing costs to better align the business with the lower demand levels.
I believe that last year's downturn is likely to sharply reverse as a result of significant pent-up demand and a strong PC upgrade cycle (which is already happening broadly across many companies in the technology universe). Ingram Micro's operating profits are likely to increase from approximately $320 million in 2009 to at least $450 million this year and possibly over $500 million under a normal demand environment given an improved top line and a lower cost structure.
There are several factors restraining Ingram Micro's valuation:
(1) a view that low operating margins present significant operating risk
Ingram Micro's reported operating margins of 1.0% to 1.5% are deceptively low. The company takes around a 5% to 6% mark-up on products that it resells but it records the full gross sales price as revenues. Given that around 95% of the sales are purely variable costs, I consider the operating profit as a percent of the gross profit as a more accurate reflection of the business's operating margin - this number is closer to 20% and has not fluctuated significantly over time.
To support my view that the true operating margin is higher (and hence the operating risk is lower), I would point out that Ingram Micro has never had an unprofitable quarter in its history as a public company - a period that includes the most recent financial crisis and the technology downturn of 2000 to 2002. In 2009, the true operating margin only declined from 22% to 20% despite a double digit decline in sales.
(2) a lack of appreciation of the margin of safety provided by the balance sheet
Perhaps what I like most about Ingram Micro is the margin of safety provided by a highly liquid balance sheet and a stock valuation right around its tangible book value. Ingram Micro's balance sheet consists of approximately $530 million of net cash and $2 billion of working capital. The working capital consists of receivables and inventory, both of which turn over every 30 to 40 days and are therefore highly liquid and readily valuable. The company has never had material credit losses and inventory is generally protected from any price cuts by its suppliers.
(3) the soft top-line results of the past year
Recent evidence pertaining to technology spend indicates a very strong rebound off of the depressed levels of 2009. As a result, I believe the soft top line results of 2009 should dramatically reverse allowing the company to register double digit top-line growth and margin expansion.
(4) a view that fairly low returns on equity demand a low valuation
Ingram Micro's return on equity has historically averaged around 10%. While this is a respectable level, it is well below the levels to which technology investors are accustomed, and it has therefore negatively impacted the stock's valuation. However, this figure significantly understates the attractiveness of Ingram Micro's business. The company has historically operated with virtually no net debt and has more recently held a sizeable cash balance. The company's pre-tax return on capital has averaged over 15% but return on equity has been weighed down heavily by its conservative capital structure. To highlight this point, if the company utilized a 50% debt / total capitalization ratio, I estimate return on equity would increase to a very attractive level of approximately 17%. Given the historical stability of the operating cash flows and the highly liquid nature of the company's assets, such a capitalization level could still be arguably conservative.
Actually, I would argue that almost the entire market capitalization of Ingram could be sitting in excess capital. I don't think it would be inconceivable for the company to operate with debt to capitalization levels closer to 80% to 90% - much like a financial company. Its assets are better credit quality than your average bank and the return on assets are higher and more consistent. While the company is certainly not going to lever to this level, it highlights the attractiveness of this asset to a financial buyer and demonstrates the level over overcapitalization/safety at Ingram.
I believe there are several possible outcomes for an investment in Ingram Micro:
(1) the company will productively deploy its cash balance in buybacks or acquisitions as it has in the past resulting in a higher return on equity and a higher stock valuation;
(2) the stock will appreciate as the negativity around soft demand reverses and the market discounts the cash flows to the equity holders at an appropriately low discount rate (reflecting their unusually low risk), resulting in a multiple above tangible book value; or
(3) the company will be acquired - this would be a particularly attractive asset to a private equity firm.
I believe a target valuation in line with historical levels (8x operating profit and 1.3x tangible book value) is reasonable, if not conservative. This multiple would also be at a discount to the current multiples in the pharmaceutical distribution businesses (such as MCK, ABC and CAH) - which I believe is a relevant comparison as they have a fairly similar business model.
My target would place the stock at approximately $27 per share one year from now, which is roughly 50% above the recent price. These potential returns are particularly attractive given the low risk provided by the company's conservative capital structure.
