notes from bb&t 1-on-1 conference
DESCRIPTION
These are my notes from 1-on-1 and small group meetings with seven publicly traded companies at a recent BB&T conference held at the Ritz Carlton in San Francisco.TRANSCRIPT
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
BB&T Conference Notes- 8/10/11
San Francisco 1-on-1 Conference
The Ritz-Carlton, San Francisco
Schedule for Benjamin Claremon - Cove Street Capital
Wednesday, August 10, 2011
07:45-08:25 am Diamond Foods, Inc.
Steve Neil, Linda Segre
09:30-10:10 am CIBER, Inc.
Gary Kohn, Claude Pumilia
10:15-10:55 am Perficient, Inc.
Jeff Davis
11:00-11:40 am Kansas City Southern
Bill Galligan, Mike Upchurch
12:45-01:25 pm Tyson Foods, Inc.
Julie Kegley, Dennis Leatherby, Jim Lochner
01:30-02:10 pm The Gorman-Rupp Company
Jeff Gorman, Wayne Knabel
03:45-04:25 pm Kirby Corporation
Steve Holcomb, Joe Pyne
Diamond Foods: CFO Steven Neil
Description
Diamond Foods, Inc., a packaged food company, engages in processing, marketing, and distributing snack products,
as well as culinary, in-shell, and ingredient nuts. Its snack products include glazed nuts, roasted and mixed nuts,
breakfast trail mix products, microwave popcorn products, and potato and tortilla chips. The company’s culinary
nuts comprise shelled nuts, pegboard nuts, and harvest reserve premium nuts. Its in-shell nuts consist of uncracked
nuts and mixed nuts; and ingredient/food service products include shelled and processed nuts, and custom-processed
nuts. The company offers its products under the Emerald, Pop Secret, Kettle, and Diamond of California brand
names. Diamond Foods, Inc. sells its products directly to retailers and indirectly through wholesale distributors, who
serve independent and small regional retail grocery store chains and convenience stores. The company offers its
products in the United States, the United Kingdom, Germany, the Netherlands, Spain, Italy, Canada, South Korea,
Turkey, and Japan. Diamond Foods, Inc. was founded in 1912 and is based in San Francisco, California.
Ticker DMND TTM EBITDA ($mm) $135
Current Price $71.85 TTM EPS $2.15
Market Cap ($mm) $1,579 5 Yr. Avg. Op. Margin 5.40%
Enterprise Value ($mm) $2,150 5 Yr. Avg. EBITDA Margin 7.06%
Dividend Yield 0.30% Trailing EV/EBITDA 15.9x
Average Volume (mm) 0.24 Trailing P/E Ratio 33.3x
*Data from Capital IQ
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Market and Company Background
Nuts
o Planters is their largest nut competitor and is peanut focused
Emerald is focused on younger consumers
Share is about 10% of the market
o Diamond is the culinary nut brand with market share 10x the next largest brand
Popcorn
o 28% market share for Pop Secret
o Pop Secret is now in Sam’s Club and Wal-Mart after not being available for a while
o Much higher margins than nuts
Cost of corn is much lower than the cost of commodity nuts
Bought Kettle Brand in 2010
o Is an all-natural product
o 6 month shelf life instead of 3 months with other chips
o This acquisition got them outside of the US
Profitable business in the UK
55% revenue comes from the UK
The Pringles deal will close by the end of year
o Great brand, especially outside the US
Is the number 4 chip brand in the world in terms of sales
o It was an orphan brand
It was the last food asset at P&G
o Is a manufactured crisp
15-18 month shelf life
Means that it can go around the world
o Nice infrastructure for them to pick up
o Want to use Pringles to lever Kettle and other brands
o The acquisition will cause non-North America revenue to increase from 21% to 46% and move
snack from 58% of revenue to 83% of revenue
o Pringles is under-represented in grocery
Brand is in convenience stores to some extent but more so in mass stores like Target and
Wal-Mart
Want to focus more on grocery going forward
o All of their buyers are the same for the chips, nuts and Pringles
Which is why it is easy for them to integrate the additional brands
Biggest cost are commodities
o 30%-40% of total COGS
o The second biggest cost is trade funds
These are netted against sales so you never see it on the P&L
Represent how much you have to pay to market the brand to retailers
Have developed a lot of leverage with the buyers
Allows you to get more SKUs in their stores
Having all three brands in convenience stores is important
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
If you are negotiating with the same buyer, you have more leverage
Not being the biggest (Frito Lay is) is actually an advantage sometimes
o The stores want multiple brands on the shelves and they like brands to compete
2 nationally branded and one store brand
o They like to be one of the alternatives to the other major brands
o They can do wholesale delivery (which is much cheaper) or manage the shelf for the stores
Growth Drivers
What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In
other words, what are the main drivers of Diamond’s performance?
o They are focused on profitable revenue growth
Normal growth is 2-3% in this business but they have grown 20%
o Increased scale in COGS or in OPEX
Revenue synergies
Brands make other brands stronger
o Execution
Have earned trust from Wall Street
Believe they are great students of the game
Try to get the analysts to their plants to educate them
o Want analysts to understand their business
Give full year guidance and the next quarter guidance
o Also give 5 year guidance
o Seasonality makes quarters lumpy depending on the timing of harvests
o Try to be transparent as can be
The non-retail business is a great cash generator and gives them scale
o But after they acquire Pringles, non-retail sales will not be that
impactful anymore
o Retail is going to 87% of the total
Pretty aggressive acquisition activity with Kettle Foods and Pringles recently
o What made the company believe that this was the right time to make acquisitions?
Started off with a list of what companies they would like to buy and what was for sale
Pop Secret was on there as well as Pringles and Kettle
o Started going through this exercise 3.5 years ago
Had been speaking with the brands and investment banks at
that time
Were targeting companies that could come on the market that fit their strategic
goals
o Needed to be in the position to act when something came on the market
o Won’t go into frozen food because it is a different buyer
Will stay in their niche
o If a buy was a good idea, they were willing to pursue it, even if they
were in the midst of an integration
Have been able to start integration of Pringles now before the
close because of the Reverse Morris Trust
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
But that has not been a distraction as they are still
focusing on their core operations of their existing
business
Looking at fill-ins in Europe or Asia
o Are aggressive listeners
o Pop Chips is on the market
Investment firm that represents them is in the building same
building as Diamond
It is in their growth segment
Probably not making money right now due to the investment
in the brand
Somewhere near $1.3B in debt will be on the balance sheet after the Pringles deal—can you explain the
analysis that was undertaken to determine how the management team could be comfortable with that level
of debt?
o EBITDA is growing so fast with the Pringles deal that they are actually deleveraging due to the
acquisition
o Don’t care about the amount of debt as long as they have cash flows
Cash gives you choices
o Pure dollar amount of debt is not that important
o Margins are expanding as well due to acquisitions
Allows them to reinvest in their brands
o Any idea what gross debt/EBITDA will look like when the acquisition closes?
