From the Mailbag: Overhill Farms, Inc. (OFI)

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Frank Voisin is a value investor and independent analyst whose site, Frankly Speaking, contains Frank’s investment theses as well as educational material to help investors avoid value traps. Subscribe to Frank’s feed here.

Increasingly over the last month, I have been receiving emails from readers with questions about particular companies. I hope to begin instituting a regular feature where I will review these companies (after responding to the reader privately, to give him/her a chance to act). If you have a company that appears to be a value opportunity and want my take on it, contact me here.

Today’s company comes from Clark, who asks what I think of Overhill Farms, Inc. (AMEX:OFI). OFI manufactures prepared frozen food products for branded retail, private label, foodservice and airline customers, including Jenny Craig, American Airlines and Safeway. There are several things to like about this company, namely its low debt level which the company has been aggressively repaying over the last few years (currently $13.6m worth of debt, down from $43.9m in 2007, a reduction of 70% in just three years!) and a stable and somewhat improving gross margin (the last three years of the recession have shown the gross margin to improve to 12.2% from a previous average of 11%). However, I have a few concerns that make this company an inappropriate value investment from my perspective.

First, the company derives its revenues from an extremely concentrated source, with 73% of its sales coming from its three largest customers. The company recently saw one of its customers, H.J. Heinz, cancel its contracts and bring production of its frozen food products in-house. Though its other large customers would likely be less capable of bringing production in-house (since they are not already engaged in the food manufacturing business), there is always a risk that one of these large customers could switch suppliers which would decimate the company’s profitability. Already, due to the reduction in total revenues over the last few years, the company has had to switch to smaller production runs in order to keep inventory levels at reasonable levels. The consequence has been COGS increasing in the current fiscal year (eroding the stability of the gross margin, as mentioned above).

Second, the company’s board has historically shunned takeover offers. In February 2008, Louis Giraudo (a partner of GESD Capital Partners and a director of OFI) resigned when the company failed to pursue a bid of $4.40/share by GESD. The company had been trading for just $2.30 in the days prior to the offer (though it had traded above $4.40 earlier in 2007).

Third, the company has, in the wake of this takeover offer, amended its employment contracts with senior executives to add golden parachutes in the event of a change in control.

Finally, and most importantly, the company is not currently trading at a discount to its intrinsic value. On an asset basis, it has tangible book value per share including operating leases around $1.60 and negative NCAV. On an earnings basis, the company fares better with an EPV using historical margins and a reasonable estimate of stable revenues of approximately $4.80 (Not bad, considering the company recently traded at a discount to this, though in my opinion not with a sufficient margin of safety). Given the company’s reliance on a few major customers, this EPV is not as certain as I would like, and I would have to see the company trading at a very significant discount before I would reconsider.

Talk to Frank about OFI

Author Disclosure: No position.

Read more: From the Mailbag: Overhill Farms, Inc. (OFI) | Frankly Speaking
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