An investment screen to consider - cash boxes with a business attached #2 (Idea 1: FF)

This post is a build on the previous post regarding investments that I term as “cash boxes with a business attached”. The criteria is as follows:

1. Large cash box (preferably >50% of market cap)

2. Is it a locked cash box or an open cash box - either a history of capital returns or a large investor to ensure alignment

3. Sound business attached (consistent profitability with a long operational history)

4. No overearning - preferably company going through a temporal trough

5. Cheap on normalized FCF

Typically, these businesses aren’t conventionally great businesses; they’re not “moaty” and typically in industries with terminal values in question; they also tend to fall in the small-cap universe, a result of inability for institutional ownership and a lack of coverage in general. And usually, they’re “fallen angels” of sorts - I cited ANF as an example - you’re buying these businesses when the future is bleak and the market is penalizing the stock for uncertainty. However, this where our cash-box magic comes to work - a large net cash buffer prevents the company from making irrational business decisions i.e. cutting its workforce, slashing R&D, slashing sales and marketing spend - which levered businesses often do, further exacerbating their precarious competitive position. A history of capital returns however ensures that when the company’s prospects turn, cash (at least some) will be distributed back, and at the very least increasing the pool of willing owners of the stock.

With that said, here is one interesting stonk I’ve come across recently.

FutureFuel (FF)

FutureFuel operates two disparate businesses through a single facility in Batesville, North Arkansas - a chemicals manufacturing segment and biofuels production segment. This one is quite fascinating because it seems like the market is viewing it as a biodiesel company due to majority of revenues coming from biodiesel (plus the name “Future Fuel”) despite majority of profits coming from the chemicals division. Given that biodiesel has been going through a rough patch with feedstock inflation and the collapse of D4 RIN values, the stock has been just going down pretty much since the Q2 23 report and was also removed from the S&P Composite 1500 index so really sort of a “if you don’t love me now, you’ll never love me again” type stock. It also doesn’t help that company doesn’t conduct quarterly conference calls nor provides guidance; given the independent balance sheet of the company, there is no analyst coverage.

At present, FF sports a 250m market cap with 205m of net cash equating to a 45m EV. Shares outstanding have remained stable for the last decade and apart from the LTM, the company has consistently earned a solid amount of FCF that would simply not justify a 45m EV (remember, this would send one laughing out the deal room).

The main issue with the stock is that yes, whilst biodiesel margins have compressed, FF’s biofuels operation is still profitable and what’s been eating the P&L is the firm’s poor hedging of margins - an issue that is easily rectifiable. In fact, against 45m of EV, FF generated 18m of EBITDA from its core operations through the L9M - an astoundingly cheap multiple even without annualizing figures.

Setting aside the headline multiple, this is where I think the story gets interesting. FF operates both businesses in a facility located Batesville, Arkansas. First up, just from a land value perspective (not captured on the b/s), FF’s 2200 acres of land is worth at least ~10m and more realistically, 13-14m (assuming ~3m per 500 acres) - so around ~30% of the extant EV. Secondly, out of the 2200 acres of land, FF only uses 500 acres so there’s room for further expansion of the facility. Thirdly and more importantly, both the chemicals and biofuels operations are within the same small facility and FF could easily shutter its biofuels operations which the firm has stated in their 10K that they would should there be any government incentive changes obviating the profit bolstering.

As seen above, the chemicals segment has a pretty stable gross margin profile - over the years, FF seems to have retired its lower margin product/customers. On top of this, the chemicals business has no customer concentration - what multiple does such a business warrant? Since FF is mainly specialty chemicals, this could warrant a low teens EBITDA multiple.

The biofuels segment on the other hand features unstable gross margins with large customer concentration - the sensitivity to feedstock prices so drastic that a 10% change in feedstock prices leads to a 91.2% decline in gross profits (pg 46 2022 10k).

In a world where the biofuels business is temporarily shuttered (and maybe FF changes its name to “SpecChem Solutions”), FF would have generated ~3.4m of EBIT (add back biofuels GP loss) for Q3 23 and 12m of EBIT for the L9M. Assuming 15m of EBIT and the market valuing it as a specialty chem co, FF would theoretically be worth at least 150-200m, including the 200m cash, equating to a stock price north of $8 minimum (not accounting for the optionality of biofuels to the acquirer).

Another way to think of this - and here’s the cash box idea - given the large cash balance and thus high interest income, supposing we valued that cash box at a certain multiple: e.g. L9M FF generated 7m of interest income or ~8-9m annualized - depending on one’s view of interest rates, capitalizing that stream at a 3-4x multiple would basically cover half of the current 45m EV. And as long as rates remain elevated, this cash box is basically akin to a business growing at ~3-4% p.a. but maybe with its terminal value in question (hence the low multiple).

The next question would then be, is it a locked cash box? Firstly, FF pays out an annual 24c of dividends ~4% yield on the current stock price. Secondly, FF in 2020/21, paid out ~260m of dividends (both special and regular divs), basically, in excess of the current market cap. Whilst the company is run conservatively, there is alignment in that Chairman Paul Novelly owns ~39% of the company through various vehicles and isn’t paid a fat salary from FF. He obtains his salary as CEO of Apex Oil (not a shoddy company but sizeable, doing 4.4b of revenues in 2023), an affiliate business - related party transactions are not that significant and are conducted at market clearing prices.

To sum it all up, this is just a disgustingly cheap stock unfairly penalized by the market. Will the company get a hold of its hedging strategy at some point? Hopefully. Will D4 RIN prices recover anytime soon? Given that RD generates more RIN than traditional biodiesel and there is an influx of RD capacity coming online, RIN values may continue their downtrend at least until marginally profitable plants shutter for being underwater and the S/D dynamics fixes itself. On the bright side, feedstock prices have moderated.

Nevertheless, Novelly is getting old (79 years old) and the company has way loads of cash to survive - even LTM for the worst 12 months in awhile, FF generated positive FCF (10m of OCF against 6m of CAPEX) - potential value catalysts from left field would be the company getting acquired at a lovely premium (given the stability in the chem business, this business could run net debt) or just having things turn out not as bad as prognosticated and at some point, the company divving out a large chunk of its cash, on top of stock price appreciation.

Again, open to feedback on these hairy names.

In the next post, I’ll cover some retail names that fit this criteria.