Upswing in demand, possible buybacks, return to normal valuation, potential buyout
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37 | |
Net cash per share is $4.50. The stock is $7. The valuation is clearly ridiculous at these levels and I agree with your suggestion that the downside is extremely low and the upside is large. Also given that windfall taxes fall dramatically as oil went through $100 and approaches $70, the sensitivity to declining oil prices in our valuation is much lower than would otherwise be the case. | |
36 | |
hawkeye, Seems HNR is now trading at about $3 net cash per share. It appears that there isn't much downside given the possible upside. Anything changed your view of this company? Thanks. | |
34 | |
Thanks for your questions. I think the Q2 earnings show that things are on track. The company has almost $5 in cash for a $9.25 stock. My asset values in the write-up have not changed and in fact the recent change in the windfall tax to a lower reference price than WTI actually helps this valuation. The production ramp is very encouraging. I have no real issues with management. I think they are being fairly aggressive on the buyback and doing a fine job getting the Venezuela assets up and running. I definitely think some sort of sale of the company or assets would make a lot of sense since the discount here is fairly absurd and I imagine they can at least double shareholder value in a transaction. I will not be at the conference but I will try to do a webcast if possible. In summary, the stock has more than 50% of its market cap in cash and production will be ramping dramatically over the next 12 months. The company has numerous upside levers through new fields in Venezuela and the other exploratory projects. The risk/reward here is unusually attractive in my opinion. | |
33 | |
Hawkeye, Any comments on Q2 earnings? Any changes in your assessment of valuation? Are you comfortable that these are the right guys to run this business? Should mgmt sell the company (or take it private) given the incredible Venezuela discount that could be diversified away to some degree by a larger company? Do you plan to attend the EnerCom Oil & Gas Conference in Denver next week? Thanks. | |
32 | |
Answers to you questions: 1) I agree that SG&A is too high for this company, but I don't believe it is going to fall anytime soon. They are spending on some of the exploratory projects. Hopefully, they get a great return on that spend, but only time will tell. 2) I think the 40k b/d estimate is very reasonable. For a frame of reference, the CEO estimated 75k b/d by 2011 per an Aug 21, 2006 press release. Given the sheer size of their reserve base, production levels are merely a function of capital and logistics. I have assumed in my capital plan (after conversations with the company) 36 wells per yr drilled, which would get us safely to the 40k b/d estimate. Of course, they could spend more or less, but it shouldn't dramatically alter the asset value of the company. Keep in mind they are ramping from extremely depressed levels now. Production was 36k b/d in 2005 and now they have more reserves. 3) Operating expenses per BOE have gone up due to fixed cost deleveraging and cost inflation. I think cost inflation will continue, but they should get significant fixed cost leverage from increased production. I assume the expenses per BOE come down from the current levels, but never get back to the levels of the past. 4) I have no reason to believe the production mix should change much. If anything, it will slant to more oil given their reserve base has a higher % of oil vs. gas than current production levels imply. 5) A summary of the report from 2006 was filed at the end of the proxy. Here is a link: http://www.sec.gov/Archives/edgar/data/845289/000095012906009424/0000950129-06-009424-index.htm | |
30 | |
Thanks for the questions. 1) From $70 to $100 WTI oil, HNR pays a windfall tax of 50% of WTI less $70. So if WTI is $100, HNR owes $15 per barrel tax. They sell their oil around 85% of WTI. So they net $70 instead of $85 when oil is $100. They can in turn deduct this tax from their ordinary 50% tax, so the easiest way to think about it is that they simply realize less revenue per barrel, which of course lowers their taxable income. At $120 oil, they would have to pay 60% of $120 - $100, or $12 tax. So, if oil is $120 and they can sell it for 85% of WTI, they will sell oil for $102 (85% of $120) less $15 tax (from $70 to $100) less an additional $12 (from $100 to $120) = $85 net of the tax (but before the ordinary 50% tax on income). Rising oil prices are good for Harvest. As you can see, at $120 oil, they make $85 net revenue per barrel instead of $70 when oil is $100. 2) I have not been counting on the protection of the netherlands for my HNR thesis. I suppose the protection is marginally helpful, but unlikely to matter one way or another in my view. As I discussed in the writeup, I believe there is a mutually beneficial relationship and I don't see any real prospect of this ending with a legal dispute. If nationalization is the ultimate route, I don't believe the courts would make much of a difference in the outcome anyway. | |
28 | |
Harvest received the petrodelta dividend this morning. This is great news as it was much higher than I expected - $58mm vs. $40mm. The company now has almost 50% of its market cap in cash. | |
26 | |
There was another insider buy at Harvest. This time by the general counsel. This marks the 4th insider buy in a week. | |
25 | |
Fatman, Unfortunately, I don't have any particularly useful insights on Amoruso or the Bartells. If I learn anything, I will post it. | |
23 | |
The CEO and a director just bought $200k of stock each. | |
22 | |
