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Payfare ($PYFRF) Writeup – Delivering Growing Profits
Payfare Inc (PAY CN) is a Canadian-listed payments company with a C$290m market cap that has C$85m of cash and no debt. The business is the dominant player in a niche market, offering instant payouts to gig workers once they complete a delivery or ride. The business has a very impressive long-term track record of growth and has recently inflected to profitability. Despite partnering with the largest delivery companies like Doordash, Uber, and Lyft, the company is little known among US-growth investors. I expect that to change in the coming quarters and years for a number of reasons.
I expect the business will grow revenue at a 20% CAGR to $600m, EBITDA at a 28% CAGR to $114m, and EPS at a 25% CAGR to $1.95 in 2029. Based upon my long-term expectations for profitability, I estimate that the business may be worth over C$30/share in 2029, providing a +37% CAGR over the next 5 years.
The company was founded in 2015 and gained traction with platform gig companies starting in 2019, first winning Uber, then Lyft, then Doordash. Unlike many US fintechs, Payfare did not raise venture capital money, and instead bootstrapped the business, raising some money from its founders and friends and family until its 2021 IPO at $6/share. Because of this dynamic, many investors do not know about Payfare despite one of the best growth track records that I have seen. From 2019 to 2024, the business grew monthly active drivers from 75,000 to over 1.5m, +84% CAGR, grew gross dollar valued loaded from C$485m to C$14.6bn, +98% CAGR, and grew revenue from C$6m to C$240m, +109% CAGR. Perhaps even more impressively, the business inflected to profitability six quarters ago and hasn’t looked back, continuing to expand profit margins, including growing operating income by +320% y/y in 1Q24.
Despite all this success, the market has not noticed with the shares trading flat since their March 2021 IPO. I expect that to change for a few reasons and that the stock may have a very strong period of performance over the next 5 years.
What the business does
Payfare partners with the largest gig platform companies to enable drivers to get paid within seconds of completing a delivery or a ride. Specifically, Payfare powers programs such as DasherDirect by Payfare, LyftDirect by Payfare, and the UberPro card in Canada. Drivers sign up for the platform to make extra money. They are asked if they would like to enroll in DasherDirect by Payfare. If they opt-in, they will download the app and also be sent a card. I estimate that about 40% of Dashers prefer to be paid by the app. The main reasons for the driver preference are (1) instant payout of funds (2) ability to track gig earnings and expenses which significantly streamlines paying taxes (3) cashback rewards on things like gas (4) other benefits like health insurance and other unique offers. Payfare does not charge DoorDash or the gig drivers anything for the program. Instead, Payfare earns its revenue from interchange (swipe fees) when dashers use the card or app to make purchases. This creates a seamless, frictionless experience for all parties. The gig platforms love Payfare because it improves their driver retention and offers a benefit that keeps the drivers coming back to their platform. Often gig workers are lower to middle income people with relatively low extra cash reserves. Instead of turning to a payday loan or other high-cost source of borrowing, the driver can do a few extra deliveries and be instantly paid so they can cover their living expenses.
Growth opportunities
Payfare has three growth pillars, that I expect will driver 20% revenue growth and faster profit growth over the next 5 years.
1. Growth with existing clients.
a. Payfare grows with existing clients as their businesses grow and as program penetration increases (a higher % of existing drivers signup). DASH, UBER, and LYFT are expected to grow at a 10-15% CAGR over the next 5 years which should provide a solid base of growth for Payfare.
b. International Expansion – Payfare can take its programs to international markets with its existing clients, that currently operate internationally but do not offer an instant payment option.
2. Adding new clients. Payfare announced that it recently won a big box retailer in Canada, powering instant payments for their gig drivers. Given the scale of the customer, it seems like it is probably Walmart but could potentially be Costco or Amazon. There are additional companies
3. Entering new, adjacent verticals. Payfare is entering the earned wage access business with a partnership with Ceridian. This enables normal employers to pay their employees with paycards instantly, instead of the typical 2 week pay cycle. This matters most in high turnover industries where compensation is relatively lower, such as restaurants, retail, and hospitality. Employers can use the instant pay as a retention tool and help keep their employers from taking high-cost debt from predatory lenders, like payday lenders.
Overall, I expect Payfare will grow at a 20% CAGR over the next 5 years, given the stickiness of their customers, the track record, and the growth opportunities that are in front of them.
Valuation
I estimate that the business will generate C$600m revenue in 2029, C$180m gross profit, $114m EBITDA, $91m free cash flow, and $1.95 of EPS. Based upon payment sector valuation metrics on these future results, I estimate the business will be worth between C$27 and C$39/share in 2029, giving the potential for a +37% CAGR over the next 5 years, from the current price of C$6.06/share.
Why does the opportunity exist?
• Payfare had a trading halt that lasted for 12 trading days from June 18th until July 5th. The trading halt was because their processing partner had a internal issue getting their SOC 2 audit completed. There were no financial issues, restatements, etc with Payfare. This episode was frustrating for Payfare shareholders and is now in the rearview mirror. Payfare was restricted from buying back shares over the last several months while it worked through the SOC audit with its vendor. That has now changed, and I expect Payfare to begin a significant repurchase program given its C$85m of cash with no debt and C$25m of free cash flow generation this year. Management owns a significant amount of stock personally and are well aligned with shareholders.
• Payfare is listed on the Canadian TSX, despite generating 99% of its revenue in the US. Canadian investors don’t know the gig platform businesses as well as US investors do. And US investors don’t know that Payfare exists. I expect that Payfare will move its listing to the US Nasdaq in the next 1-2 years which will help close the awareness gap.
• Some investors may worry about customer concentration with Doordash likely a little over half of revenue and meaningful contribution from Uber and Lyft. Payfare has never lost a partner, as far as I know. One thing to keep in mind is that churn for these types of programs is higher when the program does not attract many users because there is no user base to convert to a new program manager. However, with 1.5 million monthly active users, each user would need to be issued a new card and signup for a new program if there were to be a change in the program manager. In addition, co-branding the programs like “DasherDirect by Payfare” creates brand familiarity with Payfare among the drivers so it is not a white label processing arrangement. Ultimately, the successful programs are much stickier than investors realize.
• One other question is “why don’t the gig platforms do this themselves?” Handling payments is not their core competency – their focus is on acquiring users of the service and attracting and retaining drivers. DoorDash, Uber, and Lyft could create its own payment gateways and rip out Stripe or Adyen, however, they do not do that because those companies specialize in processing consumer card payments and can do it better, faster, and cheaper than the gig platforms can internally. Likewise, it is the same case with handling payouts to the drivers – Payfare specializes in this and has superior technology and service that can do it better, faster, and cheaper than the gig platform companies can internally.
Risks
• Earnings or revenue growth do not materialize as expected.
• Customer concentration risk with a few gig platform companies.
• Key man risk with a few of Payfare’s executives being critical to the business.
Dave Inc (DAVE) Writeup
Dave is a fintech company that was started in 2016 by Jason Wilk. The company launched the Dave App in 2017. The company raised venture money in 2018-2021. The company came public in late 2021 through a merger with a SPAC, VPC Impact Acquisition Holdings III, that valued Dave at $4bn. Despite having a healthy ~10-20% profit margin for most of its life as a private company, after going public, Dave ramped up marketing and customer acquisition spending, which drove large losses in 2022 and 2023, masking the strong unit economics of the business. The management began pulling its profitability levers in 2023, and the results are beginning to show up now. There is significant upside to earnings estimates as the company continues to drive profitable growth. In particular, management is testing a new subscription pricing of $4/user/month for all customers who use Dave’s core cash advance product. By my estimates, this change alone will drive the company’s EPS to over $10/share in 2025 or 2026 versus consensus EPS of $2.10 in 2025. I estimate the stock is worth over $100/share in the next 12-18 months as the market realizes Dave’s earnings power and business value.
How the business works
Dave’s core product is a cash advance of $25 to $500, which is used by US consumers to help avoid overdraft fees and make ends meet. The business serves underserved consumers who often turn to costly check cashing or payday loans. There are three methods that consumers can borrow from Dave (1) instant on Dave card which is a 3% fee, plus Dave earns interchange on the transactions which averages about 2% (2) direct to bank account with Visa direct which is a 5% fee and (3) ACH transfer to bank account which is free. Dave does not charge interest on its cash advances – only the initial transfer fee for faster speed, similar to Venmo and CashApp’s revenue model of charging for fast delivery. Dave has 2.2m monthly active members that each average three transactions per quarter for a total of 6.6m transactions per quarter. The average origination size is $159 and the average revenue per transaction is $9, a 5.7% take rate. In addition, Dave earns money on tips and subscriptions. The cash advances are automatically repaid from the consumer’s bank account as soon as their paycheck hits the account. Dave’s credit losses are about 1.3% of originations because of the way they extend the extra cash products. Dave starts with a $25 advance. If that amount is repaid a few times, they will gradually increase it over time, up to a max of $500. The average duration is only 14 days, so the velocity of the advances is very high, allowing Dave to adjust its credit model in real-time.
Dave competes with companies like Chime, MoneyLion, and Brigit. Chime is expected to IPO in 2025 which will drive a further understanding of the cash advance business and an additional comparable company. Chime last raised capital in 2021 at a $25bn valuation.
Dave is an early adopter of artificial intelligence, using it both in its credit models to determine which consumers get cash advance offers and for how much and also in its call centers, resolving 90% of tickets without touching an agent. These results allow Dave to offer better customer service and a lower price point than competitors.
The path to $10+ EPS
Up until the last few months, Dave had no sell side analysts and investors did not understand Dave’s business model and potential. Even today, I estimate that the business has $10+ of EPS power in 2025 or 2026 versus the street modeling $2.10 of EPS in 2025. In addition to continued 20% revenue growth in the core business.
As discussed on the last earnings call, Dave implemented a new billing system and is testing new subscription pricing. I estimate that Dave could implement $3-5/month pricing for all of its monthly users. At that price point, it is still a meaningful discount to competitors such as Brigit which charge over $10/month in subscription fees.
I estimate incremental 50% EBITDA margin on core business growth, which is lower than the 150% incremental margin DAVE has driven over the last five quarters. The flow through of incremental revenue has been over 100% because Dave has reduced the level of spending on marketing and opex.
In addition, I estimate that Dave will generate $4/month on its 2.2m monthly active users, driving an incremental $106m of revenue at 90% margin. This drives 2025 EBITDA potential to $161m versus the street at $51m (the street is not modeling subscription pricing change).
From there, removing capex and capitalized software development cost, economic cost of dilution, and interest expense results in $137m of adjusted net income. Divided by 13.5m diluted share count gets $10.15/share of adjusted EPS (economic earnings). The company will not pay taxes for many years, given the large balance of NOLs. Note that stock-based compensation in the GAAP financials is based on stock awards that were granted at the time of the IPO at $320/share. I calculate economic dilution by looking at the market cap x % annual dilution from here which works out $400m x 2.5% = $10m/yr.
Valuation
I estimate that Dave is worth over $100/share based on 10x P/E. Dave currently trades at 14.2x 2025 P/E. Applying the same earnings multiple to my estimate of 2025 EPS arrives at a value of $144/share.
At $100, Dave would be valued at about $1.4bn which is meaningfully higher than its current valuation, but still significantly below the $4bn valuation that venture capitalists invested in 2021 and the IPO valuation at the same $4bn, despite Dave significantly growing revenue and inflecting the business to software-like margins >30%.
Looking at value through a different lens, consumer credit companies spend hundreds of dollars per user to acquire new users. Dave has 10.8m lifetime signups and 2.2m monthly active users. At $150 per lifetime customer signup, Dave is worth $1.6bn or $120/share. A strategic acquirer like Capital One or Citi might be interested in acquiring Dave and using Dave’s data on actual repayment history to make credit card offers to highly engaged consumers. Credit card products are much more lucrative than cash advance. Over time, if Dave is not acquired, the company may launch its own credit card or credit builder product.
Risks
• Dave may not realize the earnings power that I expect because they might not change the subscription pricing. Or consumers may use Dave less frequently if there is a pricing change.
• Dave faces credit risk. While credit metrics have meaningfully improved over the last several quarters, a weaker consumer could result in higher delinquencies and higher credit losses.
• Potential regulatory change. While Dave has never had any regulatory issues, the CFPB or other regulators could further regulate the cash advance industry which would impact the entire industry, including Dave.
Interesting partnership with BKKT+MA.
USIO has a very close relationship with MA and is already extensively working in the crypto space, as the exclusive ACH processor for Voyager (VYGR CN). I think USIO will be a big beneficiary from this change MA made over the next 1-2 years. In addition, the company's other business lines are doing great as well.
https://seekingalpha.com/article/4460820-usio-incs-payfac-business-is-a-rapidly-growing-high-quality-business-that-is-alone-worth-more-than-current-ev
$USIO new writeup on SA. Potential multi-bagger payments business.
https://seekingalpha.com/article/4460820-usio-incs-payfac-business-is-a-rapidly-growing-high-quality-business-that-is-alone-worth-more-than-current-ev
$USIO new writeup on SA. Potential multi-bagger payments business.
https://seekingalpha.com/article/4460820-usio-incs-payfac-business-is-a-rapidly-growing-high-quality-business-that-is-alone-worth-more-than-current-ev
New idea - hey guys I had a large position in TPNL, now pays in 2017. I have a new idea - do you guys have any thoughts on this?
