Wednesday, November 25, 2009

EnviroStar

EnviroStar (EVI) is a distributor of laundry equipment. This is a tiny company, with a market cap of just $7 million. But for value investors who simply focus on buying businesses that trade at discounts to their intrinsic values (instead of trying to apply small-cap or illiquidity discounts), some of this company's numbers are appealing.

The company's market cap is not much higher than its net cash position of $6 million. Often, a stock with a high cash to market cap ratio is one that is a perennial money-loser. But not in this case. Operating income over the last 7 years stands above the company's current market cap! Demand for heavy-duty equipment has, of course, waned through this recession, but there are two important attributes of this company that reduce its risk: its customers and its suppliers.

The company is not reliant on any one customer, as it distributes its products to over 1700 customers in various industries (hotel/motel, dry cleaners, hospitals etc). A diversified customer base reduces a company's risk, as its revenues/earnings are not reliant on a potential single point of failure.

Furthermore, the company is not burdened with the fixed costs associated with manufacturing this equipment. Instead, the company outsources the manufacturing to various suppliers. By acting solely as a distributor, the company has a more flexible cost structure, allowing it to react quickly to a lower demand environment. As a result, the company should be able to restore margins to previous levels with ease, relative to fixed-cost manufacturers.

The biggest risk to this company may be the way its controlling (and managing) shareholders appear to view public stockholders: as opponents rather than partners. Last December, the controlling shareholders tried to take advantage of a misbehaving market by making a bid for the remainder of the company. The bid, which valued the entire company at $6 million, likely so undervalued the company's assets that it was withdrawn just six days later. Consummation of the deal required a fairness opinion that the price offered was fair for the public stockholders, an opinion no financial advisor could likely offer with a straight face.

Despite this issue, the managing shareholders have done a great job with the company itself. Returns on equity have been commendable over the last few years, despite the fact that the company keeps a fairly sizable cash buffer around. As a result, Mr. Market appears to offer an excellent entry point at these price levels.

Disclosure: Author has a long position in shares of DCU/EVI

5 comments:

emiliano_s said...

great article. i saw this company too some time ago. showed a very stable record.

lost_value_under_my_bed said...

do you own the shares in EVI or DCU? referring to the disclaimer, i.e.

anyway, main question: have you read munger's essay where he talks about graham net-nets? he goes on to say that unlike the years gone past, today, the working capital doesn't really belong to the shareholders. in the past, the owners could wind up a business and just take the w/c out and distribute. but now, when you wind up a business you have to pay severance, health care, and a host of obligations lease terminations etc. so a simple division of working capital by the number of shares may not provide the whole picture. not saying this doesn't work. but there's a chance that there's more to it. let me know what you think.

Saj Karsan said...

Hi lost,

DCU and EVI are the same company. I've added EVI to the disclosure to avoid confusion, but at the time the article was written, the company's symbol was DCU.

I agree that you can't simply look at the working capital as a liquidation value, and buy blindly on that basis. The good news is that the company's obligations are disclosed, so you can look up if the company has pension obligations, lease commitments etc

Shane said...

First time posting on your site. I have been interested in this company for a little while but am concerned about managements intentions. Have you spoken with management at all regarding their policy on dividends? In their 10k they mention a dividend is possible but I don't see any indication they want to distribute the huge amount of cash.

Saj Karsan said...

Hi Shane,

I do not know management's intentions with respect to a dividend, however, I would venture to say that I would be very surprised if they were to issue one, based on my reading of their past actions.

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