Thursday, September 16, 2010

It's Hard To Lose Money In This Business

TSR Inc. (TSRI) provides IT personnel to its clients for contract work. As companies have aggressively cut costs, TSR has seen reductions from its clients in both hours of work requested as well as price, as the supply of labour in many areas outstrips the demand for labour. But the nature of this industry is such that this company can still make money, even in hard times!

Most businesses see losses when revenues drop by over 10%, as a result of cost structures which contain a large element of fixed costs (e.g. Consider an airline, which has almost the same costs when a plane is full as when it is almost empty.) But TSR does not have to employ workers that are not needed at client locations (i.e. contract workers that are not earning revenue are not causing losses). Therefore, when revenues fall, so do costs.

In a particular quarter, however, losses can of course occur. The company does have some fixed costs (it's impossible to have none), and so if revenue comes in lower than expected, there could be some red ink. But over longer periods, this company is incredibly flexible in how it can manage its costs versus its revenues, which is very important when the outlook is unclear. No management guesses are required in the form of capital outlays (e.g. no plants need to built) which could turn out to be underutilized; the company can simply cut costs or ramp up as is deemed necessary.

When this flexible cost structure is combined with the company's assets, TSR becomes a strong candidate for a value investment. The company trades for just $8 million, but has net current assets of $12 million. Often, companies trading at such discounts to their assets are losing money hand over fist. Due to the weak labour situation, the market appears to be treating this company as if it will lose money. But TSRI's cost structure makes losing money a difficult thing to do, protecting the investor's downside at this price.

Disclosure: Author has a long position in shares of TSRI

11 comments:

tscott said...

I like it, although at first glance it looks like the business is steadily losing profitability. But based on the market value of equity it's a good pick.

Maybe a post on trading micro caps is due, even if you put out a small $2000 order at market prices chances are it wont get filled or you will get only a partial fill for 100 shares. Then you are stuck with at $20 commission on a $200 trade. Any special trading technique insights?

Alexandre said...

I agree that a post on microcaps in genreal,if you have time of course, would be higly appreciated.

Is there any catalyst in this stock to make the market realize that this stock is undervalued? (Special dividens given in the past that might be given in the futur,stock repurchase,etc?)Although they offer tremendous value potential, I feel that companies trading at a Market cap so low often need a catalyst to reach their potential. What do you think?

tscott said...

alexandre i think it's difficult to tell when a catalyst will happen but a portfolio of these companies will have some pleasant surprises over time. Value is its own catalyst in a way.

Alexandre said...

@tscott

I agree that value is a catalyst by itself. However, I think that a form of ''value catalyst'' is needed in some situations. In the case of a ''going concern'' type of compagny (a compagny that generates cash flow and is in a decent business but is somehow higly undervalued don't really need a catalyst (this company seems to be in this situation).

In the case of a pure ''asset play'' where the company is highly undervalued but is losing money or is in a declining business, I think a catalyst is necessary. I know that the catalyst part of the analysis is close to the dirty S word (speculation) but I still think it should be an important factors in these situations. Value+catalyst=Optimal Situation. Anyways, let me know what you think.

Saj Karsan said...

Hi guys,

Good discussion.

I don't think I have a lot of expertise on trading execution, so I'm not sure I can add any value with a post. I often just try to break my purchase into blocks congruent with the stock's trading volume. There is an "all or none" feature that can also prevent the type of trade you speak of, tscott.

Regarding this company's actions in particular, Alexandre, they plan a reverse split, but that's more for customers apparently, who look at the dollar amount of the stock price and think it could be insolvent. There is also a plan in place to buy back shares, but who knows how well that's progressing this quarter.

Regarding catalysts in general, I find that earning a normal return on capital is often an excellent catalyst, so I always try to determine how plausible it is that a company can return to normal profitability (so I tend to avoid companies with risky revenues or fixed costs or companies/industries that have never made money).

I find other catalysts (buyouts, analyst coverage, activist buyers) too difficult to predict, and so I don't even try. There are value investors who do make attempts, however, I'm just not one of them because I don't think I can add value in that regard. So, you won't find a lot of discussion on catalysts on this site, with the possible exception of some discussion on whether a company can eventually generate decent earnings.

Chris of Stumptown said...

I looked at TSRI in the past and passed, but I think it is a good pick. Maybe I will look again.

Anyone look at CSPI (system builder) or VSNT (software)? I own both and both are cheap on an EV basis, especially CSPI.

Personally I use Good til cancelled limit orders but there is the risk of getting picked off on these, but less brokerage cost friction.

Anonymous said...

Any thoughts on why TSRI would be doing a 1 for 2 reverse stock split? Seems very strange for a stock that is already illiquid to be doing a transaction that makes it even more illiquid. Precursor to management taking the company private?
Jimmymac

Saj Karsan said...

Hi Jimmy,

I recall the reason having to do with customer perception of the company's solvency. By increasing the absolute value of the share price, customers seem to feel more comfortable hiring the company for longer jobs it seems.

Chris of Stumptown said...

Jeez, talk about catalysts. I sold my shares this AM at $8+ ($4 pre split).

I don't understand the price action at all.

Paul said...

Saj,


TSRI is back to about the last time you talked about it. You like it still?

Saj Karsan said...

Hi Paul,

I do, but because the market is cheaper than it was then, I'd like to see this one get cheaper too.

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