Going down to 3x from 4x now
Can you talk a little bit about the dilution and the mechanics of the deal?
o Is 29M shares issued still the appropriate amount?
29.M shares is the number
P&G realized some savings from the Reverse Morris Trust and that allowed Diamond to
pay less
Stock is expensive collateral
As long as they can pay down debt, they would rather issue debt
Being in food is a good thing because the revenues are somewhat stable
Diamond has funded debt
Banks get a return on the commitment
Banks are very selective these days but are knocking down their door
Look for accretive deals
Board and management own 7% of the equity and do not want to dilute the
shareholders
Margins
Which are the higher margin products mentioned in the 10-K?
o Does a fully integrated Pringles represent a positive or negative margin shift?
Couple hundred basis point increase in EBITDA margin
EBIT margins have gone from 2-5% in 2006-08 to 9.4% in 2010
o What is the main driver of that?
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Higher margin products than nuts combined with operating leverage
Stock Price
What is Wall Street and the market in general missing about the company/stock at the current level?
o Contrarian thesis is that they can be effective against the larger brands
They are competing against two of Frito Lay’s lower margin products
Better to compete with a brand that is not high margin for Frito Lay because
they won’t be as aggressive in competing
They competed well with Planters and Orville Redenbacher as well
They have a track record of competing
o They have great shares in certain regions
Trying to leverage that around the nation
o People are wrong that Pringles is boring
It is value brand for sure
Down from 15% to 7.5% share to day in the US
Outside the US it is a great brand
Very edgy and targets the younger consumers
Have to get the same image in the US
o Very mature and profitable in the US
CIBER Inc: CFO Claude Pumilia
Description:
CIBER is a global information technology (―IT‖) consulting, services and outsourcing company applying practical
innovation through services and solutions that deliver tangible results for both commercial and government
clients. We compete in a large and growing marketplace offering services that include application development and
management, enterprise resource planning (―ERP‖) implementation, change management, project management,
systems integration, infrastructure management and end-user computing, as well as strategic business and
technology consulting.
Ticker CBR TTM EBITDA ($mm) $9
Current Price $3.31 TTM EPS ($0.77)
Market Cap ($mm) $239 5 Yr. Avg. Op. Margin 3.54%
Enterprise Value ($mm) $274 5 Yr. Avg. EBITDA Margin 5.18%
Dividend Yield N/A Trailing EV/EBITDA 30.9x
Average Volume (mm) 0.65 Trailing P/E Ratio NM
*Data from Capital IQ
Growth Drivers
What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In
other words, what are the main drivers of CIBER’s performance?
o Increased offshore delivery will drive margin expansion
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
o Successful realignment of North American operating business
Need to improve efficiency
o Transforming process and people
Bringing the right skills to the right jobs
Being a successful service firm does not require rocket science
Excellent delivery is key
Fundamentally this is a turnaround
Have made lots of acquisitions and now have lots of P&Ls
o This is a weakness these days
o Believe there is standardization that could save money
Current Situation
The last few years have been tough for the company. What is going on with the North America division?
o The North America business ($500M in revenue) had 35 autonomous offices
The thought was that these would be entrepreneurial and drive their own profitability
Didn’t work as the company got bigger
Have recently blown up the branch model and have centralized
This has caused disruption in the sales force
The discipline required to drive project profitability had been lost
Are the government projects that come from the Federal division (11% of revenue) low margin?
o Federal business is very separate from the rest of the business
Very different contracting process
o Not a part of the core strategy
Something that could be a strategic opportunity
o Staffing when done right can be a good margin business
ERP Implementation and Competitive Dynamics
With so many companies implementing ERP systems and those projects often taking far longer than
anticipated and costing way more than projected, describe the opportunity for CIBER
o What is the company’s value proposition versus the competitors?
Big firm capability with smaller firm intimacy
You get all of their attention versus at Accenture where that might not be the
case
Best in class capability and not as costly
More effective because you have the best and brightest people
Don’t sell an experienced team and bring in young graduates
They are way more flexible
They don’t come in and tell people how to do things
o My next meeting is with Perficient. How would you distinguish yourself from that firm?
Cognizant, Accenture and IBM solutions are the companies they compete with the most
Don’t see Perficient in the market place as much
o Do they bigger players such as Accenture have any real advantage in this space?
Yes, they have a track record of discipline and process that CIBER doesn’t have
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Thus, CIBER doesn’t get to realize the margins that they generate
Firms have to transfer knowledge between projects and Accenture is better able
to do that due to their long history
o But, Accenture has priced at the top and CIOs are looking for a way to
cut costs
o What is the main competitive point right now?
Is it price, speed, customization?
Combination of speed and price
o They don’t have the overhead that the other companies have and thus
can be more flexible with price
However, they don’t sell on price anymore
o They sell on value
But that has allowed them to ask for higher gross margins
Sales people now feel comfortable asking for a
higher price
o How would your partners rate CIBER (Microsoft, Oracle, etc.)?
Would rate them quite highly in their respective areas
What you run into with CIBER is that there is a huge different between Europe and North
America
Won an award in the Netherlands because of their excellent service
They do not have strength in SAP in North America but they do in Europe
o SAP would say they need to prove themselves in the US
They are building the SAP business in the US
Think they can leverage the European relationship in the US
o Do really well when they focus on individual verticals and horizontals
as they build out specific expertise
Oracle: good work in the public sector
Microsoft: have a great relationship with the company across the world
Economy and Markets
How to you anticipate that your clients will react to all the turmoil roiling through financial markets?
o They have not seen people hesitant to roll out an ERP system in Europe
o They think they can capitalize on this turmoil and uncertainty by offering staffing and outsourcing
solutions
Many firms do not have a budget for full time positions anymore so they have to
outsource
o For a complex ERP system they might see some hesitance to invest
In 2008 they saw a breakup of big projects due to the financial crisis
But there is huge pent up demand because those projects were put off
Companies need to update and can’t really put these off any longer
What is your response to further fiscal contraction?
o The Federal business has been affected by budget cycle issues
o It is not like demand is changed; it is just pushed out
o Not having a budget for the US was an issue earlier in the year
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
International Operations
What is different about the European business?
o In Europe they decided to get more focused
Much less autonomy than there was in North America
Decided to be good in SAP
Were successful in making acquisitions
Kept driving the organization to create expertise in SAP and the utility vertical
Better management discipline and capability
Better financial management
Understanding cycles better
o What do you transfer over?