OPXS - backlog +77% in the last two months. Optex is a high-quality defense business with strong management team. I estimate the stock is worth $5.50/share in 2 years and $10/share in 5 years based on 14x P/E plus net cash. The shares are $1.58 today.
https://seekingalpha.com/article/4450533-optex-systems-a-high-quality-business-seeing-sharp-increase-in-backlog
Hi, glad to see PRKA continuing to work here over the last few years.
My favorite idea now is OPXS. Backlog is +77% in the last two months. Optex is a high-quality defense business with strong management team. I estimate the stock is worth $5.50/share in 2 years and $10/share in 5 years based on 14x P/E plus net cash. The shares are $1.58 today.
https://seekingalpha.com/article/4450533-optex-systems-a-high-quality-business-seeing-sharp-increase-in-backlog
OPXS - backlog +77% in the last two months. Optex is a high-quality defense business with strong management team. I estimate the stock is worth $5.50/share in 2 years and $10/share in 5 years based on 14x P/E plus net cash. The shares are $1.58 today.
https://seekingalpha.com/article/4450533-optex-systems-a-high-quality-business-seeing-sharp-increase-in-backlog
OPXS - backlog +77% in the last two months. Optex is a high-quality defense business with strong management team. I estimate the stock is worth $5.50/share in 2 years and $10/share in 5 years based on 14x P/E plus net cash. The shares are $1.58 today.
https://seekingalpha.com/article/4450533-optex-systems-a-high-quality-business-seeing-sharp-increase-in-backlog
OPXS - backlog +77% in the last two months. Optex is a high-quality defense business with strong management team. I estimate the stock is worth $5.50/share in 2 years and $10/share in 5 years based on 14x P/E plus net cash. The shares are $1.58 today.
https://seekingalpha.com/article/4450533-optex-systems-a-high-quality-business-seeing-sharp-increase-in-backlog
OPXS - backlog +77% in the last two months. Optex is a high-quality defense business with strong management team. I estimate the stock is worth $5.50/share in 2 years and $10/share in 5 years based on 14x P/E plus net cash. The shares are $1.58 today.
https://seekingalpha.com/article/4450533-optex-systems-a-high-quality-business-seeing-sharp-increase-in-backlog
OPXS - backlog +77% in the last two months at high quality defense business with strong management team. I estimate the stock is worth $5.50/share in 2 years and $10/share in 5 years based on 14x P/E plus net cash. The shares are $1.58 today.
https://seekingalpha.com/article/4450533-optex-systems-a-high-quality-business-seeing-sharp-increase-in-backlog
Scout Gaming (SCOUT SS) - If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
Scout Gaming (SCOUT SS) - If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
Scout Gaming (SCOUT SS) - If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
Scout Gaming (SCOUT SS) - If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
Scout Gaming (SCOUT SS) - If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
Scout Gaming (SCOUT SS) - If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
Scout Gaming (SCOUT SS) - If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company, Scout Gaming
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
If you are interested in sports betting in the US, check out this article on Europe's leading Daily Fantasy Sports company, Scout Gaming
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
If you are interested in DKNG, check out this article on Europe's leading Daily Fantasy Sports company, Scout Gaming
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
If you are interested in DKNG, check out this article on Europe's leading Daily Fantasy Sports company, Scout Gaming
https://seekingalpha.com/article/4375024-scout-gaming-europes-leading-b2b-daily-fantasy-sports-provider?comments=show&v=1600436915
I hope you are right and get a chance to buyback lower. I am a long-term holder and not selling any shares. I think the next several quarters should be strong and investors will realize what this business is worth sooner than later. Particularly next quarter as the company is lapping an easy gross margin quarter in 2Q18 (11.7%) which should result in the first quarter gross margins have expanded in years and I expect 30% topline growth to drive >50% EBITDA growth because of this easy gross margin comparison. GLTA
Greystone Logistics (GLGI) Writeup
Summary
• Greystone provides leverage to secular growth themes including distribution center automation, environmental responsibility, and America-first trade policies.
• Sales and EBITDA are expected to grow at +21% and +28% CAGR, respectively, for the next four years driven by market share gains in a growing industry and expanding margins.
• Attractive unit economics with 40% incremental ROIC which will drive already industry-leading ROIC even higher.
• The business is run by a cost-disciplined, shareholder-oriented management team that owns over 50% of the company.
• I estimate business is worth $2.29/share in the next 12 months, growing to $5.36 in four years, offering +75% CAGR potential. Shares trade for less than half of peer multiples (4.3x EV/EBITDA vs peers 8.8x and 0.7x EV/sales vs peers 1.5x), despite being a higher quality business with better organic growth, ROIC, and management alignment.
About the Business
Greystone provides the highest quality, lowest cost plastic pallets to the consumer products and retail industries. Unlike competitors, its pallets are made from 100% recycled materials which gives the company a cost advantage and is attractive to environmentally conscious customers. At its manufacturing plant in Bettendorf, IA, the company has twelve Milacron (MCRN) injection molding machines with two more on order which each produce 15,000 pallets per month. Greystone will produce over 2.5 million plastic pallets per year once these machines are installed in the next few months. I estimate the company sells its pallets for about $45/pallet.
Industry Background
• Retailers and consumer products companies are investing to automate their distribution centers, increasingly choosing plastic pallets over wood because plastic pallets function better in automated facilities, are cheaper to ship because of their lighter weight, are more hygienic with no mold/bugs, and have no nails or splinters which is safer for the products and workers. In addition, Greystone’s plastic pallets appeal to environmentally conscious businesses which is a growing trend.
• The biggest hurdle to plastic pallet adoption in the past was the higher up-front cost. Historically, a quality plastic pallet cost about $100/unit compared to an A-grade block wood pallet at $25/unit. Greystone’s efficient operations enable the company to sell their plastic pallets for about $45/unit which flips the economics over the lifetime of the pallet in favor plastic pallets (lower shipping costs, less product damage, fewer injuries, etc).
• Greystone’s customer base is almost entirely U.S. customers. Protectionist trade policies enhance Greystone’s competitive position because of a reduced threat of imported plastic pallets. The company uses 100% recycled plastic materials sourced from the U.S. Greystone’s pallets are primarily used for domestic shipments. International shipments typically use cheap whitewood pallets or lower quality plastic pallets which is a low single-digit portion of Greystone’s business.
Customer Adoption
• Just three years ago, Greystone had one anchor customer, MillerCoors, that accounted for 60% of its sales. The company has seen rapid adoption of its pallets by major retailers and consumer products companies. The company now has three anchor customers with iGPS, MillerCoors, and Walmart which has diversified its revenue stream and enabled strong sales growth which I expect to continue.
• Walmart and Costco, the two biggest physical retailers in the U.S., are two of Greystone’s biggest advocates. I think that Walmart recently started buying pallets from Greystone as they invest in next-generation fulfillment centers to more effectively compete with Amazon. iGPS is a pallet pooling company that charges shippers per “pallet issue”, collects the empty pallets, and drops them off for the next “pallet issue”. Costco prefers that its shippers use iGPS given the advantages of plastic pallets noted above, listing iGPS as the first choice among CHEP, PECO, and whitewood pallet options. Given every major consumer products company sells through these two retailers, I expect plastic pallets will continue to gain share from wood. Plastic pallets have just low single digit penetration vs the longer-term opportunity to penetrate over 30% of the market, giving a long runway for growth.
• Greystone is seeing strong demand for its products with sales +33% y/y in the last year and +77% y/y in the last quarter. The company can barely keep up with orders given the secular trend toward plastic pallets and the large increase in customer adoption in recent years.
Gross Margins
This growth does not come without a price. Greystone’s gross margins have fallen in the last 12 months as start-up costs from adding new machines have weighed on margins. I expect two factors will cause margins to improve over the next 12 months. First, the company has more injection molding machines producing pallets, so adding a new machine will have less impact on the overall costs. Second, management has placed orders for equipment to automate labor-intensive parts of the pallet manufacturing process. I estimate this automation investment will only be a few million dollars and has a 12-18 month payback period (66%-100% ROIC), resulting in a boost to gross margins in a few quarters. These two factors should cause gross margins to start improving in the next 12 months and trend toward the company’s 18% longer-term average.
Capital Investment to Support Growth
To support the strong demand, Greystone has increased capital investment in new injection molding machines because their current machines are running at full capacity utilization. Greystone has grown from six machines three years ago to twelve machines today. In addition, two more should be installed in the next few months, and I expect the company to continue to add two machines per year. This growth has caused Greystone’s debt and capitalized leases to increase from $13mm three years ago to $26mm. However, leverage has remained stable around 3x net debt/EBITDA over the last three years as Greystone generates strong incremental return on invested capital. Importantly, Greystone has financed this growth entirely through borrowing and has not diluted shareholders (shares outstanding have grown at less than a 1% CAGR over the last decade). The management and board are the largest shareholders, so they are well aligned with shareholders to create value.
Unit Economics and Incremental Return on Invested Capital
• A new Milacron injection molding machine costs about $2.6mm for the machine ($2.3mm) and molds ($0.3mm). This machine produces 15,000 pallets per month or 180,000 per year. At $45/pallet and 75% revenue capture rate, the machine generates $6.0mm in sales each year. There is little to no incremental SG&A cost to support the machine. Greystone is currently operating with 20% cash gross margins (gross margin plus depreciation % of sales) which means new machines have a 20% incremental EBITDA margins even without the margin improvement initiatives mentioned above. At $6.0mm of sales, a new machine will generate $1.2mm of EBITDA or an EBITDA creation multiple of 2.2x vs businesses in the industry worth 8.8x EV/EBITDA (ie capex investments are worth 4x what Greystone spends). I estimate maintenance capex is $0.15mm/year per machine for replacing molds, screws, and barrels every couple years, and to account to account for the average life of an injection molding machine which is over 20 years. Based on my estimates, unleveraged, pre-tax FCF after maintenance capex is $1.05mm per machine on a $2.6mm investment or a 40% pre-tax return on incremental invested capital. Greystone finances these capital investments with debt that costs 6.5%. This is one of the best carry trades I’ve seen - borrowing at 6.5% to finance an investment that returns 40% - which is hugely accretive for Greystone’s owners.
• Greystone’s current ROIC is 16.9% vs industry average 12.4%. In addition, I estimate new capital investments are generating returns 40%. I expect that Greystone’s ROIC will drift higher toward 20-30% over time. One of the primary drivers of strong stock performance is strong topline growth and improving ROIC. Greystone has both of these factors in spades.
Future Growth Financed from Operating Cash Flow
I estimate that Greystone has reached a scale where growth capex will be fully funded from operating cash flow, debt will stabilize at $25mm, and EBITDA will continue to increase 25-30% each year for the next four years. I forecast Greystone will generate $11mm of EBITDA in the next 12 months, less $1.65mm of interest, less $0.6mm of VIE and preferred payments, less $1.8mm maintenance capex ($0.15mm per machine), and less $1.0mm of cash tax, driving $6.0mm of FCF after maintenance capex. This FCF supports adding 2.3 new injection molding machines per year at a cost of $2.6mm per machine. I expect Greystone will add two machines per year going forward which means growth will be self-financed. I forecast leverage will fall from 2.9x today to 2.3x in 12 months and 1.7x in 24 months vs the industry average 2.7x net debt/EBITDA.
100% Recycled Plastic is a Competitive Advantage
• Greystone’s plastic pallets are made of 100% recycled plastic. This is an advantage over competitors that use virgin material because Greystone has lower and more stable raw materials costs as recycled plastic prices are less volatile than virgin plastic. Greystone has pelletizing machines at their factory that process and purify scrap plastic into pellets that can be used in the injection molds. In addition, Greystone’s “100% recycled” branding helps win environmentally conscious customers.
• Greystone offers customers a credit of $10-15 per damaged pallet which reduces the net cost of a new pallet to $30-35/unit. A customer like MillerCoors might have $20mm of pallet credits in their plastic pallet fleet. This recycling credit program makes it very difficult for a competitor to take Greystone’s customers because most competitors use virgin materials and typically cannot offer customers a credit for damaged pallets. This creates highly sticky and loyal customers. MillerCoors has been a customer for 20 years. I expect Greystone’s newer large customers iGPS and Walmart (and future large customer wins) will remain customers for decades in part because of Greystone’s recycling credit program.
Cost Discipline
Greystone’s SG&A % of sales is 5.5% vs the industry average 13.2%. In the last 12 months, Greystone grew sales +33%, yet SG&A grew less than 1% resulting in operating leverage. This allows the company to convert gross profits into EBITDA at a much better rate than its larger peers. It’s remarkable that a company with 1/80th of the sales of its larger peers is 2.4x as efficient, as measured by SG&A % of sales.
How does Greystone do it? The company has a culture of cost control with managers who are owners and spend money accordingly. In addition, the company does not have a large sales force. Instead, the CEO does most of the selling and for smaller customers, Greystone takes orders from its distribution partners.
Management Team
• Management owns over 50% of the shares, most of which was acquired in the open market over the last decade at prices only slightly below the current price. Management is well-aligned with shareholders and feels an obligation to deliver good returns for its owners. This stewardship mindset is apparent when looking at Greystone’s cost discipline, less than 1% annual shareholder dilution over the last decade, and management and board members providing personal guarantees on loans to the company to improve the borrowing cost.
• In addition, the CEO and CFO are paid $248k and $138k, respectively, and the board pays themselves just $30k per year. The CEO and chairman, Warren Kruger, personally owns 30% of the common stock, worth over $5 million, and is only paid $278k in compensation for CEO and chairman (18x equity / comp ratio). The management team and board intend to generate their profits alongside shareholders rather than profiting from a large compensation package at the expense of owners.
