Updates, first look at next feature idea
Updates on Electromed, Vector Group, Natural Resource Partners
Note before getting to the updates:
I am finishing up research for my next feature article. This stock is deep under the radar (zero chatter online that I can find), is growing steadily and is ludicrously undervalued on an enterprise value basis.
And this is understandable - it screens horribly on trailing numbers and has a few of the typical “micro-cap” issues that keep stocks under the radar.
However it is not tiny. The market cap is over $200 million, revenue is substantial, and the underlying business should be capable of a vastly higher public market valuation.
I think the “bad optics” will clear up over the next 12-18 months.
What really gets my attention is the call-option like upside potential. There is a reasonable bull case for +500%, even +1000% return over a 2-3 year holding period.
Downside risk is also elevated. My approach with “call option” ideas is to view 100% of the position as at risk.
This idea will be out soon.
Subscribers
Let me know (Substack DM or reply to this email) if there is an idea you would like an update on - I will either respond individually and/or include the stock in the next round of published updates.
Electromed (ELMD)
Q1 was in line with expectations set by CEO Cunniff (outlined in prior ELMD article) with revenue up 15% and operating income up 54%. Net income was up less (31%) mostly due to an abnormally low effective tax rate in Q1 2023.
The performance was particularly impressive given a cyber attack outlined during the earnings call:
…on February 21, there was a cyberattack, which began against Change Healthcare, crippling financial operations for hospitals, insurers, pharmacies and medical groups nationwide. Change Healthcare is a financial clearing house that works across the health system to make clinical, administrative and financial processes simpler and more efficient for payers, providers and consumers.
Unfortunately, because of the breach, provider claims to payers dropped significantly. Fortunately, because of the excellent work by Kristine Beyersdorf, our Vice President of Reimbursement and Payer Relations and her team, I am happy to report that we resolved nearly 75% of our delayed claims by the end of the quarter with a successful submission through an alternative clearinghouse to Change Healthcare.
Although we experienced a 3-week delay in non-Medicare claim submissions, there are still providers that have not been able to submit claims at all today. Our cash position of $11.7 million by the end of Q3 allowed us to endure the payment delays, providing the time necessary to develop contingency plans to the crisis.
Lastly, as of today, we have resolved 98% of our delayed claims and expect to be 100% resolved in Q4. I'm excited about the trajectory of the business and look forward to continuing to drive top-line growth combined with expanding operating leverage.
I continue to think ELMD presents a compelling situation over the next 6-12 months.
If execution continues to be solid (~mid teens revenue growth and improved profitability) I could see ELMD climbing to a peer EV/revenue multiple by end of fiscal 2025 (6/30 year end), which would equate to $35/share or ~100% upside from today’s price.
Anyone who considers this idea should keep in mind ELMD is a one-product medical device company with the risks inherent to such a concentrated business.
Vector Group ($VGR)
The original article can be found here, update here.
Since the original article, the fundamentals have mostly been in line with the investment case, while the share price is slightly down.
Q1 was solid, but you would have never guessed it based on the price action immediately after the earnings release (which reversed quickly).
EBITDA was up 5.5% to yr/yr to $84.4 million, while revenue was down 2.9%.
However, there is a little more to the revenue figure.
Both sales and COGS include the federal excise tax. If the excise tax is excluded (looking at core sales that impact VGR’s economics) sales were up 1% yr/yr.
This has been true for each of the past three quarters. GAAP revenue has declined, while “core” revenue has continued to increase.
Using the "core” revenue figure, EBITDA margin was up 200 basis points year-over-year, to 39% of revenue.
I believe there are a few things going on
VGR’s net income includes “noise” from relatively immaterial investments in real estate. In Q1, this non-operating noise negatively impacted earnings.
The inclusion of excise tax in GAAP revenue and COGS make recent revenue trends look worse than they are (see above).
Loss of market share due to price increases is good for profits and part of management’s strategy, which is not widely understood.
About 34.5% of VGR’s volume (the first 1.93% of market share) is exempt from MSA taxes.
Here is how I break out the COGS of each cigarette:
Note the gap between exempt and non-exempt volume would be even greater if (once again) excise tax is excluded from COGS given that it is also in revenue:
With 100% of the MSA tax applied to non-exempt volume, COGS/unit is less than half for VGR’s MSA exempt volume.
My estimate is that in Q1, MSA exempt volume had a 78% contribution margin, while the non-exempt margin is 33.4%. These numbers line up with tobacco segment margin reported in VGR’s Q1 10-Q (48.8% - matches the volume weighted average of 78% and 33.4%).
So as VGR increases Montego pricing and (very likely) loses market share, the impact on profitability will be two-fold. A larger percent of volume will be exempt from the MSA tax, while a large portion of the price increase will flow through as profitability.
Note that this is part of management’s strategy - they built low margin volume when a competitor exited the market and are now harvesting this volume with price increases.
VGR’s MSA exemption creates a defensive moat
As a thought experiment, I modeled (using my estimates/assumptions) what would happen if:
VGR moved all wholesale pricing to the level of Pyramid, their most expensive (least discounted) brand
VGR subsequently lost all market share outside of their MSA exemption (in other words, lost 65.5% of current volume)
Under these conditions, tobacco segment EBITDA would be close to unchanged even after losing 65.5% of the business.
The point is that VGR’s management has a very broad range over which to manage the price/volume mix and has a long history of doing this effectively over time.
EBITDA growth over time:
Risks I am considering/watching for:
The market might not give credit to VGR’s regulatory moat given it is a cigarette company - muted upside
Competitive pressures might become severe enough to limit the benefit from the pricing cycle
Ever-present regulatory risk
A few of you messaged/emailed saying you were buying VGR on the plunge right after earnings were released. Well done! I agreed and was buying as well.
National Resource Partners (NRP)
My summary of the bull case can be found here, initial article here.
NRP’s latest investor presentation can be found here.
There is not much new to discuss as the deleveraging progress is mechanical at this point and the business is performing in line with expectations.
Warrants have been eliminated ($10 million cash, 89K units issued in the final 4/16/24 transaction)
Only $31.66 million preferred shares remain outstanding after setting $40 million worth on 5/8/24.
NRP has used significant cash year-to-date (retiring pref/warrants, senior note payoffs, special dividend) and likely had to fully draw its credit facility to retire the latest batch of preferred shares.
If they generate ~$60 million in FCF in Q2, they will be able to settle the remaining preferred shares in cash some time around the end of Q2 or start of Q3.
With lower soda ash/coal pricing, $250 million annual FCF is a reasonable estimate of go-forward free cash flow (vs. $312 million trailing).
This equates to $19/unit distribution potential some time in mid-2025, by which time NRP will be fully or nearly debt free.
I continue to think that NRP units are undervalued. The security combines near-term potential for massive distribution growth with the option value of a massive, significantly untapped royalty portfolio as well as the potential of the carbon sequestration/green business.
I/we own shares in ELMD, VGR, NRP
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