Bring organizational knowledge
Where are we in terms of adoption of management information systems in less developed markets?
o Probably in the 2nd
or 3rd
inning in these markets
o Huge opportunity and probably very expensive to venture into
So much so that they as ask themselves if CIBER should even be playing in these
markets
There are big pockets in developed markets where CIBER is not even in
o France and California for example
o Upside is more adjacent and easier to extract
Senior Credit Facility Repayment/ Covenants
Glancing through the list of covenants in the 10-K and the recent disclosure in the 10-Q, I see that your
lender waived the June 30th
restrictions and gave you some breathing room:
o $36M in EBITDA by December and a fixed coverage ratio at .95x are the newly modified
requirements
What are you doing to meet your targets?
EBITDA was dragged down by goodwill impairments
Are not having the fixed priced project issue anymore
Europe continues to grow (Q4 was strong)
Not going to have the loss in Q2 that they had in North America
They are taking out costs
o Blocking and tackling and cash optimization
o What have the conversations with your lender been like?
Discussions went surprisingly well
CFO is 3 months into the business
The covenants were written in 2009
o They have been amended the last 4 times
But they get charged $600K for the changes
Feels good about working with the bank
Wants to strengthen the balance sheet and get rid of debt
Can repatriate cash at a lower level due to NOLs and carryforwards
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
o What are your options if you are having trouble reaching compliance?
Is there a need to look at raising more capital or refinancing now?
Fundamentally opposed to raising equity given the stock at this level
Repatriation of cash and potential asset sales could provide capital
What are you looking to do with the $78M in repayments in 2012 with about $62M in cash right now?
o Strategic alternatives for businesses
o Want to get rid of the debt
Don’t want term debt
Don’t want a large credit facility
Stock Price
What is Wall Street and the market in general missing about the company/stock at the current level?
o Contrarian thesis is that the company is transforming more than the results would suggest
There has been an influx in talent which can transform the business
o There is not a track record yet of consistency
They think they can leverage their success in Europe to build the North America business
Bring the right people to the right spots
o The culture of CIBER’s consultants and sales people is a differentiator
o The stock has been struggling for so long, this is not a company where people are focused on the
stock price
Options were not a big part of compensation until recently
Self-worth of employees is based on a unit’s performance
Have started to communicate more with employees to let them know what is going and
how the turnaround is going so far
Perficient Inc.: President and CEO Jeff Davis
Description: Perficient, Inc. is an information technology consulting firm. The Company designs, builds and
delivers technology solutions using third party software products. The solutions include custom applications, portals
and collaboration, eCommerce, online customer management, enterprise content management, business intelligence,
business integration, mobile technology, technology platform implementations, and service oriented architectures.
The solutions include business analysis, business integration, enterprise content management, customer relationship
management, service oriented architectures (SOA) and enterprise service bus (ESB), business intelligence,
ecommerce, mobile technology solutions, technology platform implementations and custom applications.
Ticker PRFT TTM EBITDA ($mm) $23
Current Price $8.31 TTM EPS $0.29
Market Cap ($mm) $268 5 Yr. Avg. Op. Margin 7.74%
Enterprise Value ($mm) $256 5 Yr. Avg. EBITDA Margin 10.52%
Dividend Yield N/A Trailing EV/EBITDA 11.2x
Average Volume (mm) 0.16 Trailing P/E Ratio 28.6x
*Data from Capital IQ
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Growth Drivers
What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In
other words, what are the main drivers of the company’s performance?
o Near term goal is to be at $500M run rate revenue by 2013
Will be close to $300M at the end of this year
Will try to reach $500M through a combo of organic growth and acquisitions
Have been an acquisitive company since the IPO in 1999
Started in 2004: have done 16 since then
Want to hit double digit organic growth
Think they could be a 12-15% grower
o Stability in the market from a macro perspective
Their issue is sentiment
Would be fine with a 1.5% GDP growth environment if people weren’t
screaming that the sky is falling
Saw that concern in Q2 2010 last year
But didn’t see that this year until now
o Are not seeing the impact to the bookings this year
But, the current turmoil feels like déjà vu all over again
Have levered up around verticals: health care and financial services
Are getting great traction in health care
o 24% of revenue and 34% of bookings in Q1
o Think that health care will be insulated from macro issues
Health care-related companied need to be more competitive
and efficient so they can’t put off investments
Financial services has seen a lot of acquisitions and firms are in the middle of a
lot of integration
o There are things they couldn’t do until the ERP systems were done with
that they are doing now
Buyers have plenty of cash—they have been hoarding cash for the last few years
o Gain scale to get a little more visibility in the market
Story is not followed that closely
Have seen a lot of expansion in gross margins
Think they can get to 40% gross and 20% EBITDA margins as a firm
o Those would be best in class for a US company
Acquisitions
You make it clear that you seek to grow through acquisitions. Can you talk about your strategy and
approach to valuations when it comes to acquisitions?
o A buy-side banker is the source of acquisitions
This is a highly fragmented business with many companies in the $10-$20M revenue
range
Focus is on enhancing the portfolio from a skills standpoint
These are strategic deals and are not done to just increase revenue
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
o Used to fill gaps in the portfolio
o Every deal fits this criteria
Also allows them to get a geographic expansion
o Pricing: 5-7x EBITDA multiple target
Have never paid more than 6x yet
The 4 they have done recently were very accretive deals
Company looks for deals that are cash accretive day one
Synergies are quite strong
Are able to help the acquisitions from a systems and a management process
standpoint
Get higher productivity out of sales guys and resources
The opportunity to cross sell is the most important thing
How do you think about using cash versus issuing shares?
o Pretty disciplined around shares
o Sometimes they will take principals out
For the most part it is half cash and half stock
Gives them retention and motivation
Have seen most people stay after the 3 year vesting period
Since 2004 about 60% have stayed
Focus on the US
Why have you decided to focus on the US versus someone like CIBER who generates a good amount of
revenue overseas?
o They are focused on the US and outside of the US only as their clients go outside
o This is an $80B industry in the US alone
There is no reason to take on the additional risk and stretch the infrastructure because the
size of the market in the US is big enough
The downside is that you don’t get the hedge
o What would make you change your mind and pursue expansion overseas?