Customer Mix
iGPS (54% of sales) operates in the pallet pooling industry (more details below). I estimate Costco (COST) is one of the biggest receivers of iGPS pallets.
MillerCoors (19% of sales) is owned by Molson Coors (TAP) and has been a customer for 20 years.
Walmart (WMT) (9% of sales) is the world’s largest retailer and I think recently became a customer.
Distributors (16% of sales) typically do not carry inventory. Instead, they take orders on behalf of their customers, and Greystone fulfills the order. Sonoco Products (SON) is one of many distributors.
Direct sales (2%) include all other customers.
Pallet Pooling Industry – Context for iGPS’s Business
• Pallet pooling companies enable shippers to save money on their pallet costs by charging customers about $5 per “pallet issue”, rather than paying $25 for a new A-grade block wood pallet that the shipper will likely never recover. There are 770mm “pallet issues” per year in the U.S., half of which are done by the pallet pooling industry. CHEP, a subsidiary of Brambles (BXB AU), is the incumbent pallet pooler with 100mm wood pallets in the U.S. and 300mm “pallet issues” per year, 80% market share of the pallet pooling industry. PECO is the #2 pallet pooler with ~17% market share of the pooled pallet industry and also only offers wood pallets. iGPS is #3 with about a 3% market share and exclusively offers plastic pallets with tracking capabilities. iGPS has been taking market share from the incumbents for the last five years as certain industries such as the beverage industry realize plastic is a better option than wood.
• I forecast that iGPS will continue to take market share from wood pallet pooling incumbents and eventually reach over 10% market share of the pooled pallet business (3x its current size). iGPS sole sources their pallets from Greystone. The only way for iGPS to gain market share is to grow their pallet fleet which means more orders for Greystone.
Source: Brambles 2018 Investor Day Slides
Plastic Pallet Competitors
• Privately-held: Rehrig Pacific, Orbis, Litco International, Shuert Technologies, Sohner Plastics, MDI, and Polymer Solutions International
• Public: Buckhorn which is owned by Myers Industries (MYE)
Greystone vs Packaging Industry
Greystone compares favorably versus the packaging industry across quality and valuation metrics. Peers are BLL, CCL/B CN, BERY, SEE, GPK, SON, BMS, SLGN, WPK CN, ITP CN, and MYE.
Quality Metrics:
1. Greystone is growing revenue 10x faster than the industry with organic sales growth of +33% vs the industry’s +3.5% growth.
2. Greystone’s 14.9% EBITDA margins are slightly below industry average 15.1% driven by lower gross margins, partially offset by lower SG&A costs.
3. Greystone’s ROIC is 16.9% vs industry 12.4%. Capex % of sales is 2.8x the industry average, though that is supporting organic sales growth 10x the industry average and is why Greystone’s ROIC continues to improve. I estimate that Greystone’s maintenance capex is 3% of sales ($0.15mm per machine) roughly in-line with the industry average 2.5% maintenance capex (plus industry spends 2.4% of sales on growth capex for total 4.9%).
4. Greystone’s leverage is slightly higher than average at 2.9x net debt / EBITDA vs peers 2.7x. I expect leverage to fall below 2x in the next 24 months.
Valuation Metrics:
1. Greystone sells for 4.3x EV/EBITDA vs peers 8.8x, 0.7x EV/sales vs peers 1.5x, and 5.7x P/E vs peers 14.7x.
2. FCF yield is trickier because Greystone is spending capex to grow 10x the rate of the industry. Once Greystone’s growth rate slows, I estimate capital intensity is similar to peers at 2.5% maintenance and 2.5% growth. If Greystone slowed its growth rate to the industry average, I estimate that the business trades at a 24% FCF yield vs peers selling for 5.8% FCF yield.
Greystone Long-Term Model
I forecast sales growth of +21% from FY18 to FY22, rising to $105mm by FY22, based on injection molding machines added and productivity per machine. I forecast gross margins will stabilize in FY19 and return to 18% by FY22 as new machine startup costs fall and management implements cost-saving automation in its pallet production lines. I forecast EBITDA will grow +28% from FY18 to FY22, rising to over $20mm by FY22. This leads to a +64% EPS CAGR over that horizon to over $0.30/share by FY22. I forecast capital expenditures and FCF based on maintenance capex of $0.15mm per machine plus $2.6mm growth capex per new machine added.
Injection molding machines
FY16 7
FY17 8
FY18 10
FY19 12
FY20 14
FY21 16
FY22 18
Sales
FY16 $26mm
FY17 $40mm
FY18 $49mm
FY19 $66mm
FY20 $79mm
FY21 $92mm
FY22 $104mm
EBITDA
FY16 $3.8mm
FY17 $7.2mm
FY18 $7.7mm
FY19 $11.0mm
FY20 $14.3mm
FY21 $17.4mm
FY22 $20.7mm
Valuation
Greystone is a higher quality business than peers given much stronger organic growth and higher ROIC (and rising) which warrants a premium to peers. However, I am valuing Greystone in-line with peers for the purpose of this analysis. I estimate Greystone is worth $2.30 in 12 months, 300% upside potential, based on 8.8x EV/EBITDA, 1.5x EV/sales, 14.7x P/E, and 5.9% FCF yield valuation in-line with peer multiples. I estimate fair value rises to $5.50 by FY22, 9x the current stock price, resulting in a +75% CAGR over the next four years.
Fair Value (average of four valuation methods)
FY16 $0.40
FY17 $1.18
FY18 $1.27
FY19 $2.29
FY20 $3.30
FY21 $4.30
FY22 $5.36
Risks
• Customer concentration with three customers – iGPS, MillerCoors, and Walmart
• Competitive industry. I think Greystone is the lowest cost and highest quality plastic pallet supplier which is why MillerCoors, Walmart, iGPS, and Costco chose the company’s pallets.
• Low gross margin industry that is capital intensive.
• Greystone is a microcap stock that is traded OTC with relatively low liquidity.
Catalyst
Catalysts
• +21% sales growth for the next four years driven by strong customer demand
• Margins expanding from the initiatives mentioned in the article
• These two factors together drive EBITDA growth of +28% for the next four years
• Rising ROIC as incremental capital investments generate >40% ROIC vs current 17% ROIC
• Greystone becoming self-financing which drives leverage to <2x net debt / EBITDA in the next 24 months
• Investors realizing the quality of Greystone’s business and re-rating the stock to an industry-average (8.8x EV/EBITDA) or better multiple
Greystone Logistics (GLGI) Writeup
Summary
• Greystone provides leverage to secular growth themes including distribution center automation, environmental responsibility, and America-first trade policies.
• Sales and EBITDA are expected to grow at +21% and +28% CAGR, respectively, for the next four years driven by market share gains in a growing industry and expanding margins.
• Attractive unit economics with 40% incremental ROIC which will drive already industry-leading ROIC even higher.
• The business is run by a cost-disciplined, shareholder-oriented management team that owns over 50% of the company.
• I estimate business is worth $2.29/share in the next 12 months, growing to $5.36 in four years, offering +75% CAGR potential. Shares trade for less than half of peer multiples (4.3x EV/EBITDA vs peers 8.8x and 0.7x EV/sales vs peers 1.5x), despite being a higher quality business with better organic growth, ROIC, and management alignment.
About the Business
Greystone provides the highest quality, lowest cost plastic pallets to the consumer products and retail industries. Unlike competitors, its pallets are made from 100% recycled materials which gives the company a cost advantage and is attractive to environmentally conscious customers. At its manufacturing plant in Bettendorf, IA, the company has twelve Milacron (MCRN) injection molding machines with two more on order which each produce 15,000 pallets per month. Greystone will produce over 2.5 million plastic pallets per year once these machines are installed in the next few months. I estimate the company sells its pallets for about $45/pallet.
Industry Background
• Retailers and consumer products companies are investing to automate their distribution centers, increasingly choosing plastic pallets over wood because plastic pallets function better in automated facilities, are cheaper to ship because of their lighter weight, are more hygienic with no mold/bugs, and have no nails or splinters which is safer for the products and workers. In addition, Greystone’s plastic pallets appeal to environmentally conscious businesses which is a growing trend.
• The biggest hurdle to plastic pallet adoption in the past was the higher up-front cost. Historically, a quality plastic pallet cost about $100/unit compared to an A-grade block wood pallet at $25/unit. Greystone’s efficient operations enable the company to sell their plastic pallets for about $45/unit which flips the economics over the lifetime of the pallet in favor plastic pallets (lower shipping costs, less product damage, fewer injuries, etc).
• Greystone’s customer base is almost entirely U.S. customers. Protectionist trade policies enhance Greystone’s competitive position because of a reduced threat of imported plastic pallets. The company uses 100% recycled plastic materials sourced from the U.S. Greystone’s pallets are primarily used for domestic shipments. International shipments typically use cheap whitewood pallets or lower quality plastic pallets which is a low single-digit portion of Greystone’s business.
Customer Adoption
• Just three years ago, Greystone had one anchor customer, MillerCoors, that accounted for 60% of its sales. The company has seen rapid adoption of its pallets by major retailers and consumer products companies. The company now has three anchor customers with iGPS, MillerCoors, and Walmart which has diversified its revenue stream and enabled strong sales growth which I expect to continue.
• Walmart and Costco, the two biggest physical retailers in the U.S., are two of Greystone’s biggest advocates. I think that Walmart recently started buying pallets from Greystone as they invest in next-generation fulfillment centers to more effectively compete with Amazon. iGPS is a pallet pooling company that charges shippers per “pallet issue”, collects the empty pallets, and drops them off for the next “pallet issue”. Costco prefers that its shippers use iGPS given the advantages of plastic pallets noted above, listing iGPS as the first choice among CHEP, PECO, and whitewood pallet options. Given every major consumer products company sells through these two retailers, I expect plastic pallets will continue to gain share from wood. Plastic pallets have just low single digit penetration vs the longer-term opportunity to penetrate over 30% of the market, giving a long runway for growth.
• Greystone is seeing strong demand for its products with sales +33% y/y in the last year and +77% y/y in the last quarter. The company can barely keep up with orders given the secular trend toward plastic pallets and the large increase in customer adoption in recent years.
Gross Margins
This growth does not come without a price. Greystone’s gross margins have fallen in the last 12 months as start-up costs from adding new machines have weighed on margins. I expect two factors will cause margins to improve over the next 12 months. First, the company has more injection molding machines producing pallets, so adding a new machine will have less impact on the overall costs. Second, management has placed orders for equipment to automate labor-intensive parts of the pallet manufacturing process. I estimate this automation investment will only be a few million dollars and has a 12-18 month payback period (66%-100% ROIC), resulting in a boost to gross margins in a few quarters. These two factors should cause gross margins to start improving in the next 12 months and trend toward the company’s 18% longer-term average.
Capital Investment to Support Growth
To support the strong demand, Greystone has increased capital investment in new injection molding machines because their current machines are running at full capacity utilization. Greystone has grown from six machines three years ago to twelve machines today. In addition, two more should be installed in the next few months, and I expect the company to continue to add two machines per year. This growth has caused Greystone’s debt and capitalized leases to increase from $13mm three years ago to $26mm. However, leverage has remained stable around 3x net debt/EBITDA over the last three years as Greystone generates strong incremental return on invested capital. Importantly, Greystone has financed this growth entirely through borrowing and has not diluted shareholders (shares outstanding have grown at less than a 1% CAGR over the last decade). The management and board are the largest shareholders, so they are well aligned with shareholders to create value.
Unit Economics and Incremental Return on Invested Capital
• A new Milacron injection molding machine costs about $2.6mm for the machine ($2.3mm) and molds ($0.3mm). This machine produces 15,000 pallets per month or 180,000 per year. At $45/pallet and 75% revenue capture rate, the machine generates $6.0mm in sales each year. There is little to no incremental SG&A cost to support the machine. Greystone is currently operating with 20% cash gross margins (gross margin plus depreciation % of sales) which means new machines have a 20% incremental EBITDA margins even without the margin improvement initiatives mentioned above. At $6.0mm of sales, a new machine will generate $1.2mm of EBITDA or an EBITDA creation multiple of 2.2x vs businesses in the industry worth 8.8x EV/EBITDA (ie capex investments are worth 4x what Greystone spends). I estimate maintenance capex is $0.15mm/year per machine for replacing molds, screws, and barrels every couple years, and to account to account for the average life of an injection molding machine which is over 20 years. Based on my estimates, unleveraged, pre-tax FCF after maintenance capex is $1.05mm per machine on a $2.6mm investment or a 40% pre-tax return on incremental invested capital. Greystone finances these capital investments with debt that costs 6.5%. This is one of the best carry trades I’ve seen - borrowing at 6.5% to finance an investment that returns 40% - which is hugely accretive for Greystone’s owners.
• Greystone’s current ROIC is 16.9% vs industry average 12.4%. In addition, I estimate new capital investments are generating returns 40%. I expect that Greystone’s ROIC will drift higher toward 20-30% over time. One of the primary drivers of strong stock performance is strong topline growth and improving ROIC. Greystone has both of these factors in spades.
