Business

Barron’s 2018 Roundtable Notes: Scott Black Long Lam Research, Ares Capital, Hooker Furniture

Scott Black – Delphi Management

For all the Barron’s 2018 Roundtable articles and notes click here.

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Notes:

Lam Research (LRCX) $212.69 ($196.40 when published)

  • It is a powerhouse in semiconductor capital equipment, and its products are used primarily in front-end wafer processing, which is becoming a $50 billion business
  • Lam has a 56%-57% market share in wafer etch, and about a 40% share in vapor deposition. It wants to gain another four percentage points in both through 2019.
  • We estimate that Lam will have $10.3 billion of revenue in fiscal 2018, up 28% year over year, and $3.065 billion in profit before taxes. With a 14% tax rate, after-tax income will total $2.6 billion. Divide by 182 million shares, fully diluted, and you get $14.48 a share in earnings.
  • Doing a similar calculation for fiscal 2019 gets you earnings per share of $15.45. Splitting the difference, the company will earn about $15 a share for calendar 2018.
  • There is no stock-based compensation to consider, so that’s a clean number.
  • Lam has $22 a share in net cash. Exclude that and the stock sells for 11.6 times earnings.
  • 71% of cash is trapped overseas, and it isn’t clear that it is going to come back here.
  • Return on book value could top 30% in calendar 2018. Free cash is equal to net income. Breaking down the business, 66% of revenue comes from memory and the rest from logic and foundry.
  • What is driving demand is smaller line widths and multipatterning, along with the Internet of Things and cloud. Lam has the wind at its back.
  • It generates 86% of its revenue in Asia, and its chief customers include Micron Technology [MU], Samsung Electronics [005930.Korea], and Taiwan Semiconductor Manufacturing [TSM].
  • The stock is overlooked becasue They retain a notion from 1995 to 2000 that semiconductor-equipment manufacturing is wildly cyclical and a bad business. In fact, the chip industry has become much less volatile.

Hi-Crush Partners (HCLP) $13.90 ($11.40 when published)

  • Mines fracking sand [used in the process of hydraulic fracturing of shale energy formations].
  • Hi-Crush mines sand in Wisconsin and at its new Kermit facility in the Permian Basin. It is the industry leader
  • There are 92 million fully diluted shares outstanding, and the market cap is $1.05 billion.
  • The company pays a 60-cent dividend per share and yields 5.3%.
  • It is a limited partnership. Earnings are rising, and you get paid while you wait.
  • Last year. it mined 8.8 million tons, or 11% of the industry total. This year, it will have a 13% share.
  • Revenue could total $878 million. We calculate operating income of $191 million, interest expense of $11 million, and profit before taxes of $180 million.
  • Our earnings estimate for the year is roughly two bucks. The Street is higher at $2.28.
  • No significant capex charges associated with the mines. That’s behind them.
  • The stock trades for 5.7 times this year’s expected earnings. The company could earn about 21% on book value, and maintenance capital spending is only about $17 million. Two of Hi-Crush’s biggest customers are Schlumberger and Halliburton. Each has an annual contract with the company.
  • Free cash flow will total $140 million this year.
  • Oil prices have gone up a lot in recent months. The rig count is up 25% from a year ago. There are 22,600 oil and gas wells operating in the U.S., up from 16,950 a year ago.
  • Natural gas is trading at about $2.80 per thousand cubic feet. It is still economical to drill at that level.
  • Primary demand [for energy] is driving demand for sand. Hi-Crush produces several types of sand. Fine sand, put through a mesh, is 75% of the mix. Coarser sand is 25%.
  • On the financials, debt is 1.5 times EBITDA. Net debt is 0.22 times equity. Tangible book value is $8.53 a share. The stock is trading for 1.34 times tangible book.
  • Hi-Crush has better economics than competitors.
  • Hi-Crush has the dominant position in the market and excellent logistics. It has good relationships with the railroads, including Union Pacific [UNP] and Canadian Pacific Railway [CP], and has built its own infrastructure and terminals down in the Permian Basin.
  • It offers a good yield and a good opportunity for growth.