There is a time when being in Europe and Asia will make sense
But they actually shut down their UK office at some point because it was not profitable
Client Retention
To what do you attribute to your high client retention rates (87% according to the 10-K)?
o Quality work and strong relationships with the clients
97% reference-ability with their clients
The 3% they don’t get are small clients that expect the world and don’t want to
pay for it
o Have to be scrappy as a small company
Every deal is critical to them
It is all about reputation
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Every client has to be satisfied
Have to incentivize employees to focus on this
o 65% of revenue now comes from Fortune 1000
These firms often have a lot of work and can offer multi-year contracts
The progression towards larger companies is something that they focus on
o Some clients are never going to be good clients and will never be happy
Small clients are less sophisticated and expect a lot for nothing
ERP
With so many companies implementing ERP systems and those projects often taking far longer than
anticipated and costing way more than projected, describe the opportunity for Perficient.
o They don’t implement ERP systems specifically
But they do support management systems work, with IBM being their largest client
Oracle and Microsoft as well are clients
Are looking to get into ERP implementation
o What is driving demand is the need to gain greater efficiencies
Clients need to be more competitive and understand their customers better
Requires a lot of information gathering and data analytics
Competition
Who are you primary competitors?
o Smaller boutique firms that specialize in certain verticals
Do the bigger players such as Accenture have any real advantage in this space?
o Company’s win rate versus the big guys is in the 65% range
o Accenture (ACN) is a well-run firm and their advantage may be brand only
The challenge is getting the ability to compete with them
Lack of brand knowledge is the problem for Perficient
ACN does not value the technologists as a firm
Being a technology specialist is not a good way to advance at ACN
o They are very focused and have an expertise that stems from having greater depth than the big
guys
Their customers (IBM for example) know their name
This begins to shine as you go through the proposal process
What is the main competitive point right now?
o Is it price, speed, customization?
Pricing is important
ACN will try to compete at the same (lower) rate in some cases
Rates are competitive but they don’t give their services away
Right now the competition mainly surrounds confidence in delivery
Want to be on budget and on time
Most customers aren’t as concerned about saving $1M if the project can be done
right
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Balance Sheet
Is having no debt an advantage when competing for contracts? In other words, do clients see it as a symbol
of your financial strength and ability to live up to you promises?
o It is not much of a concern for the customers or clients
o What helps more is being larger than the little boutiques as well as being public and transparent
Why would you avoid a modest amount of leverage?
o Cash is worthless now and they like to reinvest it in the business
o Like to have little cash and use it for acquisitions
o Have started a stock buyback program
Are $47M into a $60M buyback program
o Would take on debt for a quarter just to put on an acquisition
Consolidation
How is consolidation impacting the markets you serve?
o There will always be a lot of small shops
Due to very small barriers to entry
o There are a few companies that are still acquiring
A lot are hunkered down however
o Diamond was their size and was the only firm out there that was their size
Was taken out at somewhere around a 40% premium
Would it make sense to merge with a slightly larger player to better compete with the big boys and maybe
cut out some duplicative costs?
o It is likely that Perficient would be acquired once it gets to $500M in revenue
o The offshore guys are going to need a bigger US presence
o They are not running the business with that in mind, however
o PWC is a potential acquirer
They did buy Diamond but it is not as scalable a business
Tax Rate
I noticed the 42%+ tax rate over the last three years with a major component over the last 2 years having to
do with stock compensation
o Is there a way to reduce that rate?
Probably not
Stock comp is coming down at the end of next year
o Stock comp won’t scale with revenue because the new CFO has a
different philosophy than did his predecessor
They can try to get as much revenue from China as possible to lower the tax rate
Stock Price
What is Wall Street and the market in general missing about the company/stock at the current level?
o The Street generally is nervous that Perficient is not a good stock to hold if you have a bearish
sentiment at all about the economy
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Thinks they are not as subject to the economy as people think they are
People are concerned about an economic pullback
But they are growing 10% when GDP is growing 1.5%
Institutional holdings are strong
o Prospect of selling the company down the road leads to a little premium
Kansas City Southern: CFO Mike Upchurch
Description: Kansas City Southern (KCS) is a holding company with domestic and international rail operations in
North America that are focused on the north/south freight corridor connecting commercial and industrial markets in
the central United States with many industrial cities in Mexico. The Company is engaged primarily in the freight rail
transportation business. It generates revenues by providing its customers with freight delivery services both within
its regions, and throughout North America through connections with other Class I rail carriers. KCS’ customers
conduct business in a number of different industries, including electric-generating utilities, chemical and petroleum
products, paper and forest products, agriculture and mineral products, automotive products and intermodal
transportation.
Ticker KSU TTM EBITDA ($mm) $714
Current Price $53.96 TTM EPS $2.19
Market Cap ($mm) $5,926 5 Yr. Avg. Op. Margin 20.96%
Enterprise Value ($mm) $7,660 5 Yr. Avg. EBITDA Margin 30.98%
Dividend Yield N/A Trailing EV/EBITDA 10.5x
Average Volume (mm) 1.17 Trailing P/E Ratio 24.7x
*Data from Capital IQ
Port Arthur Crude Terminal Opportunity
Their partner in this venture (Savage Companies) is private, highly regarded and experienced in this
business
o Savage actually came to them and said suggested they establish a partnership to take advantage of
this growing opportunity
o Savage wanted to bring light sweet crude down and KCS had a great property at Port Arthur,
Texas for storage
Port is close to largest refineries in the US
The partnership is not yet finalized
Savage will likely have an exclusive agreement
3 unit trains per week is the base case
o Savage has been building a facility in the Bakkens oil sands in Canada
It is like the Gold Rush up in this region
Savage is working with Burlington North (BNSF) to bring the crude down to Kansas City
and then KCS will bring it down to the Gulf Region
BNSF could take some further down but not that much
o They would rather work with the other railroads
o It will not take Savage that much time to build a facility on KCS’s property
Will be built at Savage’s cost and Savage will potentially lease the land
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Think the deal could be finalized by the end of the year
May start seeing revenue by the middle of 2012
There is not going to be a pipeline anytime soon so this could grow into a very nice
business
o They will not make any investments unless they have a contract for long-term business
More likely that Savage or the oil company would make an investment in any necessary
equipment
o Have owned the 500 acres at Port Arthur for many years
Coal Opportunities
There is a possibility that they have a new coal contract
o They can’t really talk about it until January
o There are 10 plants on their system; they serve 8 now and will likely serve 9
Over the next 2-3 years there will likely be another coal opportunity in Arkansas where a new power plant
is being built
Margins
Are your EBITDA margins in the high 30’s achievable consistently?