Future Growth Financed from Operating Cash Flow
I estimate that Greystone has reached a scale where growth capex will be fully funded from operating cash flow, debt will stabilize at $25mm, and EBITDA will continue to increase 25-30% each year for the next four years. I forecast Greystone will generate $11mm of EBITDA in the next 12 months, less $1.65mm of interest, less $0.6mm of VIE and preferred payments, less $1.8mm maintenance capex ($0.15mm per machine), and less $1.0mm of cash tax, driving $6.0mm of FCF after maintenance capex. This FCF supports adding 2.3 new injection molding machines per year at a cost of $2.6mm per machine. I expect Greystone will add two machines per year going forward which means growth will be self-financed. I forecast leverage will fall from 2.9x today to 2.3x in 12 months and 1.7x in 24 months vs the industry average 2.7x net debt/EBITDA.
100% Recycled Plastic is a Competitive Advantage
• Greystone’s plastic pallets are made of 100% recycled plastic. This is an advantage over competitors that use virgin material because Greystone has lower and more stable raw materials costs as recycled plastic prices are less volatile than virgin plastic. Greystone has pelletizing machines at their factory that process and purify scrap plastic into pellets that can be used in the injection molds. In addition, Greystone’s “100% recycled” branding helps win environmentally conscious customers.
• Greystone offers customers a credit of $10-15 per damaged pallet which reduces the net cost of a new pallet to $30-35/unit. A customer like MillerCoors might have $20mm of pallet credits in their plastic pallet fleet. This recycling credit program makes it very difficult for a competitor to take Greystone’s customers because most competitors use virgin materials and typically cannot offer customers a credit for damaged pallets. This creates highly sticky and loyal customers. MillerCoors has been a customer for 20 years. I expect Greystone’s newer large customers iGPS and Walmart (and future large customer wins) will remain customers for decades in part because of Greystone’s recycling credit program.
Cost Discipline
Greystone’s SG&A % of sales is 5.5% vs the industry average 13.2%. In the last 12 months, Greystone grew sales +33%, yet SG&A grew less than 1% resulting in operating leverage. This allows the company to convert gross profits into EBITDA at a much better rate than its larger peers. It’s remarkable that a company with 1/80th of the sales of its larger peers is 2.4x as efficient, as measured by SG&A % of sales.
How does Greystone do it? The company has a culture of cost control with managers who are owners and spend money accordingly. In addition, the company does not have a large sales force. Instead, the CEO does most of the selling and for smaller customers, Greystone takes orders from its distribution partners.
Management Team
• Management owns over 50% of the shares, most of which was acquired in the open market over the last decade at prices only slightly below the current price. Management is well-aligned with shareholders and feels an obligation to deliver good returns for its owners. This stewardship mindset is apparent when looking at Greystone’s cost discipline, less than 1% annual shareholder dilution over the last decade, and management and board members providing personal guarantees on loans to the company to improve the borrowing cost.
• In addition, the CEO and CFO are paid $248k and $138k, respectively, and the board pays themselves just $30k per year. The CEO and chairman, Warren Kruger, personally owns 30% of the common stock, worth over $5 million, and is only paid $278k in compensation for CEO and chairman (18x equity / comp ratio). The management team and board intend to generate their profits alongside shareholders rather than profiting from a large compensation package at the expense of owners.
Customer Mix
iGPS (54% of sales) operates in the pallet pooling industry (more details below). I estimate Costco (COST) is one of the biggest receivers of iGPS pallets.
MillerCoors (19% of sales) is owned by Molson Coors (TAP) and has been a customer for 20 years.
Walmart (WMT) (9% of sales) is the world’s largest retailer and I think recently became a customer.
Distributors (16% of sales) typically do not carry inventory. Instead, they take orders on behalf of their customers, and Greystone fulfills the order. Sonoco Products (SON) is one of many distributors.
Direct sales (2%) include all other customers.
Pallet Pooling Industry – Context for iGPS’s Business
• Pallet pooling companies enable shippers to save money on their pallet costs by charging customers about $5 per “pallet issue”, rather than paying $25 for a new A-grade block wood pallet that the shipper will likely never recover. There are 770mm “pallet issues” per year in the U.S., half of which are done by the pallet pooling industry. CHEP, a subsidiary of Brambles (BXB AU), is the incumbent pallet pooler with 100mm wood pallets in the U.S. and 300mm “pallet issues” per year, 80% market share of the pallet pooling industry. PECO is the #2 pallet pooler with ~17% market share of the pooled pallet industry and also only offers wood pallets. iGPS is #3 with about a 3% market share and exclusively offers plastic pallets with tracking capabilities. iGPS has been taking market share from the incumbents for the last five years as certain industries such as the beverage industry realize plastic is a better option than wood.
• I forecast that iGPS will continue to take market share from wood pallet pooling incumbents and eventually reach over 10% market share of the pooled pallet business (3x its current size). iGPS sole sources their pallets from Greystone. The only way for iGPS to gain market share is to grow their pallet fleet which means more orders for Greystone.
Source: Brambles 2018 Investor Day Slides
Plastic Pallet Competitors
• Privately-held: Rehrig Pacific, Orbis, Litco International, Shuert Technologies, Sohner Plastics, MDI, and Polymer Solutions International
• Public: Buckhorn which is owned by Myers Industries (MYE)
Greystone vs Packaging Industry
Greystone compares favorably versus the packaging industry across quality and valuation metrics. Peers are BLL, CCL/B CN, BERY, SEE, GPK, SON, BMS, SLGN, WPK CN, ITP CN, and MYE.
Quality Metrics:
1. Greystone is growing revenue 10x faster than the industry with organic sales growth of +33% vs the industry’s +3.5% growth.
2. Greystone’s 14.9% EBITDA margins are slightly below industry average 15.1% driven by lower gross margins, partially offset by lower SG&A costs.
3. Greystone’s ROIC is 16.9% vs industry 12.4%. Capex % of sales is 2.8x the industry average, though that is supporting organic sales growth 10x the industry average and is why Greystone’s ROIC continues to improve. I estimate that Greystone’s maintenance capex is 3% of sales ($0.15mm per machine) roughly in-line with the industry average 2.5% maintenance capex (plus industry spends 2.4% of sales on growth capex for total 4.9%).
4. Greystone’s leverage is slightly higher than average at 2.9x net debt / EBITDA vs peers 2.7x. I expect leverage to fall below 2x in the next 24 months.
Valuation Metrics:
1. Greystone sells for 4.3x EV/EBITDA vs peers 8.8x, 0.7x EV/sales vs peers 1.5x, and 5.7x P/E vs peers 14.7x.
2. FCF yield is trickier because Greystone is spending capex to grow 10x the rate of the industry. Once Greystone’s growth rate slows, I estimate capital intensity is similar to peers at 2.5% maintenance and 2.5% growth. If Greystone slowed its growth rate to the industry average, I estimate that the business trades at a 24% FCF yield vs peers selling for 5.8% FCF yield.
Greystone Long-Term Model
I forecast sales growth of +21% from FY18 to FY22, rising to $105mm by FY22, based on injection molding machines added and productivity per machine. I forecast gross margins will stabilize in FY19 and return to 18% by FY22 as new machine startup costs fall and management implements cost-saving automation in its pallet production lines. I forecast EBITDA will grow +28% from FY18 to FY22, rising to over $20mm by FY22. This leads to a +64% EPS CAGR over that horizon to over $0.30/share by FY22. I forecast capital expenditures and FCF based on maintenance capex of $0.15mm per machine plus $2.6mm growth capex per new machine added.
Injection molding machines
FY16 7
FY17 8
FY18 10
FY19 12
FY20 14
FY21 16
FY22 18
Sales
FY16 $26mm
FY17 $40mm
FY18 $49mm
FY19 $66mm
FY20 $79mm
FY21 $92mm
FY22 $104mm
EBITDA
FY16 $3.8mm
FY17 $7.2mm
FY18 $7.7mm
FY19 $11.0mm
FY20 $14.3mm
FY21 $17.4mm
FY22 $20.7mm
Valuation
Greystone is a higher quality business than peers given much stronger organic growth and higher ROIC (and rising) which warrants a premium to peers. However, I am valuing Greystone in-line with peers for the purpose of this analysis. I estimate Greystone is worth $2.30 in 12 months, 300% upside potential, based on 8.8x EV/EBITDA, 1.5x EV/sales, 14.7x P/E, and 5.9% FCF yield valuation in-line with peer multiples. I estimate fair value rises to $5.50 by FY22, 9x the current stock price, resulting in a +75% CAGR over the next four years.
Fair Value (average of four valuation methods)
FY16 $0.40
FY17 $1.18
FY18 $1.27
FY19 $2.29
FY20 $3.30
FY21 $4.30
FY22 $5.36
Risks
• Customer concentration with three customers – iGPS, MillerCoors, and Walmart
• Competitive industry. I think Greystone is the lowest cost and highest quality plastic pallet supplier which is why MillerCoors, Walmart, iGPS, and Costco chose the company’s pallets.
• Low gross margin industry that is capital intensive.
• Greystone is a microcap stock that is traded OTC with relatively low liquidity.
Catalyst
Catalysts
• +21% sales growth for the next four years driven by strong customer demand
• Margins expanding from the initiatives mentioned in the article
• These two factors together drive EBITDA growth of +28% for the next four years
• Rising ROIC as incremental capital investments generate >40% ROIC vs current 17% ROIC
• Greystone becoming self-financing which drives leverage to <2x net debt / EBITDA in the next 24 months
• Investors realizing the quality of Greystone’s business and re-rating the stock to an industry-average (8.8x EV/EBITDA) or better multiple
Greystone Logistics (GLGI) Writeup
Summary
• Greystone provides leverage to secular growth themes including distribution center automation, environmental responsibility, and America-first trade policies.
• Sales and EBITDA are expected to grow at +21% and +28% CAGR, respectively, for the next four years driven by market share gains in a growing industry and expanding margins.
• Attractive unit economics with 40% incremental ROIC which will drive already industry-leading ROIC even higher.
• The business is run by a cost-disciplined, shareholder-oriented management team that owns over 50% of the company.
• I estimate business is worth $2.29/share in the next 12 months, growing to $5.36 in four years, offering +75% CAGR potential. Shares trade for less than half of peer multiples (4.3x EV/EBITDA vs peers 8.8x and 0.7x EV/sales vs peers 1.5x), despite being a higher quality business with better organic growth, ROIC, and management alignment.
About the Business
Greystone provides the highest quality, lowest cost plastic pallets to the consumer products and retail industries. Unlike competitors, its pallets are made from 100% recycled materials which gives the company a cost advantage and is attractive to environmentally conscious customers. At its manufacturing plant in Bettendorf, IA, the company has twelve Milacron (MCRN) injection molding machines with two more on order which each produce 15,000 pallets per month. Greystone will produce over 2.5 million plastic pallets per year once these machines are installed in the next few months. I estimate the company sells its pallets for about $45/pallet.
Industry Background
• Retailers and consumer products companies are investing to automate their distribution centers, increasingly choosing plastic pallets over wood because plastic pallets function better in automated facilities, are cheaper to ship because of their lighter weight, are more hygienic with no mold/bugs, and have no nails or splinters which is safer for the products and workers. In addition, Greystone’s plastic pallets appeal to environmentally conscious businesses which is a growing trend.
• The biggest hurdle to plastic pallet adoption in the past was the higher up-front cost. Historically, a quality plastic pallet cost about $100/unit compared to an A-grade block wood pallet at $25/unit. Greystone’s efficient operations enable the company to sell their plastic pallets for about $45/unit which flips the economics over the lifetime of the pallet in favor plastic pallets (lower shipping costs, less product damage, fewer injuries, etc).
• Greystone’s customer base is almost entirely U.S. customers. Protectionist trade policies enhance Greystone’s competitive position because of a reduced threat of imported plastic pallets. The company uses 100% recycled plastic materials sourced from the U.S. Greystone’s pallets are primarily used for domestic shipments. International shipments typically use cheap whitewood pallets or lower quality plastic pallets which is a low single-digit portion of Greystone’s business.
Customer Adoption
• Just three years ago, Greystone had one anchor customer, MillerCoors, that accounted for 60% of its sales. The company has seen rapid adoption of its pallets by major retailers and consumer products companies. The company now has three anchor customers with iGPS, MillerCoors, and Walmart which has diversified its revenue stream and enabled strong sales growth which I expect to continue.
• Walmart and Costco, the two biggest physical retailers in the U.S., are two of Greystone’s biggest advocates. I think that Walmart recently started buying pallets from Greystone as they invest in next-generation fulfillment centers to more effectively compete with Amazon. iGPS is a pallet pooling company that charges shippers per “pallet issue”, collects the empty pallets, and drops them off for the next “pallet issue”. Costco prefers that its shippers use iGPS given the advantages of plastic pallets noted above, listing iGPS as the first choice among CHEP, PECO, and whitewood pallet options. Given every major consumer products company sells through these two retailers, I expect plastic pallets will continue to gain share from wood. Plastic pallets have just low single digit penetration vs the longer-term opportunity to penetrate over 30% of the market, giving a long runway for growth.
• Greystone is seeing strong demand for its products with sales +33% y/y in the last year and +77% y/y in the last quarter. The company can barely keep up with orders given the secular trend toward plastic pallets and the large increase in customer adoption in recent years.
Gross Margins
This growth does not come without a price. Greystone’s gross margins have fallen in the last 12 months as start-up costs from adding new machines have weighed on margins. I expect two factors will cause margins to improve over the next 12 months. First, the company has more injection molding machines producing pallets, so adding a new machine will have less impact on the overall costs. Second, management has placed orders for equipment to automate labor-intensive parts of the pallet manufacturing process. I estimate this automation investment will only be a few million dollars and has a 12-18 month payback period (66%-100% ROIC), resulting in a boost to gross margins in a few quarters. These two factors should cause gross margins to start improving in the next 12 months and trend toward the company’s 18% longer-term average.
