When the market starts getting jittery about a possible recession, a lot of stocks start feeling the pain in advance, especially small cap stocks. As most of us know, the market lives a little bit ahead of us all. Most news is "baked" into the prices and when the news hits, if negative (as anticipated) stocks suddenly go up and vice versa for the positive news. Some companies may not survive an economic downturn, while others are positioned very well to walk straight into the storm and walk out without a scratch. Trying to find these companies is a difficult task in this market, when you have newcomers like Beyond Meat trading at a price to sales multiple of 56. That's right, to sales, not earnings. We try to find companies that are trading below book value, still have a decent price to earnings ratio and have a history of managerial strength when times get rough.
Current Price: $23.02
Shares Outstanding: 17.42M
Market Cap: $384M
We are now coming back to a stock that we have been invested in in the recent past, Cai International, Inc. (NYSE:CAI). The company's business is quite simple. They borrow capital at a low cost (roughly 3.87% annual), buy brand new containers from a Chinese manufacturer and lease out those containers to shipping companies and retail customers. Each container, measured in CEU (20 foot equivalent) will bring you roughly $50 profit in a year. Make sure not to spend it all at once. When you have 1.6 million of them, it comes out to a decent figure at the end of the year. So, you buy a container for roughly $1750 from a manufacturer, rent it or lease it out for roughly $200 a year, for 5 years and then sell it for roughly $1200. Seems Quite simple right? Not so fast. Let say you rented it out to a customer that dropped it off in Vancouver and your next customer for it is in Beijing. You would have to ship it at your own cost, which would probably cost you more than the whole container, unless you can find someone to rent it for that exact trip. Your best bet is to have long term customers, who will sign a contract to lease it for all 5 years that you will own it. Or you can place it with CAI and they will do it for you.
1.6 million CEUs valued at $2.4 billion dollars on company balance sheet, amortized. Now, on their earnings call slides, the company reported that used containers are getting about $1246 on average per CEU. Which equates to about $2 billion dollars if, theoretically, they were to sell them all right now. Some containers are newer, in fact because of an aggressive business expansion in the last few years roughly half of the containers are less than 3 years old or so it seems (don't quote me on it). Of course, the cost of a used container is determined by its age and the condition it is in.
On top of shipping containers, the company has been operating railcars for a few years now but appears to have found a buyer for it and anticipates to close the deal by the end of 2019. The remaining railcar fleet is valued at $320.8 million, while (according to ER slides) rail-related debt is about $250 million, which the company plans to retire completely upon the conclusion of the sale, leaving roughly $70.8 million in cash.
Total net funded debt is about $2.1 billion. Let’s factor in the upcoming sale of the railcar business, which will leave the company with roughly $1.78 billion net funded debt. And about $2.4 billion in revenue generating assets valued of about $700 million counting in other assets, of which only roughly $20 million worth are intangible. Today's market cap of the company is about $450 million, counting in preferred stock and its price to book ratio is roughly 0.6. At the same time the company plans to bring in net profit of roughly $70 million this year. The company has also been buying back shares and has to carry a certain ratio of debt to equity. So far, in the last 12 months the company bought back 2 million shares, of which 0.9 million shares were bought back in Q2 2019. With the amount of cash CAI generates now, they can continue to repurchase roughly 2 million shares annually. Given that $250 million of all debt will be retired, their debt to equity ratio will not go outside the allowed range.
A few years ago, CAI has entered logistics business and has grown its revenue to $115 million in 2018, 38% compared to 2017. Gross operating margin for logistics segment was $14 million in 2018 and roughly $7.6 million in the first half of 2019. Given the uncertainties around US-China trade deal, the company has decided to cut down on its logistics workforce by 23% to increase profit margin. We are not the biggest fans of the logistics segment in general at this time, being well invested in LTL segment (ODFL, YRCW). Company CEO Garcia mentioned that he is not happy with the logistics side of the business either as he is looking to allocate capital into something with higher ROE. We would not be surprised if he decides to abandon the logistics segment or significantly downsize it, which will negatively affect top line but substantially improve company's bottom line.
Yes, the US-China trade deal is a big deal. We value Management's decision to slow down on growth and capital expenditures this year until more clarity on a possible trade deal arrives. Of course, we paid close attention to long term contracts for container leasing, where 88% of all containers are leased on long term basis. In Q2 of 2019 utilization of the company owned fleet was at 98.8%, just under the average utilization rate of 99%, which leads us to believe that having 88% of containers leased on a long-term basis has saved the company from the impact of already enforced tariffs and a slowdown in global trade.
Many companies trade below their book value in anticipation of negative earnings. If the company starts losing money, it can have a hard time paying off its debt and has to sell assets below value. We see a rather decent cushion in earnings now to withstand a recession and still continue profiting from their business. Even if profits get much lower and assets decrease in value, the company would have bought back enough stock to support the same price to book ratio in a few years. Used container prices have decreased roughly 16% since their all-time high figure in Q4 2018, while a sale of 0.85% of its fleet, the company recorded a $111 net gain on each sold container, which leaves enough cushion to protect company's assets if used container prices continue to decline. Nonetheless, management states that they believe manufacturers in China will close some manufacturing facilities this year, which will decrease supply in New containers.
We believe that fair price for CAI ordinary shares should be at least at book value of roughly $34 per share, which assumes a ~48% premium to today's price. Counting in the company's decision to lower debt obligations by selling the railcar business and its ability to continue net income, that figure should be closer to $42 per share, which would have the company trading at roughly 12 times earnings, which is still a lower valuation than where its closest competitor, Textainer Group Holdings Limite (NYSE:TGH), is trading at right now. We anticipate that the company will use at least half of equity created by sale of remaining railcars to repurchase more stock. If the company continues to buyback roughly 2 million shares per year, above share price targets may be raised accordingly.
