Capral

Over the last decade, Capral has seen some very tough times.  The start of its problems can be traced to the construction of its factory in Bremer Park, Qld in 2004 followed up quickly by the acquisition of Crane Aluminium for $124 million. Debt piled up at the same time cheap overseas products were coming into the market. The combination of slowing volumes and margins together with high debt levels hit Capral hard. A few capital raisings were done to pay down debt and keep the company afloat. The recipe of capital raisings, write downs and losses over the period resulted in a share price decline above 80% over the last decade.

So what is there to like?

  • It is really cheap. At the current share price, it is an elusive “Graham net nets” (current assets less total liabilities > market capitalisation).
  • Has been slowly reducing overheads over the past 10 years to increase its competitiveness.
  • Posted a profit in FY2016 and has no debt.
  • Managed to get anti-dumping duties applied to certain imported extrusions products coming into Australia.
  • It has huge tax losses and at the same time is able to pay a franked dividend (a very unique situation).

Who is Capral?

Capral was founded in 1936 (formerly Alcan) and is Australia’s largest manufacturer and distributor of aluminium extrusions. It has a national footprint and operates five manufacturing plants. Its products are primarily used in the building industry for residential and commercial buildings (windows and door frames etc) but they also supply aluminium sheets for industrial uses (e.g. trailer and boat manufacturing).

This video shows the aluminium extrusion process.

A rough breakdown of their revenue source is 50% residential, 20% commercial and 30% industrial.

How cheap?

This is best illustrated by a comparison of its balance sheet (FY2016) and current market capitalisation:

Hypothetically speaking, you could liquidate Capral’s current assets and still have some leftover cash after paying off all the creditors. In addition, you would also get the fixed assets (book value $41.2 million) for free, among them the plant and equipment at the Bremer Park factory which was built at a cost of $90 million in 2004/05.

“Net nets” are very elusive in today’s market so there is huge pessimism about Capral’s future.

Why is the market so pessimistic?

The Australian aluminium extrusion industry is unable to compete with cheap overseas imports especially ones coming from China. China can produce aluminium extrusion relatively cheaper than Australia as their cost of labour in much lower, they enjoy huge economies scale given their market size relative to Australia and the aluminium industry receives subsidies and grants from the Chinese government, further lowering their costs.

The latest fall in share price was caused by a downgraded in Capral’s EBITDA range forecast for 2017 from $19m – $22m to $15m – $19m at the AGM on 11 May 2017. Management explained that this downgrade is due to the weak housing construction market in WA experience in Q1 2017.

So what’s there to like?

I basically like it because I think the market is overly pessimistic about its prospects. The market is valuing it on the basis that it will go broke slowly over time. This is possible but far from a foregone conclusion in my opinion. Capral has no debt and even managed to pay a 1.25 cents dividend for FY2016 (9.6% yield at current price). Not bad for a company being valued far below liquidation value. Over the past 5 years, it has managed to produce positive operating cash flow (ignoring acquisitions and financing flows).

Earnings have risen quite substantially since 2014. This can be attributed to an increase in residential construction activity, Capral lowering its cost base and countervailing duties being levied on certain imported products.

As shown above, there has been a massive increase in residential building approvals driven by “Other residential” category (mainly high rise apartments) over the past 3 years.  The building approvals for the “Other residential” category is at unprecedented levels. The data shows signs that building approvals are starting to cool off and if it happens, the Other residential category will be hit worse than detached housing. Capral only has a small exposure to the high rise apartment segment. I understand that windows and doors that go into most high rise apartment today come pre-fabricated from China so our local window and door manufacturers are cut out of that space.

Capral’s exposure is mostly in the detached housing or low rise apartment market whereby there is a lack of volume (orders are smaller) and uniformity in the product shapes and sizes.

Capral has been gradually lowering its costs over the past 9 years. The definition of cost below includes all expenses with the exception of finance cost and impairments.  Although aggregate cost has increased since 2013, it has actually declined on a cost per tonne basis. The sales volumes in 2008 were quite similar to 2016 and over this period, cost per tonne decreased by 15%.

As a result of the years of poor performance, Capral has accumulated tax losses of $286.6 million.  If Capral can make a consistent profit, it will not need to pay taxes for many years. In addition, Capral also has franking credits of $27.1 million.  Having both tax losses and franking credits at the same time is very unique and hugely beneficial for shareholders.

Capral has been the industry leader in championing the anti-dumping commission to investigate cases of dumping and applying countervailing duties to the delinquent overseas exporters.  Although the industry had some success with countervailing duties imposed on certain Chinese, Vietnamese and Malaysian exporters, circumvention activities are difficult to police. Nonetheless, Capral has credited the countervailing duties for reducing the market share for imports from 40% to 35%.

