Author Topic: FRD - Friedman Industries  (Read 9380 times)

samaniv

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Re: FRD - Friedman Industries
« Reply #10 on: July 06, 2017, 11:00:42 AM »
Hey wabuffo,

Thanks for the comments. You raise some good points on the inventory valuation. A few comments:

1) There is a 5.6MN LIFO cost reserve - and given that weighted average cost more accurately follows inventory movement (hence reason LIFO not allowed under IFRS) - the true inventory carrying value is actually 39.5M. Meaning the discount I have taken is just over 20%.

2) Steel does not spoil or go obsolete - so the only real time FRD would sell it below carrying value would be if there was a fire sale. This would probably only happen if there was a forced liquidation (requiring a sharp write-down). I do not see a forced liquidation as likely - given that FRD has no debt.

I have noted that this is their "liquidation value" but most companies which we value on a liquidation  basis - never actually liquidate. So this is very much a theoretical exercise to show that something is cheap. Most net-nets don't realize value through liquidation, but through mean reversion, special dividends, or some other catalyst. The exercise of showing that a security trades at a discount to net current asset value is merely just to show that a security is cheap.

So yes, I agree that in a firesale a 30-40% markdown on inventory would be required. But a more probable outcome is that Friedman sells  its inventory for above carrying value and is left with an operating business which generates earnings going forward. I view it as unlikely that the inventory ever gets sold at a 30-40% discount.

I see how you could make the argument that in a true liquidation a firesale would be required and therefore the downside is not as well protected as I have implied in my article. But I view this as a highly improbable outcome.

Rather than computed the "liquidation value", I am really trying to value the redundant assets. I am trying to make the argument that FRD has its market cap in redundant assets which will be sold off, leaving an operating business for essentially free.



wabuffo

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Re: FRD - Friedman Industries
« Reply #11 on: July 06, 2017, 12:58:36 PM »
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1) There is a 5.6MN LIFO cost reserve - and given that weighted average cost more accurately follows inventory movement (hence reason LIFO not allowed under IFRS) - the true inventory carrying value is actually 39.5M. Meaning the discount I have taken is just over 20%.

Samaniv,

Whether FRD used weighted average or LIFO inventory accounting is irrelevant, IMHO.  The inventory dollar value on their books is just the accounting value of the sunk cost of past cash consumed by the Company for steel purchases and labor embedded in the finished goods.  LIFO/FIFO/weighted avg is just the different flow assumptions of what historical production cost of goods gets allocated to the units when sold. 

It is neither a conservative (nor aggressive) indicator of anything that might be useful in estimating economic value.  The true economic value is largely what customers are paying for these goods today.  In a fast-turning inventory environment, you could use the accounting values as a good proxy.   But in this situation. I would argue the value of their "investment" in tubular finished goods is too high under either LIFO or weighted avg accounting since they have over two years supply.  This indicates to me that they are resisting selling below their "conservative" LIFO cost because it would mean realizing a larger accounting loss (even if it means realizing a positive cash flow). The longer they wait, the more risk they take that steel prices fall (for which they would have to write down their inventory values further).  Of course, they could get lucky if steel imports are restricted by the US govt -- but I wouldn't want to build that into an investment thesis.

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I have noted that this is their "liquidation value" but most companies which we value on a liquidation  basis - never actually liquidate.

Well I think that this particular company has a better than 50/50 chance of actually liquidating - so you better start sharpening your pencil!  Its management team sunk almost $10m into expanding its tubular plant just as this business segment collapsed and is very long inventory it can't sell.  That may be a fatal mistake in a tough business with razor thin margins.  Meanwhile its bleeding cash and its "conservative" Grahamian liquidation value per share keeps falling every quarter for the last couple of years.  It sounds like you are making a big assumption that this business is a going concern and you have time to wait.  I'm not so certain of that.

If not a complete liquidation - then at least a partial liquidation of its tubular segment may be likely where they have $37m of assets (capital + inventory) tied up earning less than nothing and consuming cash for over two years now.   Perhaps they get lucky and the business rebounds, perhaps they don't and they take on bank debt to keep the plates spinning in the air...

I think it would be helpful to do a deeper-dive on the actual math of what value would be left over if they actually liquidate (or partially liquidate), including one-time exit costs.  I haven't done a detailed analysis but my estimate is less than $4 per share, FWIW.  But I haven't looked closely at it so that's a SWAG and not worth much as an estimate.  As Munger has said about these Graham cigar butts, you think you have this nice net working capital...and then you shut down and the working capital is gone!