Petrofalcon paid Anadarko $200 million. Anadarko had 2P reserves of 35.8mm barrels. However, 1/3 of those reserves go to the government in the the form of royalties. So, they really have 24mm net 2P reserves. Taking the $171 million purchase price divided by 24mm net 2P reserves, get to $8.33 per BOE. Petrofalcon also received a voucher, so depending how you value that you could get closer to $7 per BOE. When Harvest quotes 2P reserves of 75mm BOE of 2P, that is after already deducting 1/3 of their reserves for the Royalty. Multiplying $8 per BOE times 75mm of 2P reserves gives you a value for Harvest's interest of $600mm or $17 per share (consistent with my base case valuation). According to mgmt, Harvest's fields have even more probable reserves and oil in place, so HNR is potentially even more valuable. | |
21 | |
The Petrofalcon deal went for 4-6 dollars per BOE before royalties. In the conference call and in your writeup you are talking about 6-8 per BOE after royalties. Could you explain the distinction and what is the discount factor for HNR's oil in the ground to account for royalties? | |
20 | |
Jim, Thanks for the question. Petrodelta is not only self-funding, but it should generate excess cash (perhaps a considerable amount). The exact amount is unknown because it will depend on how much drilling they do. I suspect they will be aggressive here to get 2P and 3P into 1P and to increase production (which is, of course, a good thing). I estimate a free cash flow number to be around $200mm (or higher if oil prices stay up here) from 2008-2009 based on a ramp toward 30k barrels per day. We have estimated that they will have 3 rigs running in the field drilling 1 well per month, which is 36 wells per year. Each well should cost no more than $2.5mm, which would be capex of $90mm. The $200mm Petrodelta FCF would result in net cash of $65mm to Harvest. I don't suspect they will pay out all the cash in dividends, but I believe it should at a minimum cause cash at the corporate level to increase and not decrease. | |
19 | |
I see from the Q that after 1Q they spent $4MM to acquire Gabon asset and they are talking about Indonesia and Gulf Coast U.S. being $20 million investments over time. Is the Venezuela buildup self funding or are they going to be pumping money into that too? I like it but want to make sure that cash is not there to be spent on assets you are counting in your valuation. That would be double counting the cash and would mean there msy be more downside here than it appears. For $4.50 to be the "low" that cash of course has to still BE there the day Venezuela blows us up. What do you think cash flow at the HNR level looks like the next year or two? And how much do you think will be hiding at the non-consolidated Venezuela level? Thanks for a very interesting and well written idea. An oil company at a low... | |
18 | |
Steve is retiring. He is not going anywhere else. There is nothing at all that gives me concern here. There is no aspect of the accounting that I can even think of that I would worry about given they have not even been recognizing any revenues until recently. For what it's worth, the departing controller bought some shares yesterday. | |
17 | |
Heffer - Management has a very impressive exploration and recovery track record in Venezuela which hopefully tells us something about their abilities. But importantly, the VP of Ops has worked in senior roles at major oil companies in many different regions of the world including Indonesia (where a major Harvest project is). I believe Harvest has been very disciplined in acquiring assets outside of Venezuela. The company has averaged around $150mm of cash over the past five years and has spent only a minimal amount of it. They have emphasized deals where they put only small amounts of capital at risk. In fact, there are few energy companies I could think of that have exercised such discipline (most can't spend money quick enough and have significant leverage). | |
16 | |
Thanks for your question. I believe the Crystallex situation is very different from Harvest's. My understanding is that Crystallex was denied a permit, supposedly for environmental reasons. In contrast, Harvest is effectively in partnership with the government through their ownership in Petrodelta. I think the relationship is mutually beneficial as Venezuela gets considerable cash flow from royalties, taxes and through their 60% ownership. If you want to consider an expropration, I think there are several examples to look to and it would imply Harvest would get substantial consideration - which would be well above the current price in my view. While I share your concern and appreciate how difficult it is to precisely quantify or discount such risks, I would like to point out a few points that support my conclusions" 1) If Harvest owned an asset of this quality in any other region, I think the stock would easily be in the high 20s (given the conservatism of their reserves and the likelihood of 2P and 3P becoming proved). 2) Harvest has 50% of its market cap in cash + other assets outside of Venezuela. 3) Harvest was given considerable compensation when the structure of the relationship was changed 4) A windfall tax is not unique to Venezuela. In fact, the US imposed an oil profits windfall tax from 1980-1988. Hope that helps | |
15 | |
any thoughts on the cfo's resignation? | |
14 | |
does management have a good track record of finding/developing acreage outside of venezuela? if not, why aren't you worried that they will burn through all their cash developing these assets, which may have been hastily acquired/ overpaid for in their desire to diversify away from venezuela? | |
12 | |
Very interesting -- Kurt Nelson's purchase of 5,000 shares today seems to be the first open market purchase by management in more than two years (the most recent prior purchase seems to be James Edmiston buying some shares on March 10, 2006). | |
11 | |
For what it's worth, the former controller bought some shares today in the open market. With regard to management's ownership - while I believe on an absolute basis, their ownership does not seem huge, I believe they have a very material amount of their net worth in the company (judging by their cash comp). I also think the buyback program reinforces their view of how cheap the stock is. | |