Capital Investment to Support Growth
To support the strong demand, Greystone has increased capital investment in new injection molding machines because their current machines are running at full capacity utilization. Greystone has grown from six machines three years ago to twelve machines today. In addition, two more should be installed in the next few months, and I expect the company to continue to add two machines per year. This growth has caused Greystone’s debt and capitalized leases to increase from $13mm three years ago to $26mm. However, leverage has remained stable around 3x net debt/EBITDA over the last three years as Greystone generates strong incremental return on invested capital. Importantly, Greystone has financed this growth entirely through borrowing and has not diluted shareholders (shares outstanding have grown at less than a 1% CAGR over the last decade). The management and board are the largest shareholders, so they are well aligned with shareholders to create value.
Unit Economics and Incremental Return on Invested Capital
• A new Milacron injection molding machine costs about $2.6mm for the machine ($2.3mm) and molds ($0.3mm). This machine produces 15,000 pallets per month or 180,000 per year. At $45/pallet and 75% revenue capture rate, the machine generates $6.0mm in sales each year. There is little to no incremental SG&A cost to support the machine. Greystone is currently operating with 20% cash gross margins (gross margin plus depreciation % of sales) which means new machines have a 20% incremental EBITDA margins even without the margin improvement initiatives mentioned above. At $6.0mm of sales, a new machine will generate $1.2mm of EBITDA or an EBITDA creation multiple of 2.2x vs businesses in the industry worth 8.8x EV/EBITDA (ie capex investments are worth 4x what Greystone spends). I estimate maintenance capex is $0.15mm/year per machine for replacing molds, screws, and barrels every couple years, and to account to account for the average life of an injection molding machine which is over 20 years. Based on my estimates, unleveraged, pre-tax FCF after maintenance capex is $1.05mm per machine on a $2.6mm investment or a 40% pre-tax return on incremental invested capital. Greystone finances these capital investments with debt that costs 6.5%. This is one of the best carry trades I’ve seen - borrowing at 6.5% to finance an investment that returns 40% - which is hugely accretive for Greystone’s owners.
• Greystone’s current ROIC is 16.9% vs industry average 12.4%. In addition, I estimate new capital investments are generating returns 40%. I expect that Greystone’s ROIC will drift higher toward 20-30% over time. One of the primary drivers of strong stock performance is strong topline growth and improving ROIC. Greystone has both of these factors in spades.
Future Growth Financed from Operating Cash Flow
I estimate that Greystone has reached a scale where growth capex will be fully funded from operating cash flow, debt will stabilize at $25mm, and EBITDA will continue to increase 25-30% each year for the next four years. I forecast Greystone will generate $11mm of EBITDA in the next 12 months, less $1.65mm of interest, less $0.6mm of VIE and preferred payments, less $1.8mm maintenance capex ($0.15mm per machine), and less $1.0mm of cash tax, driving $6.0mm of FCF after maintenance capex. This FCF supports adding 2.3 new injection molding machines per year at a cost of $2.6mm per machine. I expect Greystone will add two machines per year going forward which means growth will be self-financed. I forecast leverage will fall from 2.9x today to 2.3x in 12 months and 1.7x in 24 months vs the industry average 2.7x net debt/EBITDA.
100% Recycled Plastic is a Competitive Advantage
• Greystone’s plastic pallets are made of 100% recycled plastic. This is an advantage over competitors that use virgin material because Greystone has lower and more stable raw materials costs as recycled plastic prices are less volatile than virgin plastic. Greystone has pelletizing machines at their factory that process and purify scrap plastic into pellets that can be used in the injection molds. In addition, Greystone’s “100% recycled” branding helps win environmentally conscious customers.
• Greystone offers customers a credit of $10-15 per damaged pallet which reduces the net cost of a new pallet to $30-35/unit. A customer like MillerCoors might have $20mm of pallet credits in their plastic pallet fleet. This recycling credit program makes it very difficult for a competitor to take Greystone’s customers because most competitors use virgin materials and typically cannot offer customers a credit for damaged pallets. This creates highly sticky and loyal customers. MillerCoors has been a customer for 20 years. I expect Greystone’s newer large customers iGPS and Walmart (and future large customer wins) will remain customers for decades in part because of Greystone’s recycling credit program.
Cost Discipline
Greystone’s SG&A % of sales is 5.5% vs the industry average 13.2%. In the last 12 months, Greystone grew sales +33%, yet SG&A grew less than 1% resulting in operating leverage. This allows the company to convert gross profits into EBITDA at a much better rate than its larger peers. It’s remarkable that a company with 1/80th of the sales of its larger peers is 2.4x as efficient, as measured by SG&A % of sales.
How does Greystone do it? The company has a culture of cost control with managers who are owners and spend money accordingly. In addition, the company does not have a large sales force. Instead, the CEO does most of the selling and for smaller customers, Greystone takes orders from its distribution partners.
Management Team
• Management owns over 50% of the shares, most of which was acquired in the open market over the last decade at prices only slightly below the current price. Management is well-aligned with shareholders and feels an obligation to deliver good returns for its owners. This stewardship mindset is apparent when looking at Greystone’s cost discipline, less than 1% annual shareholder dilution over the last decade, and management and board members providing personal guarantees on loans to the company to improve the borrowing cost.
• In addition, the CEO and CFO are paid $248k and $138k, respectively, and the board pays themselves just $30k per year. The CEO and chairman, Warren Kruger, personally owns 30% of the common stock, worth over $5 million, and is only paid $278k in compensation for CEO and chairman (18x equity / comp ratio). The management team and board intend to generate their profits alongside shareholders rather than profiting from a large compensation package at the expense of owners.
Customer Mix
iGPS (54% of sales) operates in the pallet pooling industry (more details below). I estimate Costco (COST) is one of the biggest receivers of iGPS pallets.
MillerCoors (19% of sales) is owned by Molson Coors (TAP) and has been a customer for 20 years.
Walmart (WMT) (9% of sales) is the world’s largest retailer and I think recently became a customer.
Distributors (16% of sales) typically do not carry inventory. Instead, they take orders on behalf of their customers, and Greystone fulfills the order. Sonoco Products (SON) is one of many distributors.
Direct sales (2%) include all other customers.
Pallet Pooling Industry – Context for iGPS’s Business
• Pallet pooling companies enable shippers to save money on their pallet costs by charging customers about $5 per “pallet issue”, rather than paying $25 for a new A-grade block wood pallet that the shipper will likely never recover. There are 770mm “pallet issues” per year in the U.S., half of which are done by the pallet pooling industry. CHEP, a subsidiary of Brambles (BXB AU), is the incumbent pallet pooler with 100mm wood pallets in the U.S. and 300mm “pallet issues” per year, 80% market share of the pallet pooling industry. PECO is the #2 pallet pooler with ~17% market share of the pooled pallet industry and also only offers wood pallets. iGPS is #3 with about a 3% market share and exclusively offers plastic pallets with tracking capabilities. iGPS has been taking market share from the incumbents for the last five years as certain industries such as the beverage industry realize plastic is a better option than wood.
• I forecast that iGPS will continue to take market share from wood pallet pooling incumbents and eventually reach over 10% market share of the pooled pallet business (3x its current size). iGPS sole sources their pallets from Greystone. The only way for iGPS to gain market share is to grow their pallet fleet which means more orders for Greystone.
Source: Brambles 2018 Investor Day Slides
Plastic Pallet Competitors
• Privately-held: Rehrig Pacific, Orbis, Litco International, Shuert Technologies, Sohner Plastics, MDI, and Polymer Solutions International
• Public: Buckhorn which is owned by Myers Industries (MYE)
Greystone vs Packaging Industry
Greystone compares favorably versus the packaging industry across quality and valuation metrics. Peers are BLL, CCL/B CN, BERY, SEE, GPK, SON, BMS, SLGN, WPK CN, ITP CN, and MYE.
Quality Metrics:
1. Greystone is growing revenue 10x faster than the industry with organic sales growth of +33% vs the industry’s +3.5% growth.
2. Greystone’s 14.9% EBITDA margins are slightly below industry average 15.1% driven by lower gross margins, partially offset by lower SG&A costs.
3. Greystone’s ROIC is 16.9% vs industry 12.4%. Capex % of sales is 2.8x the industry average, though that is supporting organic sales growth 10x the industry average and is why Greystone’s ROIC continues to improve. I estimate that Greystone’s maintenance capex is 3% of sales ($0.15mm per machine) roughly in-line with the industry average 2.5% maintenance capex (plus industry spends 2.4% of sales on growth capex for total 4.9%).
4. Greystone’s leverage is slightly higher than average at 2.9x net debt / EBITDA vs peers 2.7x. I expect leverage to fall below 2x in the next 24 months.
Valuation Metrics:
1. Greystone sells for 4.3x EV/EBITDA vs peers 8.8x, 0.7x EV/sales vs peers 1.5x, and 5.7x P/E vs peers 14.7x.
2. FCF yield is trickier because Greystone is spending capex to grow 10x the rate of the industry. Once Greystone’s growth rate slows, I estimate capital intensity is similar to peers at 2.5% maintenance and 2.5% growth. If Greystone slowed its growth rate to the industry average, I estimate that the business trades at a 24% FCF yield vs peers selling for 5.8% FCF yield.
Greystone Long-Term Model
I forecast sales growth of +21% from FY18 to FY22, rising to $105mm by FY22, based on injection molding machines added and productivity per machine. I forecast gross margins will stabilize in FY19 and return to 18% by FY22 as new machine startup costs fall and management implements cost-saving automation in its pallet production lines. I forecast EBITDA will grow +28% from FY18 to FY22, rising to over $20mm by FY22. This leads to a +64% EPS CAGR over that horizon to over $0.30/share by FY22. I forecast capital expenditures and FCF based on maintenance capex of $0.15mm per machine plus $2.6mm growth capex per new machine added.
Injection molding machines
FY16 7
FY17 8
FY18 10
FY19 12
FY20 14
FY21 16
FY22 18
Sales
FY16 $26mm
FY17 $40mm
FY18 $49mm
FY19 $66mm
FY20 $79mm
FY21 $92mm
FY22 $104mm
EBITDA
FY16 $3.8mm
FY17 $7.2mm
FY18 $7.7mm
FY19 $11.0mm
FY20 $14.3mm
FY21 $17.4mm
FY22 $20.7mm
Valuation
Greystone is a higher quality business than peers given much stronger organic growth and higher ROIC (and rising) which warrants a premium to peers. However, I am valuing Greystone in-line with peers for the purpose of this analysis. I estimate Greystone is worth $2.30 in 12 months, 300% upside potential, based on 8.8x EV/EBITDA, 1.5x EV/sales, 14.7x P/E, and 5.9% FCF yield valuation in-line with peer multiples. I estimate fair value rises to $5.50 by FY22, 9x the current stock price, resulting in a +75% CAGR over the next four years.
Fair Value (average of four valuation methods)
FY16 $0.40
FY17 $1.18
FY18 $1.27
FY19 $2.29
FY20 $3.30
FY21 $4.30
FY22 $5.36
Risks
• Customer concentration with three customers – iGPS, MillerCoors, and Walmart
• Competitive industry. I think Greystone is the lowest cost and highest quality plastic pallet supplier which is why MillerCoors, Walmart, iGPS, and Costco chose the company’s pallets.
• Low gross margin industry that is capital intensive.
• Greystone is a microcap stock that is traded OTC with relatively low liquidity.
Catalyst
Catalysts
• +21% sales growth for the next four years driven by strong customer demand
• Margins expanding from the initiatives mentioned in the article
• These two factors together drive EBITDA growth of +28% for the next four years
• Rising ROIC as incremental capital investments generate >40% ROIC vs current 17% ROIC
• Greystone becoming self-financing which drives leverage to <2x net debt / EBITDA in the next 24 months
• Investors realizing the quality of Greystone’s business and re-rating the stock to an industry-average (8.8x EV/EBITDA) or better multiple
PFHO Writeup
Pacific Health Care’s operating business, Medex (http://www.medexhco.com/), helps corporations, not-for-profits, and municipalities reduce their workers’ compensation claims costs by providing a network of healthcare providers, reviewing medical bills to reduce costs, and having a professional oversee the life of a claim. The business has similar financial traits to a law or accounting firm because highly skilled professionals are providing services, so there is no inventory, low working capital, high returns on invested capital, and net income closely matches free cash flow.
Thesis:
Strong Business. Strong FCF, low working capital and fixed results in a 109% ROIC, consistent revenue and earnings due to long-term relationships with customers.
Aligned Management Team. CEO Tom Kuboda owns over 60% and has been buying more (seven open market purchases in the last 2 years). Management takes low salaries and has maintained strong margins at different revenue levels. The board has returned cash to shareholders with a buyback and special dividend in the last two years.
Record of Growth. PFHO grew sales at a 55% CAGR from 2010-2014 as the company added new customers and grew relationships with existing customers. Sales in 1Q10 were $0.35mm, and grew to a peak of $2.75mm in 3Q14, but then declined to a low of $1.25mm in 2Q16 as PFHO lost its three largest customers (detailed below). However, since then, PFHO has grown sales back to $1.60mm as of 3Q17 (+21% y/y YTD sales growth). PFHO is back on track for 15-30% sales growth more consistent with performance from 2010-2014.
Strong Balance Sheet. PFHO has $7.02/share in net cash. The company’s cash balance covers its liabilities by over 10x. Management has hired investment bankers to review mergers & acquisitions. PFHO is not getting credit for the cash on its balance sheet, so deploying via an acquisition would unlock ~$7/share of value.