o High 20s operating and high 30s EBITDA margins are achievable
o They guide to 150 basis improvement each year
They are in the process of mining out costs
Have removed costs since the recession that have led to 500 basis points of cost
reduction
o They have taken out much of the low hanging fruit
o There are still opportunities on the labor side
o More costs cuts may be hard to take out
Volume increases and pricing increases help increase margin as well
If we are heading into a slowdown, what can you do to cut costs and hold margins?
o Grain and coal move no matter what part of the cycle you are in
Coal is more weather dependent
o The rest of the commodities move up or down based on the economic cycle
Electronics and automotive move down with the cycle
Mexico Opportunity
Think they have a great franchise in Mexico that benefits from the manufacturing shift to that country
o What inning are we in in terms of the industries being on their lines in Mexico?
Transportation of goods from China to Chicago is 5 times more expensive than the trip
from Monterey to Chicago
Plus Mexico is a better place to do business
It is easier to manage your supply chain from Mexico than from China
Think there is going to be a large shift to manufacturing in Mexico
Wages in Mexico could go up
They are not seeing it yet but it is a consideration
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Unemployment in Mexico is low and GDP growth is strong
Have not seen an impact from the drug war issue
Working on the railroad is seen as a plus job in Mexico
o Regulations in Mexico
There were restrictions of some goods that came from Asia to the US
KCS found out about this restriction and were able to have it eliminated
The relationship with Mexico is as good as it has ever been
The hurricane last year was eye opening for the government because it showed how
reliant the country was on KCS’s lines
The relationship was solidified by how efficiently KCS got back online
Consolidation
How is consolidation impacting the markets you serve?
o They are the smallest of the 7 Class 1 railroads so people are always asking if they are for sale
o They would be attractive to larger class 1 operators
o They claim they are not for sale and think they can generate shareholder value through execution
o Would they be interested in acquisitions?
They are small compared to larger carriers and likely could not buy them
They don’t see buying short line companies as valuable
It would have to be a nice piece that fits in their network
The real question is why would you even pursue acquisitions
There are few remaining synergies given the hassles
There wouldn’t be much of the cost takeout
It would be more about revenue synergies and what is going in Mexico
o That is the opportunity
Buffett Buys a Railroad
What does it say about the state of the industry that accompany like Berkshire Hathaway, a company that
always shied away from capital intensive industries, was willing to buy BNSF?
o When you look at the model it is very difficult to replicate the franchise and network
o It is insulated from competition and generates huge cash flows
o Personal belief is that Buffett got a great bargain in buying BNSF
o The business is going to be around for 50 years
o There will continue to be the opportunity to chip away truck traffic share and move more by rail
o The move by Buffett to by BNSF may be an inflation play.
Does inflation in commodity prices actually help them?
Despite rail rates going up, they go up much less than the underlying commodity
prices
If commodity prices continue to go up they will be able to raise prices
o Buffett definitely saw price increases coming
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Current state of the industry
Is this year indicative of a normal year?
o Rates have gone down since the industry was deregulated
o Irrational behavior was driving prices down
o Industry got a grip that winning share was not the best way to go forward
o Productivity and service level have increased meaningfully in recent years
o Regulation of trucking industry makes it hard for trucks to compete with rail
Lazaro Project
Lazaro (Mexico) Phase II
o The government is in the process of awarding a 2nd
concession
o All of the port operators are interested in this concession
o Think it could be 3-4M in TEUs [twenty foot equivalent units—a measure of capacity] over the
next few years from 750K now
They are the only company able to service this industry as stipulated by the current
concession
They will take all of the growth from this and it will be one of their top 4 growth
opportunities for the company as a whole
o The port could be as much as 10M TEUs in the next 10-15 years
Ownership
o They have a 50 year concession on the tracks that expires in 36 years and then have a 50 year
option after that
o Own most of the train cars and almost all cars are in use
Have a few locomotives that are idle right now but they are older machines
Not interested in refrigerated intermodal
o They haven’t been looking into it very carefully
o They have a lot of other venues for growth and are not interested in refrigerated intermodal at a
high cost
Stock Price
What is Wall Street and the market in general missing about the company/stock at the current level?
o There has been concern about a double dip and that the company will not hold up as well from a
margin standpoint
People point to what happened in the last recession
Believe KSU is a stock for an up cycle; not a down cycle
They have taken out a lot of costs since the last cycle
Are in much better position to weather another cycle
They have taken out $150-$200M costs out of the business
They took a lot of interest expenses out as well
Margin deterioration in Q4 2008 to trough was 8.9% versus the industry at 8.3%
They don’t think they are as at risk this time around
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Operating ratio was traditionally higher than the industry average but KCS is a different
company today
People are seeing the growth opportunities
Are now even above 2007 levels of volume and are up far more than the
industry
Tyson Foods: CFO Dennis Leatherby and COO Jim Lochner
Description:
Tyson Foods, Inc. is a meat protein and food production company. It produces, distributes and markets chicken, beef,
pork, prepared foods and related allied products. Its operations are conducted in four segments: Chicken, Beef, Pork
and Prepared Foods. It operates a vertically integrated poultry production process. Its integrated operations consist
of breeding stock, contract growers, feed production, processing, further-processing, marketing and transportation of
chicken and related allied products, including animal and pet food ingredients. Through its wholly owned subsidiary,
Cobb-Vantress, Inc. (Cobb), it is engaged in poultry breeding stock supply. It also processes live fed cattle and hogs
and fabricate dressed beef and pork carcasses into primal and sub-primal meat cuts, case ready beef and pork and
fully-cooked meats.
