unearthing value at nacco industries feb 2011

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Unearthing Value At NACCO Industries February 21, 2011 [email protected]

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Page 1: Unearthing Value At Nacco Industries Feb 2011

Unearthing Value At NACCO IndustriesFebruary 21, 2011

[email protected]

Page 2: Unearthing Value At Nacco Industries Feb 2011

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Company History and Overview

Originally founded in 1913, NACCO is named after its original business line, North American Coal.

Beginning in the mid 1980’s, NACCO began to diversify away from its core business by acquiring disparate companies including Eaton’s Yale Materials Handling Unit, WearEver-Proctor Silex, The Kitchen Collection and The Hystercompany . NACCO eventually merged with Hamilton–Beach Brands in 1990.

While NACCO has since divested a few non-core assets, today it remains an conglomerate comprised of four unrelated businesses. Consequently, the market has a difficult time properly valuing the company and its shares trade a steep discount to estimated intrinsic value.

NACCO Industries is a diversified industrial holding company with operations in four main business segments: lift trucks, mining, small appliances, and specialty retailing.

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NACCO Industries Investment Thesis

Odd collection of good businesses with market leading positions but few if any synergies

CoalFork LiftsHousewares and specialty retailing

Minimal sell-side research coverageOnly one analyst covering the stock

Cheap valuation on a consolidated basis

Significantly undervalued on a sum-of-the-parts basis

Spin-off or sale of non-core businesses a potential catalyst for share price appreciation

Ticker: “NC”Stock Price: $125.57

Recent Valuation Multiples:

7.76x ‘11E Earnings (ex-cash)*5.82x EV / 2011E EBITDA

Capitalization:Equity Market Value: $1,046mmEnterprise Value: $1,230 mm

*Note: cash adjusted to include $60mm payout from Harbinger lawsuit settlement announced 2/17/11

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More About NACCO’s Four Businesses

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NACCO’s Four Businesses

NC operates in four business segments

Materials Handling Group

Manufactures, sells, services and leases fork lift trucks under the Hyster and Yale brands

~56% of Revenues

~2.5% Operating Margins

Hamilton Beach Brands

Designs, distributes and markets small electric household appliances under the Hamilton Beach and Proctor Silex brands

~20% of Revenues

~7.5% Operating Margins

~17% of Revenues

~10% Operating Margins

North American Coal

Mines and markets coal primarily for fuel for power generation

Specialty retailer of kitchenware and gourmet foods under the Kitchen Collection and Le Gourmet Chef store names

~7% of Revenues

~3% Operating Margins

Kitchen Collection

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Materials Handling Group Overview (“MHG”)

NMHG designs, engineers, manufactures, sells, services and leases a comprehensive line of lift trucks and aftermarket parts marketed globally under the Hyster and Yale brands

#3 manufacturer of fork lifts behind Toyota and Linde20% market share in US, 8% globally

Very cyclical business which should benefit from economic upswing

Strong backlog indicates positive growth and demand

Excellent distribution channels and seller network

Potential acquisition target for financial buyer or competitor

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Materials Handling Group Financial Snapshot

MHG Income Statement MHG Balance Sheet MHG Cash Flow (in $mm's) (in $mm's) (in $mm's)

TTM 2009 2009Revenue 1475.2 Assets 290.8 Operating Cash Flow 115.9Operating Loss (EBIT) -31.2 Cash 163.2 Free Cash Flow 110.1Net Income -43.1 LT Debt 246.4

Margin Analysis

EBIT Margin -2.11%Net Income Margin -2.92%

Despite generating an operating loss in 2009, NACCO’s Materials Handling Group generated positive free cash flow during the same period. Given its high operating leveraged and uptick in reported revenues which are tracking +14% and +35% YoY for Q3 and Q4 2010, the business is on pace to earn an operating profit and return to profitability for FY 2010.

Source: NC company presentation and 10-K

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North American Coal Overview (“NAC”)

NAC mines and markets coal primarily as fuel for power generation and provides selected value-added mining services for other natural resources companies. Thecompany operates five surface coal mining operations and has three additional coal mines under development

#1 coal Lignite coal producer in the United States with operations mainly in North Dakota, Texas and Mississippi; amongst top 10 coal producers overall

Lignite coal is a low ranking coal type used as fuel in steam-electric power generation

Not subject to price fluctuationsThe company mines under “cost-plus” contracts with local power plant customers under which they are essentially guaranteed a fee for service regardless of the direction of coal prices

2.2MM tons of proven reserves, of which 1.2MM are committed to customers through long-term contracts expiring as far out as 2045

Original business line of company

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North American Coal Financial Snapshot

NACCO’s North American Coal segment earns predictable, stable and recurring free cash flow without the exposure to commodity price fluctuations typical of coal and other commodity producers, resulting in a high-quality, annuity-like business

NAC Income Statement NAC Balance Sheet NAC Cash Flow (in $mm's) (in $mm's) (in $mm's)

TTM 2009 2009Revenue 213.9 Assets 172.1 Operating Cash Flow 42Operating Loss (EBIT) 6.7 Cash 1.6 Free Cash Flow 31.5Net Income 3.9 LT Debt 46.8

Margin Analysis

EBIT Margin 3.13%Net Income Margin 1.82%

Source: NC company presentation and 10-K

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Hamilton Beach Brands Overview (“HBB”)

Hamilton Beach is a leading designer, marketer and distributor of small electric household appliances, as well as commercial products for restaurants, bars and hotels

Manufactures blenders, can openers, coffeemakers, food processors, indoor grills, irons, mixers, slow cookers, toasters, etc.