Gray Television (GTN) $17.55 ($16.10 when published)

  • The company is based in Atlanta. There are 89.9 million shares outstanding, and the market cap is $1.45 billion.
  • Gray has 103 stations in 57 markets. It is rated No. 1 or No. 2 in 55 of those markets. Each station operates as its own profit center. The company operates 39 CBS, 29 NBC, 21 ABC, and 14 Fox stations.
  • Gray stations have the highest political-ad spending per household of any of independent-owned and -operated stations in the U.S.
  • Total debt is five times annual Ebitda. Net debt is 2.8 times.
  • Gray ended 2017 with $880 million of revenue, which could climb to $1.1 billion this year. Winter Olympics advertising could add about $9 million and political advertising, about $130 million.
  • The company could have $416 million of broadcast cash flow. The stock is trading for 7.5 times enterprise value to broadcast cash flow, which is quite cheap.
  • Look for net income of $155 million, or $1.72 a share.
  • Gray’s No. 1 priority for cash flow is to use it to reduce debt. The company is well-run and dirt cheap.
  • Recommending the nonvoting stock. Supervoting shares [GTN.A] trade at about a $2 discount to the ordinary shares.

Ares Capital (ARCC) ($15.79 when published)

  • A specialty-finance and business-development company. It invests in the debt and equity of privately held companies.
  • It is a yield play; it pays a dividend of $1.52 a share and yields 9.6%. You might have to reach down in quality to buy a junk bond with a 5% or 6% yield. Not here, and you’re getting a higher yield.
  • The company has an investment-grade credit rating [BBB].
  • Likes to invest in noncyclical businesses with attractive growth prospects and high free cash flow.
  • Core earnings, as the company calls it, are about 36 cents a share per quarter. If Libor rises by half a percentage point this year, that could add eight cents to earnings. Ares has a Libor-sensitive balance sheet.
  • The company’s net debt-to-equity ratio of 0.61 allows it to increase its leverage and grow its portfolio. It has $600 million in excess borrowing capacity.
  • I have an earnings estimate of $1.61 a share for this year, compared with the consensus estimate of $1.57. The stock trades for 9.8 times earnings.
  • Tangible book value is $16.49 a share. The stock is selling for 96% of tangible book, with dividend coverage of 124%.
  • Return on equity is about 10.2%. If interest rates move up a little, ROE could return to 12%, where it stood in 2012.
  • Loan losses, or nonaccruing loans, are only 0.9% of the fair value of the total portfolio.
  • It avoids retailing and mining, and is cautious on oil and gas. About 21% of the portfolio is health care, 19% is business services, and 7% is consumer products.
  • Only 4.4% of the deals the company considers come into the portfolio. Management looks chiefly at investing in companies with $15 million to $75 million of annual Ebitda.
  • Some 91% of the portfolio is floating-rate, and the rest is fixed-rate. But their funding is 82% fixed and 18% floating. They have locked in the rates on the liability side but can benefit from an uptick in interest rates.
  • The average maturity of its loans is 4.2 years, and the loan-to-value ratio is about 54%.
  • Of the loans, 41% are first-lien senior secured, and 35% are second-lien senior secured. It isn’t trading down in credit quality to get more yield.
  • The management team charges a fee of approximately 25% of interest income.
  • Not worried about commercial banks getting into it.

Hooker Furniture (HOFT) ($40.75 when published)

  • A tiny company based in Virginia. The company’s furniture is sold through retailers across market segments. About two years ago, Hooker acquired Home Meridian International.
  • Hooker pays a 56-cent dividend and yields 1.4%.
  • The legacy business produced $233 million of revenue in the fiscal year ended in January 2017 and Home Meridian, $344 million, for a total of $577 million. In the year just ended, revenue was about $630 million. The company expects mid-single digit growth this year, which suggests revenue of $662 million. Add the recent acquisition of Shenandoah Furniture and you’ll get $706 million, reflecting a gain of 12% year over year. The Street is at $709 million.
  • We see 7.3% operating profit margins this year. The tax rate will fall from 35% to 21% since this is a domestic company.
  • Net income could total $40.7 million, or $3.48 a share, versus $2.62 the prior year.
  • The stock trades for 11.7 times expected earnings. Hooker isn’t as cheap on a price-to-book basis. The stock trades for 2.15 times book value of $18.96 a share.
  • The company could be debt-free by the end of the year.
  • Consumer confidence is the key driver. The housing markets helps too.
  • Costco Wholesale accounts for 10% of Hooker’s revenue. Macy’s [M], the only traditional department-store customer, is under 10%.
  • The company has good supply-chain management. It has been able to grow the top line by 27% over the past five years.
  • Operating income is up 31.9% annually in that span.
  • About 85% of the furniture is imported from Asia.
  • You’re paying a low multiple for a decent return on equity, solid free-cash generation, and a clean balance sheet.
  • Almost no one follows the company.

Article by Brian Langis