|Mar 22, 2012|
Empire Resources acts as a broker of semi-finished aluminum products for companies in the United States, Canada, Australia and New Zealand. The company sources aluminum products from a diverse base of suppliers and from its own inventory. Empire Resources also provides logistical coordination and market intelligence for its clients. The gross margin on these aluminum sales has ranged from 4.78% to 7.78% over the past decade. This margin can be thought of as the "commission" the company charges its clients.
Here are the company's fiscal results for the last ten years:
On the whole, the 2000s were an extraordinarily successful decade for Empire Resources. The company grew revenues at an annualized rate of 13.3% and was profitable in every year except for fiscal 2009 when the financial crisis cratered aluminum demand. The company responded by cutting costs, shrinking the balance sheet and de-registering from the NASDAQ. Since then, the company bounced back strongly and just achieved record revenues in the twelve trailing months.
Now for a glance at the balance sheet and some ratios:
Empire Resources rewarded shareholders richly over the past decade, growing book value per share rapidly. Over the last decade, Empire Resources compounded book value per share at 13.1% annually. Remarkably, this figure after paying a generous dividend each year since fiscal 2003. When dividends are factored in, management achieved an IRR on equity (internal rate of return) of an astounding 28.5% annually.
So far, everything is great. However, a careful reader might notice a couple troubling data points above.
1. Net income in the twelve trailing months is down 40.7 from fiscal 2010! The reason for the large decline in profits is the expiration of the "Generalized System of Preferences" (GSP) on December 31, 2010. The GSP is a government program that reduces duties and tariffs paid on imports of certain goods from many nations, including many of the products Empire Resources imports from around the world. The expiration of the GSP had a large effect on the gross margin the company realizes on its sales to customers. Fortunately, Congress has reauthorized the GSP retroactive to January 1, 2011. President Obama signed the bill into law on October 21, 2011. Empire Resources is entitled to a large refund of tariffs paid while the GSP was not in effect.
This large upcoming refund is not reflected in the company's current financial statements, which end before the GSP was reinstated. In my opinion, the market doesn't see it coming either. The company will be able to revise profits in the past three quarters upward significantly, which will take care of that alarming earnings decline.
2. Book value per share declined by 15% since the end of fiscal 2010 as diluted shares outstanding rose by 27.9%! The reason for the seeming loss of value is a large, forward-looking transaction the company has undertaken. By Empire Resources' own admission, the company sometimes finds itself at a cost disadvantage in acquiring aluminum relative to its larger competitors. The company's response to this issue was to raise $12 million in convertible debt and then loan the money at zero interest to PT Alumindo Light Metal Industry Tbk, an Indonesian aluminum producer. PT Alumindo is using the cash to expand its facilities and increase production capacity. (I cannot claim any special expertise in evaluating Indonesian aluminum foundries, but the company seems legitimate. The website is here.) In return for the loan, Empire Resources received a long-term contract for a supply of attractively-priced aluminum products from PT Alumindo. When construction is complete, Empire Resources should be able to realize a larger gross margin on its sales, greatly helping profitability.
That the transaction results in dilution is unfortunate, but company insiders put up some of their own money to purchase the company's subordinated debt. Combined with insiders' 42.6% ownership of the company, I think shareholders can feel confident that management sits on the same side of the table and they are doing as they see fit to increase the value of the business in the long run.
Empire Resources has a market cap of about $37.6 million. The company's P/E ratio based on trailing earnings is 6.9. Once again, those earnings are without the benefit of the reinstatement of the GSP. If adjusted earnings for 2011 turn out equal to 2010's profits, the company's actual P/E ratio is just 4.1. Empire Resources trades at 87% of book value and a dividend yield of 3.2%.
Empire Resources goes unnoticed and unloved by the market, but that may be changing. Management plans to re-list the stock on a national exchange, which should bring a lot more attention to the company's strong profits and growth.
Things could go wrong. The company's clients could choose to disintermediate and purchase directly from producers. An aluminum glut could reduce gross margin to almost nothing. The partnership with PT Alumindo could go badly, leaving the company without its dedicated supply and with increased debt. However, management run the company well for many years and I expect they will continue to do so.
No position, though I may purchase shares with 24 of this posting.