Operates under well known Proctor Silex and Hamilton Beach brands

Has excellent relationships with leading retailers including Wal-Mart, Target, K-Mart and Sears

Potential acquisition target for a number of strategic and financial buyers

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Hamilton Beach Brands Financial Snapshot

NACCO’s Hamilton Beach Brands segment earns attractive EBIT and net income margins while generating free cash flow well in excess of its reported GAAP earnings

HBB Income Statement HBB Balance Sheet HBB Cash Flow (in $mm's) (in $mm's) (in $mm's)

TTM 2009 2009Revenue 497 Assets 217.8 Operating Cash Flow 35.5Operating Profit (EBIT) 50.4 Cash 34.1 Free Cash Flow 33.4Net Income 26.1 LT Debt 116.3

Margin Analysis

EBIT Margin 10.14%Net Income Margin 5.25%

Source: NC company presentation and 10-K

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Kitchen Collection Overview (“KC”)

Kitchen Collection is a national specialty retailer of kitchenware and gourmet foods operating under the Kitchen Collection and Le Gourmet Chef store names in outlet and traditional malls throughout the United States

Leading specialty retailer of kitchen products

Very low margin business that requires scale and retailing expertise in order to succeed

Low to no earnings over last few years

Could be run more profitability in by a full-fledged retailer such as Bed, Bath & Beyond or Macy’s

Sale to well-capitalized strategic buyer would generate cash that could be better deployed elsewhere as well as a tax asset as purchase price would likely be below cost basis for the business

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Kitchen Collection Financial Snapshot

NACCO’s Kitchen Collection carries a net cash position but earns fairly low EBIT and net income margins. A strategic acquirer could likely expand margins and would also gain a new outlet channel through which it could offload excess inventory without tarnishing the parent company brand.

KC Income Statement KC Balance Sheet KC Cash Flow (in $mm's) (in $mm's) (in $mm's)

TTM 2009 2009Revenue 213.9 Assets 81.9 Operating Cash Flow 5.4Operating Profit (EBIT) 6.7 Cash 8.5 Free Cash Flow 4.4Net Income 3.9 LT Debt -

Margin Analysis

EBIT Margin 3.13%Net Income Margin 1.82%

Source: NC company presentation and 10-K

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A Closer Look At NACCO’s Structure

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Why Are These Businesses Together?

NACCO’s legacy conglomerate structure is the byproduct of an earlier time during which arrangements of this nature were in vogue and quite popular. Today, however, the merits of such structures are in question.

In recent years, many conglomerate business have simplified their operations by spinning off or selling their non-core businesses and have been rewarded favorably by shareholders for doing so.

NACCO’s four businesses have no apparent synergies

NACCO is one of the last types of these businesses remaining

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Why A Breakup Of NACCO Makes Sense

In early April 2007, NACCO Industries announced it would spin-off its Hamilton Beach Brands segment citing the transaction as an “opportunity for significant value enhancement for ours shareholders” and its stock soon reached all time highs. By the summer of 2007, however, the plan was shelved due to the uncertainty and volatility in the capital markets.

Recent announcements by Fortune Brands, ITT Corp., Marathon Oil, and Williams Companies amongst others to breakup their business and the subsequent share price appreciation achieved as a result are likely to cause NC management to revisit their own spin-off plans.

Illogical structure and complicated consolidated financials statements creates difficulty for investors to determine the fair value of the business

Breaking up into four distinct units with alleviate this difficulty by allowing the market to value each segment more easily thereby highlighting the intrinsic value of the business and unlocking significant value for shareholders

Create four standalone, pure-play businesses that would make attractive acquisition targets for strategic or financial buyers, further driving share price appreciation

Give shareholders a choice of whether to own the fork lift business, the coal business, the housewares businesses, the specialty retail business or all four

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Shareholder Friendly Management, Corporate Governance and Financial Reporting

NACCO Industries has a unique and open corporate structure which is somewhat atypical for holding company/conglomerate businesses

NACCO provides very transparent financial statements and thorough historical supplemental data

Each segment reports full financial statements allowing for detailed analysis

Supplemental segment data allows for even deeper fundamental work

Each business segment has its own board of directors

Each business is treated as a stand alone entity with no interference from the parent company, much like the way operating businesses are treated at Berkshire Hathaway

Each of these attributes make a separation of NACCO’s four businesses even easier

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So, What Is It Worth?