Risks

The main risk in my opinion to this company is its ability to survive in the face of cheap foreign imports.  I believe the company will survive as cheap imports are not really viable for markets where there is there is less design uniformity, smaller volume and shorter lead times.

Another interesting development is the implementation of China’s national emissions trading scheme (ETS). Aluminium production consumes a huge amount of electricity and an ETS may increase the cost of power which will lead to higher cost of production in China and possibly higher product prices. Having said that, electricity rates are also going up in Australia.

The other risk is a possibly supply disruption of aluminium billets sourced from Rio Tinto smelters in Queensland. There is a glut of global aluminium supply due to huge Chinese expansion which have already seen two of the six Australian based smelters shut in the last 5 years. I understand Capral has already started diversifying its supply of aluminium billets by purchasing a small quantity from the Middle East.

Overall

Capral is trading at very cheap levels (selling less than its working capital). Its current market capitalisation is $61.7 million and it has tangible net asset of $122.3 million and a potential tax benefit of $86 million (at 30% tax rate) from its massive tax losses. This business has low barriers to entry and relatively high fixed cost. Its sales volume is correlated to the building industry especially detached housing. Aluminium is being used more and more in the building industry as a replacement to steel due its lightweight, malleable properties and is 100% recyclable. This makes it a good choice for the trend towards green buildings.

Market share concentration of existing players is rising with the exit of Alcoa in 2014 and the acquisition of OneSteel Aluminium by Capral in 2013. Capral’s competitors are much smaller with G James Australia being the largest with about 8% market share (according to IBISworld) but their revenues have been declining and they have incurred losses between  FY2012 – FY2016 (source: Anti-dumping commission verification report – March 2017).  Scale is a significant factor and if the local industry goes down then Capral is likely to be the last man standing.

This is by no means a sure bet but in my opinion, at these share prices the stock offers lower downside risk and higher upside opportunity.

21 thoughts on “Capral

  1. Great write up.

    A few comments on your analysis:
    – the whole point of the graham net net was to figure out if youre buying a company below liquidation value. The assets on the balance sheet are not a true representation of what their liquidation value would be and some need to be discounted, Cash would be at 100%, receivables at say 85% and inventories at 50%.
    – capral also paid a ~$6m dividend earlier this year that you should probably remove from your calc but then include your estimate of cash flow for this period.

    You’re still not buying the company below liquidation value at this stage.

    1. Hi Daniel,

      You are correct, technically speaking this is not a true net net yet. I should have stated that I’ve simplified things by adopting the book values.

      I also think that calculation of net net today is more subjective because of redundancy cost, which can be quite material. I’ve read that during Graham’s era this wasn’t an issue as in a liquidation, shareholders ranked ahead of employees. Without more detailed payroll information, it would be difficult to quantify the redundancy cost so to simplify matters I’ve used the concept more as a signal for overall undervaluation.

      Thanks for your feedback, much appreciated.

  2. good work , interesting read,the property at Bremmer caught my eye , massive building the replacement cost would be huge,the land at Bremmer is now in a growth area , one draw back area is known to floor
    The pull back in the share price did not match the reduction in EBITA, ONE MAJOR HOLDER SELLING
    investment in technology will help reduce costs and make us more competitive
    The amount of cottage work going forward will increase after the budgets affordable home program
    Capral shares are not sexy their rate of return is

  3. It’s an interesting company. I had a look through its financial reports after reading your article. One thing that concerns me is the impairment of plant in 2013. The 40m impairment on plant has basically been adding around 5m PA to net profit thanks to savings on depreciation expenses. Given the nature of this business, isn’t the depreciation of plant a very real cost (the machines are going to have to be replaced). Furthermore, it seems to me that EBITDA is not a good value to use to judge this business as its covering potentially 10m of very necessary real costs (the depreciation on its plant assuming the 2013 impairment is accounting fiction) per year. Cash has also largely increased by 5m per year. Is this because the company is more profitable after considering the need to maintain its plant, or is the company actually just self liquidating by shifting capital expenditures into cash?

    Though this business seems quite cheap, I have some doubts about it’s profitability. Assuming the worst case scenario (which I think should always be the basis of judgment) this business was only profitable in 2016 (also explains the dividend) with 10 years of losses. So the question then is: was 2016 an aberration, or is this a sign that the company has changed?

