In February 2016, I wrote an article titled “Reviewing 2015 Spin-Offs For Value Investing Opportunities In 2016,” reviewing the 2015 spin-offs for investment opportunities, in light of the recent sell-down in the market. In particular, I highlighted two underperforming spin-offs, which I wrote about previously, SPX Flow (NYSE:FLOW) and Horizon Global (NYSE:HZN), whose share prices have fallen by 39% and 38% respectively since the separation from their parent companies at the time of the article in February 2016. Since then, SPX Flow’s share price has almost doubled from $15.76 to $30.95 as of May 10, 2016 (oil price has definitely been a factor notwithstanding the cheapness of the stock); while Horizon Global’s share price is up by roughly 50% from $8.26 to $12.13 as of yesterday. The outperformers among my 2015 spin-off picks, FirstService Corporation (NASDAQ:FSV) and Vista Outdoor (NYSE:VSTO) continue to perform well. FirstService Corporation’s share price rose another 22% following my February 2016 article, and Vista Outdoor is up by an additional 6% between February and now. I also previewed the spin-off of Armstrong World Industries’ (NYSE:AWI) flooring business; the new spun-off entity, Armstrong Flooring (NYSE:AFI), has seen its share price surge by approximately 28% after it traded as an independent entity. My original investment theses for these five stocks are available to my Premium Service subscribers as archived Seeking Alpha PRO articles.
On March 5, 2016, I profiled another spin-off, GCP Applied Technologies (NYSE:GCP), exclusively for my subscribers. In the past two months, GCP’s share price rose 23%. GCP, a leading global provider of high value products and technologies to the specialty construction chemicals, specialty building materials and packaging sealants and coatings industries, was spun off from W R Grace Co (WRA) on February 4, 2016. My investment thesis for GCP was premised on the point that it was a Magic Formula stock (trading at approximately 9 times EV/EBIT versus a ROIC exceeding 70%) with a wide moat derived from market leadership, significant pricing power and strong customer relationships backed by high client retention rates. GCP Applied Technologies is currently the best-performing spin-off in 2016 in terms of post-separation share price performance; the runner-up is Armstrong Flooring.
2016 Year-to-Date Spin-Offs
As my readers will know, I view spin-offs as a source of either deep-value or wide-moat investment candidates, rather than mere special situations. Readers can refer to my article on this titled “Spin-Offs As A Source Of Wide Moat And Deep Value Investment Opportunities” published here to learn more.
With this investment focus at the back of my mind, I will comment on selected 2016 spin-offs below.
There were 8 new spin-offs in 2016 year-to-date and as mentioned earlier, GCP Applied Technologies and Armstrong Flooring are the top two outperformers. The underperformers are OncoCyte Corporation (NYSEMKT:OCX) and Quorum Health Corporation (NYSE:QHC), whose share prices are down by approximately 42% and 28% respectively post-spinoff. Excluding two of them which are ADRs, only of them, Armstrong Flooring, is trading below book, making it a potential deep value investment candidate. Manitowoc Foodservice (NYSE:MFS), Nuvectra Corp (NASDAQ:NVTR) and GCP Applied Technologies are potential wide moat stocks based on their high ROICs.
Armstrong Flooring
Armstrong Flooring, the largest North American producer of resilient and wood flooring products for use primarily in the construction and renovation of residential, commercial and institutional buildings, was spun-off from Armstrong World Industries on April 1, 2016. Notwithstanding Armstrong Flooring’s share price outperformance post-spinoff, it still trades at roughly 0.7 times P/B given that the flooring business is an inferior one compared with Armstrong World Industries’ wide moat ceiling business. The flooring business offering mostly commoditized products, is cyclical (significant exposure to U.S. residential market) and has a relatively weak competitive position. This is validated by the flooring business’ financial numbers. Armstrong Flooring’s resilient flooring and hardwood flooring businesses achieved mediocre EBITDA margins of 13% and 4% respectively in FY2014 when it was still part of Armstrong World Industries. Nevertheless, Armstrong Flooring exhibits potential for margin expansion with respect to the shift towards higher margin products, as there is significant operating leverage embedded with the flooring business. Armstrong World Industries claimed that the flooring business can achieve a minimum of 20% incremental margins on additional volume.
Armstrong Flooring’s key strategy is margin expansion via focusing on expanding market share in the high growth LVT (Luxury Vinyl Tile) segment and increasing the proportion of sales from accessories and floor care solutions. Freedonia mentioned in its July 2015 US Hard Surface Flooring Market report that “Among all hard surface flooring types, vinyl flooring is expected to post the most rapid gains in demand going forward, driven by the increasing use of luxury vinyl tile.” In January 2015, Mohawk Industries (NYSE:MHK), a leader in U.S. carpets, bought IVC Group , a European LVT manufacturer for $1.2 billion. Commenting on the acquisition, Mohawk CEO Jeff Lorberbaum highlighted that “The greatest opportunities from the IVC acquisition are in LVT, which has increased globally around 18 percent in the past year,” and “In the United States, LVT represents about 5 percent of the total flooring market, but sales are projected to grow more than 15 percent annually over the next five years.” Armstrong Flooring’s LVT business was a source of outperformance for the company in 1Q2016, as LVT volumes grew 42% year-on-year, contributing an increase in adjusted EBITDA from $3 million in 1Q2015 to $10 million in 1Q2016. In addition, Armstrong Flooring expects to benefit from cross-selling higher margin, complementary products like accessories and floor care solutions.
An investment in Armstrong Flooring will be premised on either a margin expansion story or a disposal of the business to a strategic buyer.
