Description
Mile Marker is the kind of investment that seems almost too good to be true. I made the trek down to Florida and spent a half day with management to investigate what looked like the chance to own part of a business with investment nirvana like characteristics: extremely profitable (40%+ ROIC), cheap (7.6x EBIT/EV), growing (75% revenue growth the past year and 43% CAGR the past 4 years), understandable (they make winches), revenue visibility ($70mm backlog or 3 times 2004 revenue on just a portion of their revenue stream), a demonstrated edge (patented hydraulic winch and reasons why they are the low cost producer), clean balance sheet (no long term debt) and a management that buys back stock and pays out a healthy and growing 6.5% dividend yield. When you have less than 350 shareholders and no institutional ownership, things can be too good and true.
This will be my tenth idea presented to VIC over the past four years. I’m looking to go 10 for 10 versus Mr. Market with one of my more exciting finds of the bunch.
Mile Marker Internal (“MMRK”) is a distributor of specialized vehicle parts primarily for the 4-wheel drive recreational/utility/military vehicle markets. The companies claim to fame is a patented hydraulic winch that utilizes a vehicle’s power steering pump as its energy source. This was designed for the U.S. Military and has been chosen to replace Warn Industries (the 800 pound gorilla in the industry and now a division of Dover) electric winch on the U.S. Army’s Humvee vehicles. Besides offering a lower price point, feedback suggests that Mile Markers product beats Warns winches when it comes to reliability, continuity, and endurance (the latter is actually documented in a video that MMRK gives to all prospective clients showing the strength of its cable versus competitors). Revenue has grown from $5.5mm in 2000 to $23mm in 2004 and things couldn’t look brighter for the future prospects of the company.
Snapshot:
Stock Price: 4.0
Shares Outstanding: 10mm
Total Debt: 3.76mm
Cash: .34mm
Market Cap: 40mm
EV: 43mm
Dividend Per Share: .26
Div Yield: 6.5%
ROIC: 40%
ROE: 70%
TTM:
EBIT: 7.6x
EBITDA: 7.3x
P/E: 11x
Sales: 1.8x
The company looks cheap when you look at trailing twelve month multiples but things start to get much more interesting when you look one to two years out.
Operating Leverage:
Past financials reveal operating leverage and explosive growth. The operating leverage is a result of Mile Marker’s ability to outsource all their manufacturing to China. The firm has warehouses in Florida and Washington (a new space in Washington was just purchased which should tell you what Management thinks about future growth) that serve strictly as distribution centers where the winches and hubs get assembled/inspected and then shipped out all over again.
Historical Financials ($mm):
04 03
Revenue 23.3 13.2
CGS 12.3 7.2
Gross Profit 11.0 6.0
Selling Expenses 1.6 1.1
G&A Expenses 3.7 2.7
Operating Income 5.7 2.1
Interest Expense .15 .11
Income Taxes 1.9 .70
Net Income 3.5 1.3
The beauty of Mile Markers distributor versus manufacturer model shows up in their numbers. While gross profit margins only increased from 45% to 47%, operating margins increased from 16% to 24%. This is obviously because SG&A grew much slower than the 75% jump in revenue. Additionally, working capital as a percentage of revenue (AR + Inventory less AP), declined from 44% to 33% from 03 to 04. Finally, net income and FCF should track closely because the company has minimal maintenance CAPEX requirements due to its outsourcing model (03 capex of $1.8mm included a $1.2mm purchase of their Florida building). This model has proved advantageous to Mile Marker because they have been able to price their products below their competitors. I have read the PPM that WARN circulated in 2003 when it was being shopped around to private equity firms (ultimately bought for $325mm by Dover when it had TTM revenue of $150mm and $40mm in EBITDA) and they talk about how they are in the process of moving some of their facilities overseas to locations like Mexico. The reality is that even today WARN does most of their manufacturing in a plant in Oregon that is 10 times the square feet of Mile Marker’s combined distribution warehouses and serves as a home to over 500 workers. Mile Marker simply doesn’t have to deal with these legacy issues and it shows up in their pricing.
Future Revenue Growth:
The big question centers around future revenue growth and that is where things get interesting.
2004 Revenue Break out:
$mm % of Revenue
Military Winches: 8.8 38%
OEM: 7.0 30%
Electric Winches: 3.5 15%
Hydraulic Winches: 2.3 10%
Hubs: 1.6 7%
Total: 23mm
Military Winches:
Mile Marker sold 3,249 replacement winches in 2004 that went to replace the old WARN winches on military humvees. If you look at the old press releases, you will notice that the company has been continually rewarded with accelerated orders from the military for these winches. Most recently on February 15th, the Company announced their biggest contract to date for 15,975 winches worth up to $40,608,450 over five years. Since 1999, the company has delivered a total of 8,700 winches (with no complaints I might add and every announced contract fulfilled whose timeline came up), and has a total backlog now of 27,538 winches worth approximately $67,962,040. This equates to around $2,500 bucks per winch (notice volume discount from 04 price of $2,700). If you look at the total number of humvees that AM General has produced for military use (180,000) and combine it with the knowledge that every one out of five is to be equipped with a Mile Marker Winch, you get pretty darn close to the total cumulative orders that Mile Marker is projected to ultimately produce (36,000 versus 36,238).
