I had been looking for a simple investment idea and found one in The Red Corner. I'm in debt to the author for the lead and advice.
The business of Macro Entreprises Inc. is constructing and repairing pipelines and facilities. It operates in British Columbia and Alberta, Canada. Its clients are companies in the oil and natural gas industries.
The business of Macro Entreprises Inc. is constructing and repairing pipelines and facilities. It operates in British Columbia and Alberta, Canada. Its clients are companies in the oil and natural gas industries.
Macro has to bid for projects and then attempt to establish a relationship with a customer through high quality execution. I found proof of that in higher than average returns on capital Macro has been historically able to achieve. Macro also has several master service agreements, which allow it to get projects without needing to bid. The company tends to deal with big customers.
In May 2014 the company released its Q1 financial results. Reportedly, in an attempt to establish a long-term relationship with a new customer, they had agreed on a couple of low-margin fixed-price projects. As the CEO said, they "lost some people" for one of them and had to look for replacement contractors, which led to unexpected costs. By Q2 the project was completed with the total loss of $8 mil. Since the margin on this project was low and the price was fixed, there wasn't much room for error.
The Q1 results triggered a sale on the stock market. With the failed project on their income statement, margins and return on capital appeared low. The market seems to think that they are going to stay.
Discussing the failed project, they mentioned that the customer was satisfied with their high quality work. I haven't found any reference of other failed projects in financial reports from prior years.
If I pretend that the failed project didn't happen, then I see a normal year with the gross margin close to the historical 20%.
Conservatively looking at the continuing value, it appears that current price is only half the value:
Now, obviously revenues of Macro are going to be as cyclical as the oil and gas industry. When oil companies choose not to build new pipes, Macro will have to rely on repair projects and its master service agreements. These projects have higher gross margin. If I halve revenues to $90 mil. and assume 25% gross margin, I still get NOPLAT of $11 mil.
Macro appears to be ready to weather the potential storm - NOPLAT covers interest expense 10 times. Its assets are not specialized and the industry isn't dying, so it will be easy to sell if need be.
I hope I'm right and my first ever stock position will turn into a good investment within a year or two. My average cost is 2.14 and I think it's worth at least 10 P/E.
Added October 11th, 2016:
It's nearly the second time I caught up with MCR in the two years that I have been holding it.
While 2015 seemed to be in line with the downside prediction in the post, the last two quarters were worse - they became cashflow negative. Macro's clients delayed integrity work and, given the tiny revenue, fixed costs adversely affected operating margins.
Management has guided a significant improvement in the second half of the year, but the year overall is going to be bottom-line negative. I think, however, that unless Macro's clients are on the verge of bankruptcy, the integrity work can't be postponed for long, since inspecting pipelines seems to be required by law. If Macro returns to profitability of 2015, the time is again on its side. We could then revert back to watching the EV go to 0 while the excess cash is building up.
Management skipped the Q2 conference call and that, no doubt, has affected investor's thoughts as they contemplate the future.