Ticker TSN TTM EBITDA ($mm) $2,042
Current Price $17.56 TTM EPS $2.28
Market Cap ($mm) $6,575 5 Yr. Avg. Op. Margin 2.14%
Enterprise Value ($mm) $8,081 5 Yr. Avg. EBITDA Margin 4.04%
Dividend Yield 0.90% Trailing EV/EBITDA 4.0x
Average Volume (mm) 4.68 Trailing P/E Ratio 7.7x
*Data from Capital IQ
Growth Drivers
What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In
other words, what are the main drivers of the company’s performance?
o The beef and pork businesses are best in class and sales are at all times highs
Believe this is ongoing and sustainable
Not likely to grow that much off of this base though
o Prepared foods and chicken are the growth opportunities
Currently the chicken industry is oversupplied versus demand
Competitors are losing money
Tyson achieved a 1% return on sales while others are losing money
As supply comes back online there will be growth
o Mexico is mature
o India is small but a good market
o Brazil is a good export play
o China is the exciting story
Especially as KFC and McDonald’s grow fast
o Trying to come up with the correct business model in these markets
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Prepared foods range from bacon to pizza crusts to toppings
There is room for growth in prepared foods as well
o Expect to be investment grade in the coming years
The company is tainted by its past
Underperformed from 2006 to 2008
Management starved the core businesses from capital
Leadership change has focused people on the details and execution
o New team saw all of the poor decisions made by the previous
management teams and has learned how to incentivize people
Have subdivided the company into smaller business units so that they can focus
o FY 2010 was the best year in the company’s history
If the stock traded at a decent multiple, the stock could be $23
Plus, there is going to be growth on top of the current numbers
There is not one silver bullet to continued improvement
It will come from all around management execution
Raw Materials
What commodities are you most exposed to? What is the best way for the company to protect its margins
against volatile commodity prices?
o Major inputs
Corn & soybeans make up 42% of chicken COGS
Raise their own chickens
Live cattle
Do not raise their own; buy on spot market
Live hogs
Do not raise their own; buy on spot market
o Don’t think they are going to see a big decline in feed costs going forward
Think we are in new normal of higher costs
They have been investing in their facilities to make them more competitive
Are adding mix capability
Other competitors are now pulling back
o Can you talk about the hedging strategy a bit?
Strategy is to not take crazy trading risks and call it hedging
If they can buy call options they will to prevent runaway costs
Are willing to pay reasonable insurance premiums
Very conservative strategy
International Opportunity
Major export markets include Canada, Central America, China, the European Union, Japan, Mexico, the
Middle East, Russia, South Korea, Taiwan and Vietnam
Describe the international opportunity and especially the chicken opportunity in China
o In 2010 export revenue was about 32% of the total
o In China, KFC does not have franchisees
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
All company owned stores
In the US, KFC has a franchisee model and good new ideas often cannot pass to the
franchisees
The company-owned model has been one of the reasons for KFC’s success in
China
o The Chinese-based poultry industry is a small player, is segmented and not vertically integrated
These small players are only thinking about keeping birds alive using antibiotics
Not worried about genetics
KFC has a supply chain challenge of guaranteeing controlled production
They are not getting quality products and people are being poisoned all time in
China
o This leads companies to look for vertically integrated companies
Companies that owns their own distribution, have a supply
chain that works, can focus on genetics and can control the
feed quality
Believe they are going to have to go to company-owned farms in China
The outsourced grower model might not work
They will produce them cheaper than the current players in China
o Competitors’ leveragability is not good
o Cost to produce is 10-15% lower for Tyson
The competitors, over vaccinate, which is costly
o Have proven that the model works in India as well
The government has started to regulate the small producers
o Tyson is a huge protein producer and the Chinese government will
eventually get its arms around protein production
Controlled production is going to be a key and Tyson will be
able to charge more for it
There is 1 chicken producer in China that has done
well but the market as a whole is not that competitive
McDonald’s does not have any beef items on the menu in China
o You have to ask for beef to get it
Demand from the chains led the industry to focus on vertically integrated
companies
Land use rights have to be carefully negotiated in China
But, they think they offer the regions a lot and will be able to ―own‖ their own
land
o Protein production is a priority in China because it provides jobs and
offers China the ability to feed its people
Don’t want to go too fast but they are looking at 2 years to get things up and
running
In India live production is a competitive advantage
Expect it to be as big a play as China as well
This downturn may shake out the industry and be good for Tyson
How do international sale margins compare to those in the US?
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employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
o They think they can exceed the margins outside of the US but there are a number of challenges
o Think they can charge a premium for their controlled process
Capital Allocation
Is debt repayment a priority? Can you talk a little about the decision between debt repayment and
buybacks?
o They have gone through a change and have set a goal for the capital structure
Wanted to assure the agencies that they have liquidity
$1.8B in liquidity
Gross Debt to EBITDA: 1.3x or less
o 1.2x this quarter
Have been buying shares with excess liquidity
o But would rather make acquisitions
Are already spending more CAPEX than D&A
o They are investing in their business
Is it important to get your credit rating above BBB- on the revolver?
o Yes, they want to be rated investment grade by all the rating agencies
Margins
The difference in margins in hogs and cattle comes from much longer production cycle
o Supply does not get too high as easily as it is for chicken because it takes longer for the animals to
mature
Lag phase leads to higher margins
Acquisition Strategy
Domestic chicken market: very fragmented after Pilgrim’s Pride (17% share) and Tyson (22% share)
o Very small players below them
o Very diversified group of regional firms
Many of these are in financial trouble due to distress
Can’t really roll up these firms because the government will watch Tyson’s actions very carefully when it
comes to chicken to prevent a regional monopoly
o They would have to move out to the west coast for acquisitions
May be better off making acquisitions in prepared foods
o Most people don’t know how big they are in pepperoni, taco meat, and pizza crust
There are a lot of people who want to them to buy assets
Both bankers and companies themselves
o Pricing and assets have been right though
Stock Price
What is Wall Street and the market in general missing about the company/stock at the current level?
o There is no forgiveness for the past sins
o Chicken is being held against them
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employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
But chicken only represents 1/3 of their earnings potential
o Tyson’s Pork and Beef segments are big players in the industry
No livestock risk
Most of the supply comes from the spot market
Very competitive on the cost structure and location
Gorman-Rupp Company: President/CEO Jeff Gorman
Description:
The Gorman-Rupp Company (Gorman-Rupp) designs, manufactures and sells pumps and related equipment (pump
and motor controls) for use in water, wastewater, construction, industrial, petroleum, original equipment, agriculture,
fire protection, heating, ventilating and air conditioning (HVAC), military and other liquid-handling applications.
The Company operates principally in one business segment, the manufacture and sale of pumps and related fluid
control equipment and systems. The Company’s product line consists of pump models ranging in size from 0.25
inch to 144 inches and ranging in rated capacity from less than one gallon per minute to in excess of 750,000 gallons
per minute. The types of pumps which the Company produces include self priming centrifugal, standard centrifugal,
magnetic drive centrifugal, axial and mixed flow, rotary gear, diaphragm, bellows and oscillating.
