January 19, 2015 Comments

On Monday, the New York stock markets were closed for the Martin Luther King holiday. Toronto was open and finished the day about unchanged.

Bombardier took another tumble. Melcor was down 2.6% to $16.55.

So, let’s take a look at both of these.

Melcor is trading at 64% of book value per share. It’s book equity is $726 million and it has debt of $589 million. The debt plus equity adds to $1,315 million. With the $726 million of equity trading at 64 cents on the dollar that is $465 million. Based on the trading price, the sum of the debt plus equity is trading at (465 + 589) = $1054 million. This assumes the debt is worth booth value. This means that the sum of the debt plus equity is trading at 80 cents on the dollar. In effect the assets of the company are trading at about 80 cents on the dollar. Now it is worth thinking about whether this is a good deal.

The worry, of course, is that these assets are falling in market value and earnings poewer due to lower oil prices and a possible recession in Canada.

The assets that are trading at this 80 cents consist as follows:

45% of the assets are investment properties which have high occupancies. These assets are marked to market and so they are certainly susceptible to a fall in value if interest rates rise and/or the “cap rate” at which these type of assets falls. I do not watch the REIT market carefully or the cap rates at which western Canadian office and retail properties trade hands. But I have certainly not seen and indication that these assets would trade hands at a 20% discount.

42% of the assets consists of land inventory. This includes raw land, partially developed land and fully developed building lots. IT would also include capitalized interest and administration costs associated with developing this land. Historically Melcor makes significant profit when it sells developed lots and so I would think that this land would be worth perhaps 30% more than book value. It is certainly possible that the price of building lots will drop in a recession and certainly that the pace of sales would drop. This could lead to Melcor having to sit on and carry the land for more years and it could lead to lower profits. But, overall it would take a deep recession before the value of this land would slip down as low as book value.

8% of the assets consist of receivables, most of which are longer term receivables from home builders. These assets should be worth close to book value, perhaps 90 to 95% of book value allowing for the time value of money and allowing for some bad debt especially if new home sales slow significantly.

The remaining 5% of assets consists of cash, equipment and some tenant improvements.

In addition to the assets on the books I suspect the company would have sopem goodwill value reflecting its value as a goping concern.

Overall I would certainly think that the assets are worth somewhat more than book value perhaps int he range of 20 to 50% more than book value but that is a rough guess.

But I think the opportunity to buy these assets at 80% of book value is attractive. And since share holders are not buying the whole company with debt plus equity, I think the more relevant figure is that the shares at=re trading at 64% of book value. Arguably that is about 50 cents on the dollar to what these shares “should” be worth.

It is true that Melcor has often traded under book value. This past Summer it had been trading above book value and there was some expectation aht that might continue as the company grew and become more noticed by larger investors.

Still, we don’t know how deep the slow-down or recession in Alberta will be and so these shares could certainly decline further and could take a long time to recover. But one has to be fairly pessimistic about Alberta’s long term future to think that Melcor would not recover at some point.

Turning to earnings. It should be pointed out that Melcor has a history of trading at a low multiple to earnings. At the present time Melcor is trading at 5.2 times trailing GAAP earnings and 7.5 times trailing adjusted earnings. And that is not based on any particularly large spike in earnings in the last 12 months. At $16.55, the market appears to be assuming that Melcor’s earnings will decline significantly and will not recover for quite some time such as several years.

Overall, there are always scenarios by which we (and certainly the market) can convince ourselves that shares are still too high. But I think Melcor offers excellent long-term value at this price.

Turning to Bombardier…

The common shares were down 6.2% today to $2.71

The one series of pref shares that I follow and own were down another 9.2% today to $16.25. At that price these shares are yielding 9.6%. It appears that the market is now seriously worried about a default on these shares or at least a temporary suspension of the dividend.

Our report on thes shares states “The company can convert these into a non-voting Class B common shares at any time at a 5% discount to the class B share price and at a minimum price of $2.00 per class B share.” That may also now be a concern because this could mean that if the the price of the common shares goes below $2.00 they could force the pref share holders to take 12.5 common shares per pref. and with the common now at $2.71 this is perhaps starting to loom as a possibility where s until this month that did not seem like something to be concerned about.

According to one site I just checked a Bombardier bond due in 2016 is trading at 103% of par to yield 6.97%. So that is actually a bit of a positive as that would not indicate imminent bankruptcy at least. TD Direct does not show any bonds for them. probably considering them too risky.

Bombardier’s credit rating is below investment grade.

The bottom line is that this a weak company. I have also long thought it to be poorly managed. Still, I had rated the pref and common shares as a speculative Buy while also indicating many of the weaker points particularly in the report on the common shares.

If this were a stronger company I would likely buy at the lower prices. But this is a weak company and so I hesitate to do that.

At last report the company indicates it has sufficient cash and lines of credit to see it through the year, as I understand it at which point presumably it expects profits to be looking up.

It’s very difficult to know what to do with this one. On the balance of probabilities I don’t expect Bombardier to default but that is certainly a possibility.

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