Frank Voisin is the author of the popular value focused website Frankly Speaking, found at http://www.FrankVoisin.com
Jewett-Cameron Trading Company Ltd. (NASDAQ:JCTCF) operates in four industries: industrial wood products; lawn, garden and pet supplies; seed processing and sales; and industrial tools and clamps. The company has been aggressively repurchasing shares over the last two years, reducing its shares outstanding from 2,390,977 by 34% to 1,567,971subsequent to the end of the recent quarter. Furthermore, insiders own 969,202 of these shares, or 62% of the company. To paraphrase Peter Lynch, ”there are many reasons insiders sell, but only one reason insiders buy” and that is a strong confidence in the company’s prospects.
Given the bullishness of those best positioned to assess the company’s prospects, I thought it would be worth taking a closer look. With JCTCF, there are many things to like. For one, the company has a market cap of $14.2 million, no debt and $3.9 million in cash, for an EV of $10.3 million. Over the past three years, the company has generated average free cash flow of $2.4 million, representing a 23% yield. Furthermore, the company is trading at a (slight) discount to its tangible book value of $15.3 million, which should provide somewhat of a floor for how low the company could go (especially considering that it is profitable).
The company has been consistently profitable for the last decade and generated positive free cash flow for the last eight years. Given the company’s large excess cash position and lack of debt, invested capital is the appropriate comparison metric, and over the last four years, it generated average CROIC of 25.7% and average ROIC of 16.9%.
All of this impresses me. But there are a few points of concern.
First, the company’s revenues took a dramatic hit in the recession, with 2004-2008 average revenues of $71 million declining 41% from 2009 to 2011 to just $42 million. While all of its operating segments experienced some decline, the bulk was due to its Greenwood segment which sells wood to boat manufacturers. This division saw revenues decline from $28 million to just $8.5 million over the period. Here’s what the company had to say:
Sales of plywood to boat manufacturers … has been severely affected by weak economic conditions. Boat manufacturers continue to work down excess inventory accumulated over the several years, and until such point, we do not foresee an industry recovery. We continue to develop a readiness to participate when the market rebounds.
Suggesting that the decline is due to weak economic conditions might be only part of the truth. The worst of the decline in this division occurred in 2009 when the company made this announcement in its 10-K (emphasis mine):
Sales at Greenwood were $11,484,094, which was a decrease of $16,503,957 or 59% compared to sales of $27,988,051 in 2008. The sharp decline is attributable to continued weak demand from the boat manufacturing industry. Sales of plywood to boat manufacturers represented approximately 24% and 59% of Greenwood’s total sales during 2009 and 2008 respectively, and demand from these customers has been severely affected by weak economic conditions. Furthermore, Greenwood lost a major group of boat manufacturing customers, when a two year contract came up for renewal at June 30, 2008.
The company does not break out how much of the decline was due to the loss of a “major group of boat manufacturing customers” but given the use of the intensifier “major” suggests that this might account for most. If this loss means that these manufacturers found a different supplier, then JCTCF has lost market share and will not automatically rebound to past levels as this market picks up. Unfortunately, this is all that was disclosed, and there isn’t enough here to go on.
Another potential issue here is related to executive compensation, which is too low. Yes, you read that correctly. This is the first time I’ve ever complained about executives being under compensated. Since 2000, the company’s CEO, Donald Boone, has taken a salary of $36,000. He has received zero bonus in all but one year (2001, when he received $30,000) and zero options or other non-cash awards. Furthermore, the company’s CFOs have tended to earn very little, often in the high $80k range. Compare this to the Corporate Secretary. Michael Nasser, who has earned roughly $177,000 for most of the decade. There is no explanation given as to why the Corporate Secretary earns a multiple of the CEO. Both own significant portions of the company (29.89% and 13.88% for the CEO and Secretary, respectively).
The concern here is that if the CEO were to retire, his replacement would certainly not work for $36,000 per year. One would expect a CEO to earn at least what other executives earn, which would increase the executive compensation by at least $150,000. This might not seem like much, but $150,000 of extra compensation (a $100,000 after tax expense) represents 11% of last year’s earnings! This is also an understatement of the problem, as I noted the CFO seems to be underpaid as well.
The final issue worth highlighting is that company insiders do own a significant portion of the stock and the company is aggressively repurchasing shares. There is a risk that, as unrelated investors become a smaller and smaller portion of the investor base, the company could be taken private at a price that does not reflect the company’s true value (drag along provisions allow minority shareholders to be pulled along if a deal is approved by the majority, though there are regulations that do mitigate this risk to a degree). Another issue related to this is the potential for the company to cease filing with the SEC (and avoid the high associated costs) if the number of investors drops below a certain threshold.
So overall, JCTCF looks like a good opportunity, but there are some risks that investors need to be aware of. What do you think of JCTCF?