Ticker GRC TTM EBITDA ($mm) $59
Current Price $27.31 TTM EPS $1.52
Market Cap ($mm) $568 5 Yr. Avg. Op. Margin 11.06%
Enterprise Value ($mm) $561 5 Yr. Avg. EBITDA Margin 13.92%
Dividend Yield 1.30% Trailing EV/EBITDA 9.6x
Average Volume (mm) 0.05 Trailing P/E Ratio 17.8x
*Data from Capital IQ
Growth Drivers
What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In
other words, what are the main drivers of the company’s performance?
o Very diversified across markets but are heavily into the water sector
Want to be diversified so that one market can’t really hurt them
Their fortunes are tied to the broader economy but they are not totally at the mercy of out
of control factors
o How well capital goods move will be important in the future
Being in water is important because you cannot deprive people of water
o Acquisitions will play a part but they will not only grow that way
Has to be the right fit before they move but they currently have the room on the balance
sheet to make acquisitions
o International markets represent the most important opportunity
Based on the need for fresh water and sanitary conditions in emerging markets
Competition
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Who would you saw your most formidable competitors are?
o Really depends on the market
o Most of the pump companies that are left are buried in the financial statements of bigger firms
Think it is an advantage to be independent
They are more flexible and can move fast
Of the comps I glanced at, it looks like GRC has some of the highest EBIT margins. What would you say is
your competitive advantage versus the rest of the industry?
o There is no cost advantage necessarily
Commodity prices are the same and the cost of the engine is the same
Gross margin line is the same
o However, the culture of the company stands out among all of the competitors
Still very much a family company
Quality is the most important factor
75 years of reputation in the industry helps them get a foot in the door and to maintain
relationships
Consolidation
How is consolidation impacting the markets you serve?
o The whole pump industry is very fragmented
o Lots of mom and pop businesses
This is a niche product
o The National Pump acquisition was a good opportunity
National knew that it had to get into the international markets and thus had to marry up
with Gorman Rupp in order to capitalize on the opportunity
o There would not be an advantage to hooking up with a big company like ITT
IDEX has been pretty aggressive and ITT is now breaking up so they are not likely to be
as active as they have been
o The company has an eye out for acquisitions
Have no set target though
Have you taken any measures that would allow you to protect margins during the downside of the cycle?
o Came out of the bottom of the cycle a lot stronger
o Took some big hits as 2009 was a challenging year for all of their markets
But some of their markets did well in 2009 and it helped to be diversified
o Have benefitted as the top line grew more than expected
Have continued their capacity investments even when people thought they were crazy to
do so
How do you manage cost inflation?
o Are you typically able to pass along cost increases?
Company never has trouble passing along cost increases
Normally get a premium for their product
Quality of the product is there
Have a lot of loyal customers
International
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Can you talk a little bit about the international opportunity?
o The key is having the right distribution
o Sometimes it takes a few years to get it right
o Tend to go with smaller, family-owned distribution
o Made an acquisition of National Pump that had low international sales
Think that National’s deep well pumps will do well internationally because the
distribution network is already set up
How do international margins compare to those in the US?
o Pretty much the same
In the total scheme the margins could be a bit less than in the US due to slightly higher
SG&A
Family Ownership and Control
How should we think about the family’s 25%+ ownership of the company and the fact that the top positions
are filled by Gormans?
o High insider ownership: 30% of shares are closely held between the 2 families
o Gorman Rupp is a profit sharing company when it comes to the employees
o Even though they are public it feels like a family-owned company
o Hard to find a company with a better dividend record
39 straight years of dividend increases
Recent share split was a way to get the shares out there in a controlled manner
o They want to increase the float
We like insider large insider ownership. Would you say that the incentives of management are aligned with
those of shareholders?
o Managers receive a base salary and then a profit sharing component that is a larger percentage
than normal
Capital Allocation
Talk to me a little about the decision process surrounding the choice of whether to make acquisitions,
increase the dividend or invest in CAPEX
o Each division manager has the ability to make capital expenditures
o Believe in reinvesting in equipment that helps them be more productive
o Do measure return on invested capital but it is not as important as other metrics
Especially since comp is based on profit sharing
Backlog
Is the backlog the best barometer of how the company is doing?
o Yes, for sure
o How much visibility do you typically have into the next year and beyond?
They have about a year of visibility
Some power generation business is longer-term and thus they have a little more
visibility
o Demand drivers of record backlog
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
A lot going on in the oil and gas industry
Spikes in the power generation business
National Pump acquisition
Owner was looking forward to retirement even though he is staying on
Blended well with their agriculture and municipal businesses
o It was an overall great fit
o They are not turnaround people
Like to pay EBITDA numbers under 10x
o Multiple on National was around 8x
o During the decision process, management reflects on a lot of things
Has to be a fair price
Has to fit with the firm’s marketing capabilities and product offerings
Has to fit culturally
Want to stay in the pump business
o Do not want to stray away from that
Lack of appreciation by people new to the company
The breadth and diversity of products is not well understood
There is a lot of opportunity out there domestically and internationally
People are always going to flush toilets
Just achieved ISO 14000, which is an environmental standard
o They have a love/hate relationship with the EPA
They believe they have to be environmentally responsible company more so than others
because they are in the water market
Day-to-day tasks of the CFO
Makes sure that the customers are satisfied and that employees are involved
Oversees the business on a day to day basis
Balance Sheet
Goal is to have no debt by year end
The National acquisition led to some debt that they expect to be outstanding for only 5 quarters
Stability and good dividends are important to investors
o Leveraging up the company to make acquisitions is not the way to go
o Most acquisitions are cash –based
Gives them a ton of flexibility
o Have great banking relationships and have access to capital that allows them to make acquisitions
or build plants whenever they want
Never have to worry about interest rate risk
o Never have to beg for cash
o Have leverage with banks
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Stock Price
What is Wall Street and the market in general missing about the company/stock at the current level?
o Company has a strong balance sheet and is a dividend payer
For the most part people get the picture
Compounded returns since the IPO are very impressive
o Most holders have been in the stock for a long time
Economic Downturn
What does their world look like in a situation in which the US is in a prolonged state of fiscal contraction
and economic malaise?
o Agriculture markets can be cyclical
Make up about 5% of revenue
o Construction markets can be seasonal
o They are in 7-8 key markets
The biggest market is 20% of total revenue
o What about the municipal side of the business?