The bad news is that I don’t foresee any growth from this segment after this backlog is fulfilled. The good news is that I have confidence that they will be produced. A backlog of 3 times total revenue on a 38% piece of the 2004 revenue pie is hard not to get excited about - especially when you consider that the other segments have momentum as well.
OEM:
The OEM segment represents 30% of Mile Markers 2004 revenue and I expect this segment to increase substantially in 2005. This segment reflects the fact that every NEW military humvee gets a Mile Marker Winch (1 in 5 doesn’t apply here). An article in the Associated Press dated January 8th, 2005 stated that “AM General said in December it was working to manufacture an additional 100 humvees per month – 550 monthly – by February in response to calls for more armored humvees in Iraq.” The math works out to revenue run rate of around $13.5mm annually for this segment although the duration of this production I cannot predict.
Electric, Hydraulic, and Hubs:
Together these segments represent 32% of Mile Markers 2004 revenue and are all commercial (recreational truck winches, ATV’s etc.) in nature. I expect Hub revenue to level off but there should be sustainable gains in the electric and hydraulic revenue. Beginning in 2005, Mile Marker began making ATV sales in what has traditionally been a market controlled by Winch (92% of the $44mm market controlled by Winch according to their 03 estimates.) The recreational truck market is estimated to be around $150mm and Mile Marker should increasingly gain market share here given their lower price points and heightened effort in this arena (lot of potential gains here but impossible to quantify).
Management and why I’m comfortable with them:
All investments have some sort of “hair” on them and typically one is left playing a game of probabilities in determining how to weigh them accordingly. This is one of the few cases where most of the big negatives dealt with perception with the implied opportunity to be resolved by reality.
• Florida Location – Maybe it is because I grew up in Peoria, Illinois and I’m just jealous but I have a clear and negative bias toward firms located in Florida. It seems to attract the slick get rich quick crowd.
• History of the company – The Company gained public equity status by doing a reverse merger. Never a good combination when you combine this with issue #1.
• Nepotism and Management Control – Richard Aho, Drew Aho, and Richard’s former wife are all on the board of directors and control over 50% of the company.
The biggest contributor to helping me get comfort with all three of these issues was the time I spent in person with Mile Markers CFO, Al Hirsch. Besides actually touring the warehouse and seeing the winches being made, my assessment of the overall integrity and smarts of Al couldn’t be higher. On a $40mm market cap company, I have never seen a more sophisticated and above board CFO. Al graduated from NYU (took Peter Drucker’s course – got a C!) and ran his own consulting firm before joining Mile Marker. This guy understands how to run a company from a financial perspective in a way that would make even Dan Loeb grin (slightly). An owner today can be certain that the future value creation that goes on at Mile Marker will accrue to all shareholders equally and that dividends and stock buybacks will continue to play a significant role.
Dividend Note and Implications:
Dividends have increased from 10 cents a share in 03, to 16.5 cents a share in 04, and most recently got bumped up to 26 cents a share for 05. They typically like to pay out 50% of earnings as dividends which would imply .50 cents a share in earnings in 05. This equates to a $5mm dollar earnings level for 2005 which implies a 40% YOY earnings increase and an 8x P/E for a company that is rapidly growing and has a return on invested capital over 40%.
Valuation:
One could use the Dover comps on WARN to easily do a back of the envelop calculation on Mile Markers likely 2005 sales and EBITDA range that would show at least 50% upside in price from here (8x EBITDA in the 7-9mm range). I don’t think the company would sell out at this price given the future growth ahead.
I have run a 5 year discounted DCF that I feel is super conservative and shows the range for potential upside using two key variables: revenue growth and operating margins.
Base Case Assumptions:
Excess Return Period: 5 years
Revenue Growth: 20%
Operating Margins: 25%
WACC: 10%
D&A = Capex
Working Cap as % of sales: 33%
Tax Rate: 36%
Valuation Output:
Discounted Excess Return Period FCFF: 14.5mm
Discounted Corporate Residual Value: 57.5mm
Plus Cash: 0.3mm
Total Corporate Value: 72.4mm
Less Debt: 3.7mm
Total Value to Common Equity: 68.7mm
Intrinsic Stock Value: 6.9
Common Stock Upside Today: 72%
Under this scenario, 2009 revenue is $58mm and NOPAT is $9mm. While I got terminal value by assuming the company earns their cost of capital after year 5, terminal value is also equivalent to one times sales (or double what Dover paid for WARN). I would be shocked if we don’t see $50mm in revenues in the next few years given the backlog but I want to be conservative.
Intrinsic Value Sensitivity Table:
Operating Margin Revenue Growth
10% 20% 30%
20% 3.7 5.2 7.4
25% 4.8 6.9 9.7
30% 5.9 8.5 12.0
Conclusion:
Mile Marker is priced today in the quadrant that assumes 10% revenue growth and operating margins of 20% for 5 years. Talk about margin of safety.
Catalyst
Operating results
Increasing dividend