Acquisition Candidate. The business generates high ROIC, strong FCF, and has a good record of growth, so would make an attractive acquisition candidate. Management already owns over 60%, so could finance a go-private transaction with its existing cash balances plus borrowings. In addition, the sector has high private equity interest (as outlined below), so shares could be acquired by private equity at 10x 2018 EV/EBITDA of $2.5mm which would be $40/share.
Business Description
Services:
The company are workers’ compensation cost containment specialists. They provide the following services that help corporations, not-for-profits, municipalities, and insurance companies reduce workers’ comp costs.
• HCO (Health Care Organization) is network of healthcare professionals and service providers that work with Medex to help injured employees quickly recover while also controlling the cost for the employer. Medex charges the employer per enrollee and sometimes also generates revenue from the dollars saved by using the network
• MPN (Medical Provider Network) is similar to an HCO but do not require the same level of medical expertise in treating workplace injuries
• UR (Utilization Review) involves an experienced professional reviewing the injured workers’ recovery plan to ensure there is not excessive treatment. Medex will typically charge the client a percentage of the money saved
• MBR (Medical Bill Review) involves an experienced professional reviewing health services provided and ensuring proper reimbursement (coding review, rebundling, etc)
• NCM (Nurse Case Management) services has a nurse oversee the recovery process to ensure it is moving along at an appropriate pace in order and following-up with the injured worker to ensure he/she is attending treatment sessions which reduces time out of the office and saves money
Customers:
• Corporate: Best Buy (BBY), Walmart (WMT), Republic Services Group (RSG), Hilton Worldwide (HLT), KPC Healthcare
• Municipalities: City of Long Beach, City of Carson, City of Oceanside, San Jose Unified School District
• Not-For-Profit: Goodwill, AAA
• Other: Athens, SHARP, Preferred Operator Group, DART
Competitors:
• Corvel (CRVL) is the only publicly traded peer and sells for 13.7x TTM EV/EBITDA and 31x TTM P/E
• Sedgwick – largest company in the sector was acquired by KKR in 2014 for 12x EV/EBITDA
• Concentra – Humana (HUM) sold to private equity in 2015
• First Health – owned by Coventry
• Genex – Apax Partners private equity acquired in 2014
Why shares fell from their highs:
As noted above, PFHO had a strong track record from 2010 to 2014, growing sales at a +55% CAGR. Starting in 2014, PFHO lost its three largest customers Prime Insurance, Companion, and AmTrust for different reasons. This caused PFHO’s revenue to fall from $2.75mm in 3Q14 to $1.25mm in 2Q16
• Prime Insurance – PFHO had been providing overflow processing services for Prime in 2013-2014 and Prime caught up on overflow work, so was able to take the work back in-house.
• Companion Property & Casualty Insurance was acquired by Enstar Group and Enstar brought the services in-house.
• AmTrust cited changing business needs as the reason for no longer using PFHO’s UR, NCM, and MPN services.
PFHO’s remaining customer base is focused on corporates, not-for-profits, and municipalities which have proven to be more stable than insurance customers because they are less likely to perform the services in-house. Evidence of this stability is that revenues have consistently grown since 2Q16 when the large insurance clients were fully off of PFHO’s platform. Since 2Q16, revenue has grown at a ~20% rate which I expect is sustainable going forward.
Financial Analysis
I estimate PFHO is back to ~20% revenue growth based on results from 2Q16 through 3Q17. EBITDA margins have continued to recover each quarter from their low of 12% to 27% in the last quarter. I estimate EBITDA margins will continue to recover to ~35% where they were in 2014 and 2015 as revenue continues to grow. This results in EPS growth at a 33% CAGR for the next 3 years.
PFHO Financial Model
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Revenue 1,616 2,832 4,827 6,573 9,463 8,225 5,688 6,500 7,800 9,360 11,232
Growth 75% 70% 36% 44% -13% -31% 14% 20% 20% 20%
EBITDA (76) 336 1,262 2,099 3,347 2,892 1,054 1,750 2,496 3,276 3,931
Margin -5% 12% 26% 32% 35% 35% 19% 27% 32% 35% 35%
EPS $ (0.08) $ 0.25 $ 0.89 $ 1.54 $ 2.45 $ 2.10 $ 0.71 $ 1.22 $ 1.80 $ 2.38 $ 2.87
Growth 256% 73% 59% -14% -66% 72% 47% 33% 21%
Cash / Share $ 0.44 $ 0.46 $ 0.60 $ 1.58 $ 3.68 $ 4.79 $ 6.26 $ 7.32 $ 9.12 $ 11.50 $ 14.37
Growth 30% 164% 133% 30% 31% 17% 25% 26% 25%
Valuation
CRVL is the only publicly traded comparable at 13.7x EV/EBITDA and 31x P/E. However, Corvel has more scale so will likely trade for a premium to PFHO (though PFHO does have better margins and growth). I estimate PFHO’s fair value is 10x EV/EBITDA and 20x P/E ex-cash. At $2.5mm EBITDA in 2018, I estimate PFHO’s EV is $25mm plus $7mm of cash = $32mm / 0.8mm shares = $40.00 fair value today. By 2020, I estimate PFHO will generate $3.9mm of EBITDA and be worth $39mm EV + $11mm net cash = $60mm / 0.8mm share = $75/share
Catalysts
• Continuing to deliver revenue growth and margin expansion which grows EPS
• Generating FCF and continuing to build FCF
• Deploying large cash balance for an acquisition which will accelerate the growth profile
• Takeover acquisition – either management buyout (using large cash balance) or selling to one of the many private equity companies involved in the sector
Risks
• More customer losses
• Poor acquisition or overpay
• Regulatory changes that negatively impact the workers’ comp cost containment industry
PFHO Writeup
Pacific Health Care’s operating business, Medex (http://www.medexhco.com/), helps corporations, not-for-profits, and municipalities reduce their workers’ compensation claims costs by providing a network of healthcare providers, reviewing medical bills to reduce costs, and having a professional oversee the life of a claim. The business has similar financial traits to a law or accounting firm because highly skilled professionals are providing services, so there is no inventory, low working capital, high returns on invested capital, and net income closely matches free cash flow.
Thesis:
Strong Business. Strong FCF, low working capital and fixed results in a 109% ROIC, consistent revenue and earnings due to long-term relationships with customers.
Aligned Management Team. CEO Tom Kuboda owns over 60% and has been buying more (seven open market purchases in the last 2 years). Management takes low salaries and has maintained strong margins at different revenue levels. The board has returned cash to shareholders with a buyback and special dividend in the last two years.
Record of Growth. PFHO grew sales at a 55% CAGR from 2010-2014 as the company added new customers and grew relationships with existing customers. Sales in 1Q10 were $0.35mm, and grew to a peak of $2.75mm in 3Q14, but then declined to a low of $1.25mm in 2Q16 as PFHO lost its three largest customers (detailed below). However, since then, PFHO has grown sales back to $1.60mm as of 3Q17 (+21% y/y YTD sales growth). PFHO is back on track for 15-30% sales growth more consistent with performance from 2010-2014.
Strong Balance Sheet. PFHO has $7.02/share in net cash. The company’s cash balance covers its liabilities by over 10x. Management has hired investment bankers to review mergers & acquisitions. PFHO is not getting credit for the cash on its balance sheet, so deploying via an acquisition would unlock ~$7/share of value.
Acquisition Candidate. The business generates high ROIC, strong FCF, and has a good record of growth, so would make an attractive acquisition candidate. Management already owns over 60%, so could finance a go-private transaction with its existing cash balances plus borrowings. In addition, the sector has high private equity interest (as outlined below), so shares could be acquired by private equity at 10x 2018 EV/EBITDA of $2.5mm which would be $40/share.
Business Description
Services:
The company are workers’ compensation cost containment specialists. They provide the following services that help corporations, not-for-profits, municipalities, and insurance companies reduce workers’ comp costs.
• HCO (Health Care Organization) is network of healthcare professionals and service providers that work with Medex to help injured employees quickly recover while also controlling the cost for the employer. Medex charges the employer per enrollee and sometimes also generates revenue from the dollars saved by using the network
• MPN (Medical Provider Network) is similar to an HCO but do not require the same level of medical expertise in treating workplace injuries
• UR (Utilization Review) involves an experienced professional reviewing the injured workers’ recovery plan to ensure there is not excessive treatment. Medex will typically charge the client a percentage of the money saved
• MBR (Medical Bill Review) involves an experienced professional reviewing health services provided and ensuring proper reimbursement (coding review, rebundling, etc)
• NCM (Nurse Case Management) services has a nurse oversee the recovery process to ensure it is moving along at an appropriate pace in order and following-up with the injured worker to ensure he/she is attending treatment sessions which reduces time out of the office and saves money
Customers:
• Corporate: Best Buy (BBY), Walmart (WMT), Republic Services Group (RSG), Hilton Worldwide (HLT), KPC Healthcare
• Municipalities: City of Long Beach, City of Carson, City of Oceanside, San Jose Unified School District
• Not-For-Profit: Goodwill, AAA
• Other: Athens, SHARP, Preferred Operator Group, DART
Competitors:
• Corvel (CRVL) is the only publicly traded peer and sells for 13.7x TTM EV/EBITDA and 31x TTM P/E
• Sedgwick – largest company in the sector was acquired by KKR in 2014 for 12x EV/EBITDA
• Concentra – Humana (HUM) sold to private equity in 2015
• First Health – owned by Coventry
• Genex – Apax Partners private equity acquired in 2014
Why shares fell from their highs:
As noted above, PFHO had a strong track record from 2010 to 2014, growing sales at a +55% CAGR. Starting in 2014, PFHO lost its three largest customers Prime Insurance, Companion, and AmTrust for different reasons. This caused PFHO’s revenue to fall from $2.75mm in 3Q14 to $1.25mm in 2Q16
• Prime Insurance – PFHO had been providing overflow processing services for Prime in 2013-2014 and Prime caught up on overflow work, so was able to take the work back in-house.
• Companion Property & Casualty Insurance was acquired by Enstar Group and Enstar brought the services in-house.
• AmTrust cited changing business needs as the reason for no longer using PFHO’s UR, NCM, and MPN services.
PFHO’s remaining customer base is focused on corporates, not-for-profits, and municipalities which have proven to be more stable than insurance customers because they are less likely to perform the services in-house. Evidence of this stability is that revenues have consistently grown since 2Q16 when the large insurance clients were fully off of PFHO’s platform. Since 2Q16, revenue has grown at a ~20% rate which I expect is sustainable going forward.
Financial Analysis
I estimate PFHO is back to ~20% revenue growth based on results from 2Q16 through 3Q17. EBITDA margins have continued to recover each quarter from their low of 12% to 27% in the last quarter. I estimate EBITDA margins will continue to recover to ~35% where they were in 2014 and 2015 as revenue continues to grow. This results in EPS growth at a 33% CAGR for the next 3 years.
PFHO Financial Model
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Revenue 1,616 2,832 4,827 6,573 9,463 8,225 5,688 6,500 7,800 9,360 11,232
Growth 75% 70% 36% 44% -13% -31% 14% 20% 20% 20%
EBITDA (76) 336 1,262 2,099 3,347 2,892 1,054 1,750 2,496 3,276 3,931
Margin -5% 12% 26% 32% 35% 35% 19% 27% 32% 35% 35%
EPS $ (0.08) $ 0.25 $ 0.89 $ 1.54 $ 2.45 $ 2.10 $ 0.71 $ 1.22 $ 1.80 $ 2.38 $ 2.87
Growth 256% 73% 59% -14% -66% 72% 47% 33% 21%
Cash / Share $ 0.44 $ 0.46 $ 0.60 $ 1.58 $ 3.68 $ 4.79 $ 6.26 $ 7.32 $ 9.12 $ 11.50 $ 14.37
Growth 30% 164% 133% 30% 31% 17% 25% 26% 25%
Valuation
CRVL is the only publicly traded comparable at 13.7x EV/EBITDA and 31x P/E. However, Corvel has more scale so will likely trade for a premium to PFHO (though PFHO does have better margins and growth). I estimate PFHO’s fair value is 10x EV/EBITDA and 20x P/E ex-cash. At $2.5mm EBITDA in 2018, I estimate PFHO’s EV is $25mm plus $7mm of cash = $32mm / 0.8mm shares = $40.00 fair value today. By 2020, I estimate PFHO will generate $3.9mm of EBITDA and be worth $39mm EV + $11mm net cash = $60mm / 0.8mm share = $75/share
Catalysts
• Continuing to deliver revenue growth and margin expansion which grows EPS
• Generating FCF and continuing to build FCF
• Deploying large cash balance for an acquisition which will accelerate the growth profile
• Takeover acquisition – either management buyout (using large cash balance) or selling to one of the many private equity companies involved in the sector
Risks
• More customer losses
• Poor acquisition or overpay
• Regulatory changes that negatively impact the workers’ comp cost containment industry
Pacific Health Care Organization Inc (PFHO) Writeup
Pacific Health Care’s operating business, Medex (http://www.medexhco.com/), helps corporations, not-for-profits, and municipalities reduce their workers’ compensation claims costs by providing a network of healthcare providers, reviewing medical bills to reduce costs, and having a professional oversee the life of a claim. The business has similar financial traits to a law or accounting firm because highly skilled professionals are providing services, so there is no inventory, low working capital, high returns on invested capital, and net income closely matches free cash flow.