10 | |
1. The dividend will be declared in the coming weeks by the board of Petrodelta. The exact amount is not determined, but clearly Harvest has an estimate of how much cash they plan to distribute. Because the intent is to leave some working capital at Petrodelta, 100% of the cash will not be distributed, so it remains an estimate at this time. 2. Through Q3 2007, the conversion process was not finalized and Harvest did not have a contractual means to recognize the ownership, so in accordance with GAAP, the company could not recognize the income or costs from Petrodelta. Page 7 of the 9/30/07 10Q discusses this. http://www.sec.gov/Archives/edgar/data/845289/000095012907005207/h50588e10vq.htm 3. The other 20% is owned by Vinccler Construction, a Venezuelan construction company. | |
8 | |
hawkeye, thanks for the writeup 1) why is the dividend payable between $30-50m? if it's a payable that means the dividend has been declared, so how could there be such a wide range? shouldnt they know what they're owed? 2) can you provide some more background on why petrodelta - a company that HNR owns 32% of - doesnt show up anywhere on HNR's financials? this just seems totally bizarre 3) who owns the other 20% of harvest vinccler? thanks | |
7 | |
The lack of insider buying IS a disconnect. But it's not enough to destroy the thesis, in my view. If insiders were selling, that would be different. Also, the fact that the company has bought back stock offsets somewhat the lack of mgmt buying. Still, I would love to know why mgmt isn't more greedy, or better yet, I'd love to see them file some Form 4s. | |
6 | |
Thanks for your question. I agree the Raymond James analysis was terribly poor. Harvest is owed money from Petrodelta for operations from 2006-today. Petrodelta has been operating and building up cash. Now that the conversion is finalized, Petrodelta will pay out dividends to Harvest and PDVSA. This issue has been discussed on prior conference calls (and I have discussed it directly with management as well). On the most recent call, they gave clarity as to amount and timing - $30mm to $50mm in 30-60 days. This number makes sense to me since it represents most of the cash that I estimate Harvest has in Petrodelta (ie, the $58mm). Hope that helps. | |
5 | |
if mgmt is frustrated by how cheap the stock is, why do they own so little of the company (~1%) and not buy on the open market? | |
4 | |
For those interested in doing more research, here are a couple of things I found helpful in getting my arms around this situation: 1) Harvest's April 8th presentation at IPAA Oil & Gas Symposium in New York: The CEO gave a bullish presentation when stock was in mid-$12 range, pointing out that operating catalysts were underway right now. One slide showed Harvest's production, with the clear implication that production would take off quickly now that the Venezuelan relationship has been restructured. 2) Q1 earnings call: I have never before heard HNR management address the stock price as emphatically as they did on that call. They are clearly frustrated by the recent slide as oil prices have hit new highs. The Q&A showed quite clearly that the Street keeps missing the forest for the trees. One analyst focused on ROI hurdles for the recently announced U.S. Gulf Coast exploration. This would be a relevant question if the stock were at $30. At $10, the Gulf exploration is irrelevant to any rational investment case. Like to above resources: http://www.shareholder.com/harvestnr/medialist.cfm | |
3 | |
Hawkeye, interesting post. The investment thesis seems to have changed over the past few years, but I tend to agree with your major points. The recent Raymond James analysis was frankly a little baffling as far as numbers estimates go. My main question has to do with your statement that they will receive the $40M payment in the next 30-60 days. What are you basing that on? I've been passively interested in this name for a while, but haven't come across that info. Can you elaborate a bit more? | |
2 | |
THanks for your questions. On the first question, I do not think expropriation makes any sense because it would likely lead to severe production declines in the fields, which is not in Venezuela's interest. Like most regions of the world, they have decided that taxes and royalties are the most effective way to get value out of the country's resources. As I mentioned in the write-up, Harvest has signficantly increased the productivity of the fields, and it is therefore, self-serving to Venezuela to keep companies like Harvest operating there. Also, to be clear, there is big difference between expropriation without any compensation and expropriation with "fair" compensation. While I do not believe there is any meaningful chance of expropriation at all (because it would cripple their oil industrY - which Chavez cannot allow), I think even if it were to occur, Harvest would receive reasonable compensation. Prior cases such as CANTV and EDC demonstrate this. Even a conservative valuation of the fields would result in payment to Harvest that would be meaningfully above the current price. On the second question, there was a large tax liability from a few years back that was paid by Harvest. There is no liability outstanding anymore. | |
1 | |
I looked at this a few years ago: 1.) Given Chavez is basically a psycho, dont you think the chance of complete expropriation is much higher than you represent? As their production falls they will probably stop at nothing to extract more money from whereever they can get it. Is there anything in the current "restructuring" that suggests that this is the limit? 2.) I though the govt was going after the company for significant past due (historical) taxes. Is this not an ongoing issue that could result in substantial additional liabilities for past production profits? |
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