    1. Thanks for your comments squiggle.

      You are absolutely correct to say that this is a dog. FY2016’s record profit was mainly due to the housing boom (although the boom in detached housing was alot less than high rise apartments) and government intervention in imports. So there is a good chance that FY2016’s record profit may never be repeated (although management is still forecast to make a profit for FY2017).

      Re: depn. This is a relatively low tech business, all you need is a press and away you go; so machine obsolescence risk IMO is low. If you look at the PPE purchased over say the last 7 years, the average capex was $3.9 million (lower than depn over the same period). Impairment is an accounting issue and because the company is not making an adequate return on its historical capital, the accounting standard says you must impair. The beauty of it though is that the market is way ahead of the accountants and the poor returns are already factored into its price.

      At these prices, my thesis is that this is a free option as the market is pricing this for failure. So IMO, it doesn’t need to do much more than don’t go broke for an investor to make money at these levels. The tax losses itself would be quite appealing to potential acquirers.

      1. I should say for disclosure that I also bought into Capral when IOOF was bailing on it. So I’m not so much looking for a confirmation thesis as I am trying to disprove my own beliefs; beliefs which are largely the same as yours.

        Anyway, about depreciation and the use of EBITDA. I saw you mentioned Charlie Munger in another post. He’s on the record as being extremely hostile to things like EBITDA, arguing that depreciation costs are “reverse float”. I’m largely sympathetic to this view and so try to ignore EBITDA. Without going into too much detail, I try to keep in mind that its yearly profits (assuming the business will keep going ie that it will need to replace plant) are being bolstered by the big bath in 2013 (which was an impairment on real equipment, not acquisition goodwill) to a significant extent and thus also a reasonable amount of the cash it now has will need to be stored for future capital investment. Further I don’t think it’s just a simple press which needs to be purchased. Lots of Capral’s plant is actually sophisticated robotics (and hence why I believe it can even compete with imports). You can see this on Youtube. Go search for “Robotic Milling of Aluminum”.

        Long story short, I agree with your thesis. I just think that with this company we shouldn’t overestimate its profitability, which is being touched up a bit by the 2013 result. I think the stock is a bargain, but perhaps just not as big of a bargain as calculations which use EBITDA (or even just its actually net profit after 2013) suggest.

        Looking forward to your feedback, particularly if you believe anything I have said is incorrect!

        1. Thanks for your follow up comments Squiggles.

          Agree 100% with all your points. I started with showing the improvements in operating cash flow over the recent years (and tried to work out free cash flow) and threw in EBITDA as a comparison to the operating cash flow. In theory EBITDA should be very close to operating cash flow before movements in working capital.

          Re: 2013 impairment and reduction in depreciation expense. I agree it is a concern but I also believe the level of concern on this issue is related to the replacement cycle of the PPE. It would be more of a concern if the PPE is required to be replaced in next 3-5 years than say in the next 10-15 years. Anyway, I suspect that shareholders would put the company into liquidation if management asked for tens of millions for capex, lol.

    2. Hi Squiggle / DC,

      Interesting post and comments, thank you. I have reviewed the 2016 annual report and the 2017 preliminary report released today. I am in full agreement regarding EBITDA not being the most appropriate metric to value the company. However, I was wondering if you could please elaborate on how the 2013 impairment is adding ~$5m to their annual net profit (2017: $12,085)?

      I have reviewed the annual report notes regarding carrying value of property, plant and equipment and the depreciation and amortisation expenses however I am unsure how this expense as reported are adding specifically to the net profit?

      1. For example, say PPE is $100 million with 10 year useful life. So Year 1 depreciation will be $10 million annually. Then if the PPE is subsequently written down/ impaired in Year 2 to $50 million with the same 10 year useful life, future depreciation would fall to $5 million annually. Year 3 net profit will be boosted by $5 million “savings” in depreciation expense. Basically, the company has time shifted the future depreciation expenses by taking a large hit in Year 2. Qantas is a good example of this. Hope this helps.

  4. Caa should do shares buy back at current price. It will increase investors confident to buy this super cheap shares. How to contact the management to persuade shares buy back? Good job on your article. Thanks …

    1. Hi Henry – thanks for your comments. I think continuing the dividend would be a fantastic way of distributing the franking credits and getting the share price moving.

    1. Thanks for your comments SD. Given the availability of franking credits, my first preference is the continuity of the dividend. As for a buyback, if they still have surplus cash after providing for working capital and dividends then its not a bad idea at current prices.

    1. Pretty much business as usual. No big change from FY2016.
      I’ve posted a few comments on the results.

    1. Hi Jon, thanks for alerting me to this issue. I’m hopeless at IT…. I’ve set up a follow my blog widget to the side bar….

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