Funding is an issue
The company caters more to smaller and medium sized municipalities
Demand is flat even though the need is high
Waste water is a priority
Municipalities tend to find the money somewhere and can jack up water rates if
need be
Margins are similar pretty much across the board, including municipal contracts
Offer a high amount of value engineering
o Design provides an advantage
o Nobody ever gets fired for buying from Gorman Rupp
Quality backed up by service
o Weak dollar has made their product more price competitive
International revenue is now near 40% of total
Dollar has stabilized but they have continued to execute
Kirby Corp Chairman/CEO Joe Pyne:
Description
Kirby Corporation is a marine transportation and diesel engine services company. The Company, through its
subsidiaries, conducts operations in two business segments: marine transportation and diesel engine services. Its
marine transportation segment is engaged in the inland transportation of petrochemicals, black oil products, refined
petroleum products and agricultural chemicals by tank barges, and, to a lesser extent, the offshore transportation of
dry-bulk cargoes by barge. The Company’s diesel engine services segment is engaged in the overhaul and repair of
medium-speed and high-speed diesel engines and reduction gears, and related parts sales.
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Ticker KEX TTM EBITDA ($mm) $337
Current Price $53.51 TTM EPS $2.53
Market Cap ($mm) $3,009 5 Yr. Avg. Op. Margin 18.98%
Enterprise Value ($mm) $3,342 5 Yr. Avg. EBITDA Margin 26.46%
Dividend Yield N/A Trailing EV/EBITDA 9.9x
Average Volume (mm) 0.41 Trailing P/E Ratio 21.3x
*Data from Capital IQ
Growth Drivers
What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In
other words, what are the main drivers of the company’s performance?
o Low natural gas prices are important
Natural gas is a feedstock for their customers and customers are hurt by higher prices
o Modest capacity additions
o A global economy that is growing
These 3 things would create an environment where the stock works
o Utilization of fleet right now is in the mid-90s because the petrochemicals business is growing
The whole industry is likely at these levels as well
State of the petrochemical market
Still getting better
Provides 2/3rds of revenue
o 20% black oil
o 10% refined products
o The rest is agriculture
This was about the same 4 years ago
Refined products percentage is going to increase as a result of the K-Sea
acquisition
o Black oil and chemicals are the best places to make money
Agriculture chemicals are carried by old barges
US fleet of tank barges
3100 total barges in US
o They have 830, a number that represents 27-28% of the market
o They are always price takers although the pricing has continued to go up
Expecting peak pricing next year, similar to 2008 (before the crash)
o They are still building barges but they are only replacement older equipment
They have taken out capacity
The industry will always overbuild but there is no significant capacity being brought out
since most of it is replacement-based
Can’t see real overcapacity for three to four years honestly
o Overall fleet age is 23 but will be down to 17 by 2012
Useful life is 30-40 years
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Marine Value Proposition
Do you realize value for being the largest inland barge carrier?
o They get value from being the biggest
This was seen in 2008 and 2009 as they achieved rates higher than those of their
competitors
Safest, strongest balance sheet, well managed, lots of flexibility, ability to move
equipment and can cut costs for customers when needed
Biggest customer is Dow Chemical
o Dow is completely dependent on barges and Kirby serviced them
during the recent flooding
They have all of Dow’s barge business
Economies of Scale
It looks like there is a cost advantage versus rail and trucking. But how do you establish a competitive
advantage versus other barge carriers?
o Economies of scale
They think they have that on the Gulf Coast
It is easier to compete with Kirby in the river business but not in the Gulf Coast business
Can take costs out quicker than others and can stay profitable when others are
losing money
They went into the financial crisis with 80% of their contracts being long-term
o Their customers are so big that Kirby almost never have to deal with
people not being able to pay or trying to break the contract
They had some trouble with Lyondell
But now Kirby has all of Lyondell’s business and is
actually thinking about buying all of Lyondell’s boats
Margins
As fuel prices decline, do you more than make up for lost demand with cost savings?
o Fuel costs are passed on
Theoretically changes in fuel prices are earnings neutral
However, higher energy prices are generally not favorable because they hurt
customers and the economy as a whole
CAPEX and Acquisitions
Can you talk about the rationale for the K-Sea acquisition and discuss how the integration is going?
o K-Sea’s operations represent an extension of Kirby’s with the added benefit geographic diversity
Talk to the same customer at the same desk
Think they can move things inland and offshore
Think they bought it at the right time
K-Sea had too much capacity but that will rationalize over the next few years
Bought 58 barges and 63 towing vessels
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
This is high value, offshore equipment
There are backend synergies but they have not publicly quantified those as of yet
Going to spend the latter part of the year looking at those
Deal was the first example of a public company buying a public MLP
How do look at issuing shares versus taking out debt to make these acquisitions?
o Prefer not to issue shares
o Had to in the K-Sea acquisition because they did not want to get downgraded by the rating
agencies
Kirby wanted the agencies to see that the company was serious about the balance sheet
o Have bought back 21M shares since he has been the CEO
o They have more control over repurchases than a dividend
They would rather reinvest cash in their business than pay a dividend
But, they will never say never because they are close to generating enough cash
able to do everything (including a dividend)
New barges
What factors do you look at when you decide to bring on new capacity through new barges?
o He has been running the Marine side since 1984
Having been taking capacity out since then
Only started adding some capacity in 2007
Any new capacity would be added very carefully
Is the make versus buy decision all about the cost per unit?
o He would always prefer to buy versus make because when you buy you take off capacity and
when you build you increase capacity
Barge lead time
o It takes 3 months to build a barge
o In 2008 visibility was 12 months and now it 18 months
Backlog is good until the customer cancels
Is only as good as the next cycle
Consolidation
Does increased consolidation lead to more rational pricing and less knee jerk response to adding capacity?
o All capital intensive businesses face the overcapacity issue
There is always the risk of overbuilding during good times
o Pricing is rational right now
But if it gets sloppy, the pricing will get irrational very fast
Competition
Who would you saw your most formidable competitors are?
o American Commercial Lines has 10-11% share
The Inoculated Investor
The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its
employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to
encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.
Stock Price
What is Wall Street and the market in general missing about the company/stock at the current level?
o Most people who study the company think it is a great buy
o The issue is whether the price is fair or not
That has a lot to do with where earnings go
o He doesn’t think the street is missing a lot about Kirby
Look at who owns Kirby
Thinks long-term investors own the stock
The company kind of sells itself
If it’s not the right stock for certain investors then he doesn’t want them to buy it
o If we have more questions, he suggested that we call Steve Holcombe, Kirby’s IR guy
Said we should put him through the ringer
And then if we come to Houston we can see the equipment firsthand