Manitowoc Foodservice
Spun off from Manitowoc Company (NYSE:MTW) on March 4, 2016 as a result of activist influence from Relational Investors, and Carl Icahn, Manitowoc Foodservice is a designer, manufacturer and supplier of food and beverage equipment for the global commercial foodservice market, via a global network of over 3,000 distributors and dealers in over 100 countries.
Half or 12 of Manitowoc Foodservice’s 23 brands are ranked either first or second in their respective segments, including Multiplex (#1 in beverage blending systems globally and #2 in chillers globally), Cleveland (#1 in tilting skillets and steamers in North America) and Kolpak (the world’s leader in walk-in refrigeration and freezer systems) among others. Besides having a reputation for reliability and innovation, Manitowoc Foodservice’s wide moat is largely derived from the structural characteristics of the restaurant industry. The restaurant industry is inherently competitive with low profitability for most of the players and their focus lies with cost containment. Manitowoc Foodservice’s equipment helps restaurant operators save on labor and utility expenses, so the company can charge a price premium as long as the cost savings exceed the price tag for the equipment. In addition to reducing labor intensity, Manitowoc Foodservice’s equipment also contributes to customer satisfaction by improving on the efficiency of kitchen operations e.g. reducing waiting time for diners. There is also a certain degree of switching costs (e.g. re-training kitchen staff to use new equipment), as evidenced by the fact that its top five end-customers and top five dealer customers have worked with Manitowoc Foodservice for an average of 40 years and 20 years respectively.
Manitowoc Foodservice also boasts attractive financial characteristics. It is highly free cash flow generative with minimal capital expenditures. Manitowoc Foodservice’s free cash flow conversion rate (adjusted EBITDA-to-free cash flow) has ranged from 85%-92% in the past few years, while capital expenditures-to-sales ratio has been in the 1%-2% range historically. One negative that stands out is Manitowoc Foodservice’s profitability, as its EBITDA margins in the mid-teens pale in comparison to the 20%-30% EBITDA margins that Middleby (NASDAQ:MIDD) and Rational AG (OTC:RATIY) generate. This is a function of Manitowoc Foodservice’s smaller size (less significant scale economies as a result), but there remains margin improvement opportunities from cost savings, right-sizing and a larger proportion of higher-margin products.
The key risk factors for Manitowoc Foodservice are the low proportion of aftermarket recurring revenues and cyclicality. A significant part of Manitowoc Foodservice’s revenues is dependent on its clients’ replacement or repair cycles and customers are likely to defer new equipment purchases in challenging market conditions. It generates approximately 15% of its sales from KitchenCare, its aftermarket service offering, which offers maintenance services for its customers’ foodservice equipment throughout the product lifecycle. Also, equipment companies like Manitowoc Foodservice have built their brands on the durability of their products and the flip side of this is that replacement or repair cycles will be longer. As a result, Manitowoc also needs to roll out more innovative products like its new Merrychef eikon e2s high speed (15 times faster than conventional cooking methods) oven to encourage new purchases and “shorten” the replacement cycle. Manitowoc Foodservice introduced 10 new products and 20 product refreshes in 2015. With respect to cyclicality, Manitowoc Foodservice derives roughly three-quarters of its sales from North America, so emerging market risk is less of a worry here. But end-market cyclicality remains a concern, as Manitowoc Foodservice generates approximately 70% of its revenues from the restaurant segment.
Manitowoc Foodservice will be reporting its first set of quarterly results post-spinoff on Thursday, May 12, 2016 before market opens, and I will be reviewing its Q1 2016 financial numbers to have a better sense of its attractiveness on a quantitative basis.
I will be tracking the upcoming spin-offs closely and I hope to write about some of them in the near future.
Seeking Asian Spin-Off/IPO Opportunities
Of the 39 “new” stocks (with market capitalizations exceeding $100 million) listed in Asia since the beginning of 2016, two of them were spin-offs, two of them were newly-merged entities and the rest were IPOs. As a bonus for my subscribers of my premium research service, they will get access to the list of “new” Asian IPOs/spin-offs in 2016 year-to-date in a separate bonus watchlist article to be published in the next few days, where I will also profile selected names among the 39 “new” stocks.
Asia/U.S. Deep-Value Wide Moat Stocks Premium Research
Subscribers to my Asia/U.S. Deep-Value Wide Moat Stocks exclusive research service get full access to the list of deep-value and wide moat investment candidates and value traps, including “Magic Formula” stocks, wide moat compounders, hidden champions, high quality businesses, net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts.
The potential investment candidates I profiled for my subscribers in May 2016 include: (1) a U.S.-listed market leader in a niche consumer lifestyle space which is trading at 0.80 times P/NCAV and 0.70 times P/B, but remains debt-free and profitable; (2) a U.S.-listed Net Operating Losses-rich deep value play valued by the market at 2.6 times EV/EBITDA net of the present value of its NOLs; (3) an Asian-listed manufacturer of wireless communication products which is the market leader in its home market and the first to export such products to the U.S.; it is a net-net trading at 0.75 times P/NCAV with net cash equivalent to its market capitalization; (4) a U.S.-listed Magic Formula stock trading at 3 times trailing EV/EBIT and Acquirer’s Multiple, sporting a 10% dividend yield net of withholding tax; (5) a U.S.-listed Munger Cannibal trading at 7 times trailing EV/EBIT and Acquirer’s Multiple; (6) an Asian-listed company which is a global leader in a certain medical device niche trading at 3.5 times trailing EV/EBIT and 3.5 times Acquirer’s Multiple, versus a trailing ROIC of 27%.