Monday, April 6, 2009

Paulin Puts The Brakes On Manufacturing

H Paulin (PAP.A) trades at a discount to its net current asset value, meaning its current assets minus all its liabilities equal more than its market cap. This was a favourite screening tool for Ben Graham, long considered the father of value investing, and serves as a good starting point for finding value stocks.

But it's never a good idea to invest simply on this basis. As we've seen before, a company can even trade at a discount to its cash, but if it's burning through that cash, it's not likely to make for a worthy investment. As it turns out, H Paulin lost 22 cents per share in 2008, meaning its balance sheet position has deteriorated. But a closer examination of the company reveals that it holds the potential to be a terrific value investment.

The company has two main segments: manufacturing and distribution. The manufacturing segment lost $6.7 million in 2008, while the distribution segment had operating profits of $6.2 million! Paulin is basically made up of two companies, one on the verge of collapse, and one exhibiting strong revenue and market share growth!

The key to look out for in this type of situation is whether management is throwing good money after bad: is the manufacturing segment going to continue to hamper this company going forward, or will investors start to reap the benefits from the distribution business? 

Looking at the numbers, the answer appears to be the latter. The company has stated its intention to reduce its exposure to its manufacturing segment, and it has backed up its words with actions: manufacturing capex in the last two years has been just $1.2 million, compared to depreciation of $5.3 million. Also included in the loss for 2008 are charges (all to the manufacturing division) of $3 million for severance, inventory obsolescence, and asset impairments, suggesting exposure to this segment has been drastically reduced going forward.

Value investing is all about finding hidden gems. While the headline numbers of this unfollowed small-cap result in market disinterest, those willing to take a closer look may reap the rewards over the long term.

Disclosure: Author has a long position in PAP.A


Anonymous said...

Could be an interesting play, but my read is that the distribution biz cant exist without the mfg, ie they are linked in the same supply chain.

Saj Karsan said...

That is an interesting question wrt a company like this which sells from one unit to the other. To answer it though, you can look at the company's intersegment sales to see the magnitude of the cross selling going on.

Valeur et Profit said...

Hi Saj Karsan,

What about the net cash flow = 0 and the cash in the balance sheet = 0 ??

The current asset are composed only with A/R and inventories, strange ?

Thanks in advance for your explanations.

Saj Karsan said...

Hi Valeur,

Yeah, they do operate a bit differently than most corporations, seemingly operating out of their line of credit instead of cash on hand. However, that makes the 0 net cash flow number rather meaningless, as last quarter they reduced their debt from $27 to $18 million and turned in an operating profit in a tough period!

Anonymous said...

This one is a rather big winner for me, I got in at $7.80 2.5 years ago and buyout just annouced for $27.60. Most of the Net-Net workout eventually, you just need to wait.


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