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Materials Handling Group Peer Analysis

Note: Data based on 2/18/11 closing prices and fx rates

Source: Bloomberg

Toyota Linde AG Cascade Corp MedianMarket Cap (mm) $161,188 $26,127 $544 $26,127Enterprise Value $270,647 $35,005 $574 $35,005

EV / 2011E EBITDA 14.00 8.26 7.78 8.26

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North American Coal Peer Analysis

Note: Data based on 2/18/11 closing prices

Source: Bloomberg

Peabody Energy Massey Energy Co. Arch Coal, Inc. MedianMarket Cap (mm) $17,532 $6,565 $5,368 $6,565Enterprise Value $19,295 $7,207 $7,124 $7,207

EV / 2011E EBITDA 10.90 7.40 6.85 7.40

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Hamilton Beach Brands Peer Analysis

Note: Data based on 2/18/11 closing prices

Source: Bloomberg

Newell Rubbermaid Tupperware Jarden MedianMarket Cap (mm) $5,866 $3,485 $3,321 $3,485Enterprise Value $8,099 $3,665 $5,866 $5,866

EV / 2011E EBITDA 8.29 8.21 7.28 8.21

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Kitchen Collection Peer Analysis

Note: Data based on 2/18/11 closing prices

Source: Bloomberg

Bed Bath & Beyond Macy's MedianMarket Cap (mm) $1,295 $1,006 $1,151Enterprise Value $1,151 $1,693 $1,422

EV / 2011E EBITDA 7.80 5.46 6.63

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Sum-Of-The-Parts Analysis

(1) Source: BB&T estimates

(2) Housewares includes Hamilton Beach and Kitchen Collection segments

(3) NC currently has ~$180mm of net debt but based on its cash flow generating ability should have no net debt by year end 2011

Analysis suggests that at NACCO shares are currently undervalued by 37-57%.

Another way to look at it is at current levels you are essentially buying NACCO’s fork lift and coal business at a reasonable price and getting its Hamilton Beach and Kitchen Collection

businesses for free.

(data in $mm's)

Segment 2011E EBITDA(1)Low

Multiple EVHigh

Multiple EVNMHG 98 7x 686 8x 784Housewares(2) 64 7x 448 8x 512Coal 49 6x 294 7x 343

Plus: Net Debt(3) - -

Equity Value 1428 1639Shares outstanding 8.3 8.3Implied price 172.0 197.5

Current Price: $125.57% Upside 37% 57%

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The Potential For Shareholder Activism

NACCO Industries is majority controlled by the founding Taplin/Rankin families via a dual class share structure, making (on the surface) a potential activist campaign to effectuate a breakup unlikely to yield much success.

However, company management has run the businesses in a shareholder friendly way for many years, making it more likely that a large shareholder with a well reasoned plan may be able to convince controlling interests of the merits of a breakup.

As the discrepancy between intrinsic value and market price grows and transactions of this nature become more frequent, it seems logical that a management team oriented towards maximizing shareholder value would dust off its spin-off plans and reconsider breaking up the business into its four respective parts.

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Recent Transactions Support Breakup Thesis

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Corporate Breakups Are Becoming Increasingly Common

In a “new normal”, low-growth environment where top-line growth is hard to come by, company managements are looking for new and creative ways to maximize and unlock shareholder value.

Over the past few months, several companies have announced plans split-up their businesses - separating units with different margin profiles, growth trajectories and earnings drivers.

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Case Study: Fortune Brands

On December 8th, 2010 Fortune Brands announced a plan for the separation of its three core businesses : distilled spirits, home and security, and golf products.

12/8: Fortune Brands announces separation of the company’s three businesses

10/8: Pershing Square discloses 11% stake 12/8: Fortune Brands

announces separation of the company’s three businesses

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Case Study: ITT Corporation

On January 12th, 2011 ITT Corp. announced a plan for the separation of its three core businesses: water, industrial, and defense.

12/8: ITT announces separation of the company’s three businesses

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Case Study: Marathon Oil

On January 13th, 2011 Marathon Oil. announced its intent to separate its high-multiple E&P business from its low multiple refinery business.

1/13: Marathon Oil announces plans to separate E&P and refinery businesses

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Case Study: Williams Companies

On February 17th, 2011 Williams Companies announced plans to separate its E&P business from its more steady cash-flow generating pipeline business.

2/17: Williams announces separation of E&P business from pipeline business

2/17: Williams announces separation of E&P business from pipeline business

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Conclusion

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Conclusion

Underfollowed conglomerate with four good but unrelated business lines

Attractive valuation on a consolidated basis

Trading at a significant discount to fair value on a sum-of-the-parts basis

Breakup opportunity presents catalyst to unlock value

Recent voluntary breakups at FO, ITT, MRO, and WMB serve as models for a potential transaction

Upside potential: 37-57%