Thesis:
Strong Business. Strong FCF, low working capital and fixed results in a 109% ROIC, consistent revenue and earnings due to long-term relationships with customers.
Aligned Management Team. CEO Tom Kuboda owns over 60% and has been buying more (seven open market purchases in the last 2 years). Management takes low salaries and has maintained strong margins at different revenue levels. The board has returned cash to shareholders with a buyback and special dividend in the last two years.
Record of Growth. PFHO grew sales at a 55% CAGR from 2010-2014 as the company added new customers and grew relationships with existing customers. Sales in 1Q10 were $0.35mm, and grew to a peak of $2.75mm in 3Q14, but then declined to a low of $1.25mm in 2Q16 as PFHO lost its three largest customers (detailed below). However, since then, PFHO has grown sales back to $1.60mm as of 3Q17 (+21% y/y YTD sales growth). PFHO is back on track for 15-30% sales growth more consistent with performance from 2010-2014.
Strong Balance Sheet. PFHO has $7.02/share in net cash. The company’s cash balance covers its liabilities by over 10x. Management has hired investment bankers to review mergers & acquisitions. PFHO is not getting credit for the cash on its balance sheet, so deploying via an acquisition would unlock ~$7/share of value.
Acquisition Candidate. The business generates high ROIC, strong FCF, and has a good record of growth, so would make an attractive acquisition candidate. Management already owns over 60%, so could finance a go-private transaction with its existing cash balances plus borrowings. In addition, the sector has high private equity interest (as outlined below), so shares could be acquired by private equity at 10x 2018 EV/EBITDA of $2.5mm which would be $40/share.
Business Description
Services:
The company are workers’ compensation cost containment specialists. They provide the following services that help corporations, not-for-profits, municipalities, and insurance companies reduce workers’ comp costs.
• HCO (Health Care Organization) is network of healthcare professionals and service providers that work with Medex to help injured employees quickly recover while also controlling the cost for the employer. Medex charges the employer per enrollee and sometimes also generates revenue from the dollars saved by using the network
• MPN (Medical Provider Network) is similar to an HCO but do not require the same level of medical expertise in treating workplace injuries
• UR (Utilization Review) involves an experienced professional reviewing the injured workers’ recovery plan to ensure there is not excessive treatment. Medex will typically charge the client a percentage of the money saved
• MBR (Medical Bill Review) involves an experienced professional reviewing health services provided and ensuring proper reimbursement (coding review, rebundling, etc)
• NCM (Nurse Case Management) services has a nurse oversee the recovery process to ensure it is moving along at an appropriate pace in order and following-up with the injured worker to ensure he/she is attending treatment sessions which reduces time out of the office and saves money
Customers:
• Corporate: Best Buy (BBY), Walmart (WMT), Republic Services Group (RSG), Hilton Worldwide (HLT), KPC Healthcare
• Municipalities: City of Long Beach, City of Carson, City of Oceanside, San Jose Unified School District
• Not-For-Profit: Goodwill, AAA
• Other: Athens, SHARP, Preferred Operator Group, DART
Competitors:
• Corvel (CRVL) is the only publicly traded peer and sells for 13.7x TTM EV/EBITDA and 31x TTM P/E
• Sedgwick – largest company in the sector was acquired by KKR in 2014 for 12x EV/EBITDA
• Concentra – Humana (HUM) sold to private equity in 2015
• First Health – owned by Coventry
• Genex – Apax Partners private equity acquired in 2014
Why shares fell from their highs:
As noted above, PFHO had a strong track record from 2010 to 2014, growing sales at a +55% CAGR. Starting in 2014, PFHO lost its three largest customers Prime Insurance, Companion, and AmTrust for different reasons. This caused PFHO’s revenue to fall from $2.75mm in 3Q14 to $1.25mm in 2Q16
• Prime Insurance – PFHO had been providing overflow processing services for Prime in 2013-2014 and Prime caught up on overflow work, so was able to take the work back in-house.
• Companion Property & Casualty Insurance was acquired by Enstar Group and Enstar brought the services in-house.
• AmTrust cited changing business needs as the reason for no longer using PFHO’s UR, NCM, and MPN services.
PFHO’s remaining customer base is focused on corporates, not-for-profits, and municipalities which have proven to be more stable than insurance customers because they are less likely to perform the services in-house. Evidence of this stability is that revenues have consistently grown since 2Q16 when the large insurance clients were fully off of PFHO’s platform. Since 2Q16, revenue has grown at a ~20% rate which I expect is sustainable going forward.
Financial Analysis
I estimate PFHO is back to ~20% revenue growth based on results from 2Q16 through 3Q17. EBITDA margins have continued to recover each quarter from their low of 12% to 27% in the last quarter. I estimate EBITDA margins will continue to recover to ~35% where they were in 2014 and 2015 as revenue continues to grow. This results in EPS growth at a 33% CAGR for the next 3 years.
PFHO Financial Model
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Revenue 1,616 2,832 4,827 6,573 9,463 8,225 5,688 6,500 7,800 9,360 11,232
Growth 75% 70% 36% 44% -13% -31% 14% 20% 20% 20%
EBITDA (76) 336 1,262 2,099 3,347 2,892 1,054 1,750 2,496 3,276 3,931
Margin -5% 12% 26% 32% 35% 35% 19% 27% 32% 35% 35%
EPS $ (0.08) $ 0.25 $ 0.89 $ 1.54 $ 2.45 $ 2.10 $ 0.71 $ 1.22 $ 1.80 $ 2.38 $ 2.87
Growth 256% 73% 59% -14% -66% 72% 47% 33% 21%
Cash / Share $ 0.44 $ 0.46 $ 0.60 $ 1.58 $ 3.68 $ 4.79 $ 6.26 $ 7.32 $ 9.12 $ 11.50 $ 14.37
Growth 30% 164% 133% 30% 31% 17% 25% 26% 25%
Valuation
CRVL is the only publicly traded comparable at 13.7x EV/EBITDA and 31x P/E. However, Corvel has more scale so will likely trade for a premium to PFHO (though PFHO does have better margins and growth). I estimate PFHO’s fair value is 10x EV/EBITDA and 20x P/E ex-cash. At $2.5mm EBITDA in 2018, I estimate PFHO’s EV is $25mm plus $7mm of cash = $32mm / 0.8mm shares = $40.00 fair value today. By 2020, I estimate PFHO will generate $3.9mm of EBITDA and be worth $39mm EV + $11mm net cash = $60mm / 0.8mm share = $75/share
Catalysts
• Continuing to deliver revenue growth and margin expansion which grows EPS
• Generating FCF and continuing to build FCF
• Deploying large cash balance for an acquisition which will accelerate the growth profile
• Takeover acquisition – either management buyout (using large cash balance) or selling to one of the many private equity companies involved in the sector
Risks
• More customer losses
• Poor acquisition or overpay
• Regulatory changes that negatively impact the workers’ comp cost containment industry
Shares never traded at $90. The highest close was $69.86 or $71.11 including the dividend. When you make outright false statements, you lose any credibility you gained from being right in the past.
Good luck shorting PFHO
Ubertino,
You had a good call shorting PFHO from mid-2014 until early 2016 as they lost their three largest customers, but they turned the corned in early 2016, winning new customers and began growing through 2016 and into 2017. The business has a high ROIC and generates strong FCF.
While you got PFHO right for 2 years (2014 to 2016), you also identified ZYXI as a scam earlier this year and that stock is up 10x in 6 months.
Best of luck shorting PFHO from here.
Collin
Synergy CHC (SNYR) Long Idea
High ROIC, FCF generative, under-the-radar nutraceutical company selling for 2.8x EV/EBITDA
Unique distribution through social media able to target sales to millennial women which may drive 60% EBITDA growth over the next 12 months
Management and well-respected Knight (GUD CN) own 80% of shares and are well-aligned with shareholders
Synergy CHC Corp (OTCQB:SNYR) is a consumer brands company with two main products: Focus Factor, a brain supplement and Flat Tummy Tea, a weight loss tea. The company was founded by Jack Ross who had a background in retail and consumer products when he acquired Focus Factor from a lawyer in New York in January 2015 for $6 million. The brand was popular in the 1980s, but had been neglected for the last couple decades. Jack improved distribution including getting Focus Factor on the shelves of Costco, Walmart, and Amazon, more than doubling Focus Factor’s sales from less than $10 million in 2014 to over $20 million today. Focus Factor sells for $20/bottle on Amazon for 150 tables and is effectively a multi-vitamin supplement that helps people improve their memory.
Parlaying his success with Focus Factor, Jack acquired Nomad’s Choice in November 2015 for $10 million which owned Flat Tummy Tea. The weight loss tea had grown from $1 million in sales in 2014 to $7 million in 2015 and since being acquired by Synergy has grown to over $20 million in sales organically. Flat Tummy tea is sold through social media and direct email advertising campaigns. The company has figured out the formula for successfully marketing the product to millennial women through the brand’s over 1.3 million Instagram followers and paid promoters.
Synergy is now beginning to leverage its successful social media marketing engine to launch new products organically to grow sales. The most recent product is Sneaky Vaunt which is a backless, strapless push-up bra marketed to a similar consumer base as Flat Tummy Tea. The product was developed internally at Synergy and sold over $700,000 in its first month (March 2017) at a healthy 90% gross margin. Maintaining its sales pace for the year, I would expect Sneaky Vaunt to generate nearly $10 million over the next 12 months.
Next up for Synergy is launching a diet shake drink marketed through its Synergy Effect social media marketing engine to the same customer base as Flat Tummy Tea and Sneaky Vaunt. In addition, Synergy will continue to evaluate tuck-in acquisitions for products targeted at millennial women that can be better advertised through the Synergy Effect social media marketing platform. In June 2017, Synergy closed the acquisition of Per-fekt Beauty, maker of skin gels, which sells through Sephora, Ulta, and Amazon, for $0.7 million in stock (SNYR shares valued at $1.50/share in the acquisition) plus a 5% royalty on sales.
Jack Ross owns over 50% of the outstanding shares of Synergy so he is well aligned with shareholders. In addition, Knight Therapeutics (GUD CN) owns 20% of outstanding shares which it gained through warrants which were attached to loans made to Synergy to help the company acquire Focus Factor and Flat Tummy Tea. Knight Therapeutics is a well-regarded pharmaceutical and nutraceutical company run by Jonathan Goodman who was the founder of Paladin Labs which generated a 25% CAGR for shareholders over the 25 years he ran it, culminating in a well-timed sale to Endo Pharmaceuticals (ENDP) in 2014. Paladin Labs success was based on licensing drugs from US companies for distribution in Canada and then paying a royalty to the owner which was a zero-risk proposition for fledging pharmaceutical companies in the US who did not have access to distribution in Canada. After his success with Paladin Labs, Goodman started Knight Therapeutics to continue his previous strategy. Part of Knight’s mandate is to make loans to companies in the pharmaceutical or nutraceutical industries at less than 3x debt/EBITDA, typically charging low-teens interest rates and getting warrants in the business. Synergy was founded with loans from Knight which are nearly all paid off now from FCF generated by Focus Factor and Flat Tummy Tea. Having an investor with the background and reputation as good as Jonathan Goodman lends significant credibility to Jack Ross and Synergy and will ensure shareholder capital is deployed effectively.
Given the rapid organic growth in Synergy’s products and the unique way in which the business was founded, the company is still below the radar. Only about 20% of the shares are publicly traded because insiders and Knight own the majority. While the nutraceutical industry can have mixed reviews because some view the products as “alternative medicine”, the financial characteristics of the business are wonderful including 75% gross margins, high returns on tangible capital, low capex needs which result in strong conversion of EBITDA to FCF.
Synergy has 88 million shares outstanding which sell for $0.45 on OTCQB exchange under ticker SNYR, giving the business a $40 million market cap. In addition, Synergy has $5 million of debt and $2 million of cash, giving an enterprise value of $43 million. In 1Q17, the business generated $3.9 million of EBITDA, putting the run-rate EBITDA at $15.6 million and EV/EBITDA at 2.8x for a capital light business that has a strong track record of organic growth. Comparable nutraceutical companies will sell for 6-10x EV/EBITDA and many consumer branded companies will sell for over 12x EV/EBITDA. I estimate at 8x EV/EBITDA on run-rate EBITDA, SYNR’s fair value is $1.38/share, giving over 200% upside potential. Alternatively, SNYR reported 1Q17 EPS of $0.03, putting run-rate EPS at $0.12 and at 12x P/E, fair value at $1.44/share.
Beyond the current undervaluation, Synergy has a runway to continue to organically grow EBITDA which could drive fair value higher in the future. Sneaky Vaunt was only launched in March 2017, so 1Q17 results only had one month of sales. I expect Sneaky Vaunt to drive an incremental $4 million of EBITDA in the next twelve months. Given success so far with Focus Factor, Walmart is expanding from one skew (Focus Factor) to three (adding Focus Factor Kids and Focus Factor Extra Strength) and increasing from 1,200 to 4,500 stores which could add $6 million incrementally to EBITDA. Synergy acquired Per-fekt Beauty in June 2017 so will start marketing the beauty gel products through its Synergy Effect social media marketing platform which could drive $3 million of incremental EBITDA. Finally, Synergy is likely only a few weeks from launching its diet shake drink, which, if as successful as Sneaky Vaunt could drive an incremental $6 million of EBITDA. All in, Synergy has $19 million of EBITDA growth initiatives including $4 million Sneaky Vaunt, plus $6 million incremental Focus Factor sales to Walmart, plus $3 million from Per-fekt Beauty, plus $6 million from the diet shake. Against the run-rate base of $15.6 million, this could drive EBITDA as high as $34.6 million over the next 12 months. If we assume only 50% of the $19 million in growth initiatives are successful, Synergy’s EBITDA may be $25 million over the next 12 months, 60% growth y/y. Valuing Synergy shares at 8x EV/EBITDA on $25 million in next twelve months EBITDA results in $2.25 fair value, 400% upside potential. At $25 million of EBITDA, I estimate Synergy would generate $18 million of FCF vs the current market cap of $40 million and current enterprise value of $43 million.