FWIW, just trying to play devil's advocate...

wabuffo

samaniv

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Re: FRD - Friedman Industries
« Reply #12 on: July 06, 2017, 01:41:13 PM »
Wabuffo,

I appreciate the comments - in fact - its why I post on here. A couple of points to clarify my thinking:

1. Inventory -  of course the economic (net realizable value) is what we care about. The carrying value is merely a proxy. To clarify, it is the coil segment which  uses LIFO. The tubular segment uses weighted avg cost already. Consequently, the entire reserve applies to the coil segment.  They did 65M in coil sales and have 9.5MN of inventory on hand (so don't think there is an impairment issue here).

For the tubular segment - I would rather them wait and sell it when steel prices recover - rather than discount it heavily and liquidate it at depressed market prices. Yes, steel prices could decline further - but they could also rise further. There are some positive signs such as increased rig counts and US Steel re-opening mill #2 . In fact, US Steel said in their quarterly statements "Total US rig count stands at 857 in April 21 (2017), 112% increase over lowest point in May 2016. Increase in rig count is related to onshore activity which will primarily benefit Fairfield and Lone Star Welded Operations". The lone-star welded operations it the same market FRD serves.

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Meanwhile its bleeding cash

I don't really think they are "bleeding cash".  200k cash used in operations in F'17 and positive 3M in F"16. There was high cap-ex due to the facility you mentioned, but this is over now. Going forward - I don't see a massive cash burn?

I do value the company as a going-concern and do not see a 50/50 liquidation chance. I think the unlevered balance sheet gives them this flexibility to wait it out - and since they are not aggressively burning cash - they have the time to wait.

wabuffo

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Re: FRD - Friedman Industries
« Reply #13 on: July 06, 2017, 04:09:56 PM »
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I think the unlevered balance sheet gives them this flexibility to wait it out - and since they are not aggressively burning cash - they have the time to wait.


This is the key question - which comes first.....1) recovery of their customers capital spending, or 2) they run out of cash.   

Latest Q, they burned through $4m and are down to $1m of cash on the balance sheet as they try to start up their new $9m Mill at their Lone Star plant.  They do have more inventory to liquidate, so perhaps they can get more aggressive in that area in order to generate some cash.

What is your estimate of their average earning power over a complete business cycle?

wabuffo

samwise

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Re: FRD - Friedman Industries
« Reply #14 on: August 24, 2018, 02:38:24 PM »
This jumped from 6 to 11 after their recent report. I got out by 9.5.

mjohn707

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Re: FRD - Friedman Industries
« Reply #15 on: August 24, 2018, 03:19:18 PM »
This jumped from 6 to 11 after their recent report. I got out by 9.5.

I sold half of mine, probably will sell the rest of it soon
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BG2008

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Re: FRD - Friedman Industries
« Reply #16 on: August 24, 2018, 04:13:19 PM »
It's interesting that this name was stagnant for 2-3 years and then all a sudden this year, it essentially doubled.  I bought a portion in 15 or 16, I don't recall and I bought more earlier this year.  The first batch, it looked like dead money for a long time.  The second batch makes me look like a genius.  Value investing, sometimes  you just don't know and need the patience. 

samwise

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Re: FRD - Friedman Industries
« Reply #17 on: November 05, 2018, 07:54:34 PM »
Admire your patience mjohn. I feel the risk with these names is that they are really bad businesses and ones IRR goes down the longer one holds them. I've leant towards selling earlier than later, although sometimes that looks bad in retrospect. Do you have a target or scaling method that has worked for you.

BG2008, yes indeed I think this is common for ignored and less followed names. The market is not active. But if you bought in 2015 at about 6 and sold in 2018 at about 9, thats 50% in 3 years. I'd be happy if I could do that every time.

Sorry all for the very late replies.

mjohn707

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Re: FRD - Friedman Industries
« Reply #18 on: November 07, 2018, 11:13:26 AM »
Admire your patience mjohn. I feel the risk with these names is that they are really bad businesses and ones IRR goes down the longer one holds them. I've leant towards selling earlier than later, although sometimes that looks bad in retrospect. Do you have a target or scaling method that has worked for you.

BG2008, yes indeed I think this is common for ignored and less followed names. The market is not active. But if you bought in 2015 at about 6 and sold in 2018 at about 9, thats 50% in 3 years. I'd be happy if I could do that every time.

Sorry all for the very late replies.

I set a goal price and just sell when it hits that goal, sometimes part of a position a little before that and all.  Yep most of these names are bad businesses and they aren't going to be homeruns or anything like that, but sometimes a single or a double is good enough, just depends on your expectations
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