SNYR Writeup
Synergy CHC Corp (SNYR) is a consumer brands company with two main products: Focus Factor, a brain supplement and Flat Tummy Tea, a weight loss tea. The company was founded by Jack Ross who had a background in retail and consumer products when he acquired Focus Factor from a lawyer in New York in January 2015 for $6 million. The brand was popular in the 1980s, but had been neglected for the last couple decades. Jack improved distribution including getting Focus Factor on the shelves of Costco, Walmart, and Amazon, more than doubling Focus Factor’s sales from less than $10 million in 2014 to over $20 million today. Focus Factor sells for $20/bottle on Amazon for 150 tables and is effectively a multi-vitamin supplement that helps people improve their memory.
Parlaying his success with Focus Factor, Jack acquired Nomad’s Choice in November 2015 for $10 million which owned Flat Tummy Tea. The weight loss tea had grown from $1 million in sales in 2014 to $7 million in 2015 and since being acquired by Synergy has grown to over $20 million in sales organically. Flat Tummy tea is sold through social media and direct email advertising campaigns. The company has figured out the formula for successfully marketing the product to millennial women through the brand’s over 1.3 million Instagram followers and paid promoters.
Synergy is now beginning to leverage its successful social media marketing engine to launch new products organically to grow sales. The most recent product is Sneaky Vaunt which is a backless, strapless push-up bra marketed to a similar consumer base as Flat Tummy Tea. The product was developed internally at Synergy and sold over $700,000 in its first month (March 2017) at a healthy 90% gross margin. Maintaining its sales pace for the year, I would expect Sneaky Vaunt to generate nearly $10 million over the next 12 months.
Next up for Synergy is launching a diet shake drink marketed through its Synergy Effect social media marketing engine to the same customer base as Flat Tummy Tea and Sneaky Vaunt. In addition, Synergy will continue to evaluate tuck-in acquisitions for products targeted at millennial women that can be better advertised through the Synergy Effect social media marketing platform. In June 2017, Synergy closed the acquisition of Per-fekt Beauty, maker of skin gels, which sells through Sephora, Ulta, and Amazon, for $0.7 million in stock (SNYR shares valued at $1.50/share in the acquisition) plus a 5% royalty on sales.
Jack Ross owns over 50% of the outstanding shares of Synergy so he is well aligned with shareholders. In addition, Knight Therapeutics (GUD CN) owns 20% of outstanding shares which it gained through warrants which were attached to loans made to Synergy to help the company acquire Focus Factor and Flat Tummy Tea. Knight Therapeutics is a well-regarded pharmaceutical and nutraceutical company run by Jonathan Goodman who was the founder of Paladin Labs which generated a 25% CAGR for shareholders over the 25 years he ran it, culminating in a well-timed sale to Endo Pharmaceuticals (ENDP) in 2014. Paladin Labs success was based on licensing drugs from US companies for distribution in Canada and then paying a royalty to the owner which was a zero-risk proposition for fledging pharmaceutical companies in the US who did not have access to distribution in Canada. After his success with Paladin Labs, Goodman started Knight Therapeutics to continue his previous strategy. Part of Knight’s mandate is to make loans to companies in the pharmaceutical or nutraceutical industries at less than 3x debt/EBITDA, typically charging low-teens interest rates and getting warrants in the business. Synergy was founded with loans from Knight which are nearly all paid off now from FCF generated by Focus Factor and Flat Tummy Tea. Having an investor with the background and reputation as good as Jonathan Goodman lends significant credibility to Jack Ross and Synergy and will ensure shareholder capital is deployed effectively.
Given the rapid organic growth in Synergy’s products and the unique way in which the business was founded, the company is still below the radar. Only about 20% of the shares are publicly traded because insiders and Knight own the majority. While the nutraceutical industry can have mixed reviews because some view the products as “alternative medicine”, the financial characteristics of the business are wonderful including 75% gross margins, high returns on tangible capital, low capex needs which result in strong conversion of EBITDA to FCF.
Synergy has 88 million shares outstanding which sell for $0.45 on OTCQB exchange under ticker SNYR, giving the business a $40 million market cap. In addition, Synergy has $5 million of debt and $2 million of cash, giving an enterprise value of $43 million. In 1Q17, the business generated $3.9 million of EBITDA, putting the run-rate EBITDA at $15.6 million and EV/EBITDA at 2.8x for a capital light business that has a strong track record of organic growth. Comparable nutraceutical companies will sell for 6-10x EV/EBITDA and many consumer branded companies will sell for over 12x EV/EBITDA. I estimate at 8x EV/EBITDA on run-rate EBITDA, SYNR’s fair value is $1.38/share, giving over 200% upside potential. Alternatively, SNYR reported 1Q17 EPS of $0.03, putting run-rate EPS at $0.12 and at 12x P/E, fair value at $1.44/share.
Beyond the current undervaluation, Synergy has a runway to continue to organically grow EBITDA which could drive fair value higher in the future. Sneaky Vaunt was only launched in March 2017, so 1Q17 results only had one month of sales. I expect Sneaky Vaunt to drive an incremental $4 million of EBITDA in the next twelve months. Given success so far with Focus Factor, Walmart is expanding from one skew (Focus Factor) to three (adding Focus Factor Kids and Focus Factor Extra Strength) and increasing from 1,200 to 4,500 stores which could add $6 million incrementally to EBITDA. Synergy acquired Per-fekt Beauty in June 2017 so will start marketing the beauty gel products through its Synergy Effect social media marketing platform which could drive $3 million of incremental EBITDA. Finally, Synergy is likely only a few weeks from launching its diet shake drink, which, if as successful as Sneaky Vaunt could drive an incremental $6 million of EBITDA. All in, Synergy has $19 million of EBITDA growth initiatives including $4 million Sneaky Vaunt, plus $6 million incremental Focus Factor sales to Walmart, plus $3 million from Per-fekt Beauty, plus $6 million from the diet shake. Against the run-rate base of $15.6 million, this could drive EBITDA as high as $34.6 million over the next 12 months. If we assume only 50% of the $19 million in growth initiatives are successful, Synergy’s EBITDA may be $25 million over the next 12 months, 60% growth y/y. Valuing Synergy shares at 8x EV/EBITDA on $25 million in next twelve months EBITDA results in $2.25 fair value, 400% upside potential. At $25 million of EBITDA, I estimate Synergy would generate $18 million of FCF vs the current market cap of $40 million and current enterprise value of $43 million.
SNYR Writeup
Synergy CHC Corp (SNYR) is a consumer brands company with two main products: Focus Factor, a brain supplement and Flat Tummy Tea, a weight loss tea. The company was founded by Jack Ross who had a background in retail and consumer products when he acquired Focus Factor from a lawyer in New York in January 2015 for $6 million. The brand was popular in the 1980s, but had been neglected for the last couple decades. Jack improved distribution including getting Focus Factor on the shelves of Costco, Walmart, and Amazon, more than doubling Focus Factor’s sales from less than $10 million in 2014 to over $20 million today. Focus Factor sells for $20/bottle on Amazon for 150 tables and is effectively a multi-vitamin supplement that helps people improve their memory.
Parlaying his success with Focus Factor, Jack acquired Nomad’s Choice in November 2015 for $10 million which owned Flat Tummy Tea. The weight loss tea had grown from $1 million in sales in 2014 to $7 million in 2015 and since being acquired by Synergy has grown to over $20 million in sales organically. Flat Tummy tea is sold through social media and direct email advertising campaigns. The company has figured out the formula for successfully marketing the product to millennial women through the brand’s over 1.3 million Instagram followers and paid promoters.
Synergy is now beginning to leverage its successful social media marketing engine to launch new products organically to grow sales. The most recent product is Sneaky Vaunt which is a backless, strapless push-up bra marketed to a similar consumer base as Flat Tummy Tea. The product was developed internally at Synergy and sold over $700,000 in its first month (March 2017) at a healthy 90% gross margin. Maintaining its sales pace for the year, I would expect Sneaky Vaunt to generate nearly $10 million over the next 12 months.
Next up for Synergy is launching a diet shake drink marketed through its Synergy Effect social media marketing engine to the same customer base as Flat Tummy Tea and Sneaky Vaunt. In addition, Synergy will continue to evaluate tuck-in acquisitions for products targeted at millennial women that can be better advertised through the Synergy Effect social media marketing platform. In June 2017, Synergy closed the acquisition of Per-fekt Beauty, maker of skin gels, which sells through Sephora, Ulta, and Amazon, for $0.7 million in stock (SNYR shares valued at $1.50/share in the acquisition) plus a 5% royalty on sales.
Jack Ross owns over 50% of the outstanding shares of Synergy so he is well aligned with shareholders. In addition, Knight Therapeutics (GUD CN) owns 20% of outstanding shares which it gained through warrants which were attached to loans made to Synergy to help the company acquire Focus Factor and Flat Tummy Tea. Knight Therapeutics is a well-regarded pharmaceutical and nutraceutical company run by Jonathan Goodman who was the founder of Paladin Labs which generated a 25% CAGR for shareholders over the 25 years he ran it, culminating in a well-timed sale to Endo Pharmaceuticals (ENDP) in 2014. Paladin Labs success was based on licensing drugs from US companies for distribution in Canada and then paying a royalty to the owner which was a zero-risk proposition for fledging pharmaceutical companies in the US who did not have access to distribution in Canada. After his success with Paladin Labs, Goodman started Knight Therapeutics to continue his previous strategy. Part of Knight’s mandate is to make loans to companies in the pharmaceutical or nutraceutical industries at less than 3x debt/EBITDA, typically charging low-teens interest rates and getting warrants in the business. Synergy was founded with loans from Knight which are nearly all paid off now from FCF generated by Focus Factor and Flat Tummy Tea. Having an investor with the background and reputation as good as Jonathan Goodman lends significant credibility to Jack Ross and Synergy and will ensure shareholder capital is deployed effectively.
Given the rapid organic growth in Synergy’s products and the unique way in which the business was founded, the company is still below the radar. Only about 20% of the shares are publicly traded because insiders and Knight own the majority. While the nutraceutical industry can have mixed reviews because some view the products as “alternative medicine”, the financial characteristics of the business are wonderful including 75% gross margins, high returns on tangible capital, low capex needs which result in strong conversion of EBITDA to FCF.
Synergy has 88 million shares outstanding which sell for $0.45 on OTCQB exchange under ticker SNYR, giving the business a $40 million market cap. In addition, Synergy has $5 million of debt and $2 million of cash, giving an enterprise value of $43 million. In 1Q17, the business generated $3.9 million of EBITDA, putting the run-rate EBITDA at $15.6 million and EV/EBITDA at 2.8x for a capital light business that has a strong track record of organic growth. Comparable nutraceutical companies will sell for 6-10x EV/EBITDA and many consumer branded companies will sell for over 12x EV/EBITDA. I estimate at 8x EV/EBITDA on run-rate EBITDA, SYNR’s fair value is $1.38/share, giving over 200% upside potential. Alternatively, SNYR reported 1Q17 EPS of $0.03, putting run-rate EPS at $0.12 and at 12x P/E, fair value at $1.44/share.
Beyond the current undervaluation, Synergy has a runway to continue to organically grow EBITDA which could drive fair value higher in the future. Sneaky Vaunt was only launched in March 2017, so 1Q17 results only had one month of sales. I expect Sneaky Vaunt to drive an incremental $4 million of EBITDA in the next twelve months. Given success so far with Focus Factor, Walmart is expanding from one skew (Focus Factor) to three (adding Focus Factor Kids and Focus Factor Extra Strength) and increasing from 1,200 to 4,500 stores which could add $6 million incrementally to EBITDA. Synergy acquired Per-fekt Beauty in June 2017 so will start marketing the beauty gel products through its Synergy Effect social media marketing platform which could drive $3 million of incremental EBITDA. Finally, Synergy is likely only a few weeks from launching its diet shake drink, which, if as successful as Sneaky Vaunt could drive an incremental $6 million of EBITDA. All in, Synergy has $19 million of EBITDA growth initiatives including $4 million Sneaky Vaunt, plus $6 million incremental Focus Factor sales to Walmart, plus $3 million from Per-fekt Beauty, plus $6 million from the diet shake. Against the run-rate base of $15.6 million, this could drive EBITDA as high as $34.6 million over the next 12 months. If we assume only 50% of the $19 million in growth initiatives are successful, Synergy’s EBITDA may be $25 million over the next 12 months, 60% growth y/y. Valuing Synergy shares at 8x EV/EBITDA on $25 million in next twelve months EBITDA results in $2.25 fair value, 400% upside potential. At $25 million of EBITDA, I estimate Synergy would generate $18 million of FCF vs the current market cap of $40 million and current enterprise value of $43 million.
SKIS is over leveraged, hasn't grown EBITDA in 5 years, and has poor cash conversion. I would pass
Thanks, I've been long since $0.08-0.10