In this newsletter, I share the most intriguing investment ideas I've come across in the past week from a variety of sources, including Value Investors Club, various investing blogs, hedge fund letters, and more. I aim to present you with concise and easily digestible investment idea summaries that quickly capture the essence of the thesis.
This week's newsletter includes:
Cronos Group (CRON) - A bet on the US cannabis industry.
Franklin Street Properties (FSP) - Potential liquidation of a REIT.
DLH Holdings (DLHC) - Cheap US government contractor.
The Monarch Cement Company (MCEM) - Misvalued cement producer.
Newpark Resources (NR) - Potential divestiture of a lower-quality segment.
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Cronos Group (CRON, $709m)
Cannabis producer and distributor CRON presents an intriguing opportunity to play the expected tailwinds in the US cannabis industry. The Department of Health and Human Services has recently recommended reclassifying cannabis from a Schedule 1 substance (e.g. heroin and LSD) to a Schedule 3 substance (e.g. anabolic steroids). The reclassification is anticipated to receive approval from relevant authorities, including the US president, as it would enable the current administration to secure approval from the younger generation shortly before the 2024 election. This potential reclassification would be a significant boon for the industry, as it would grant cannabis companies access to banking and capital markets, intellectual property protections, insurance, and the ability to conduct business across states.
Cronos appears to be the best vehicle to bet on these industry tailwinds. The company boasts superior intellectual property compared to competing multi-state operators (MSOs) and has the potential to establish the most robust distribution network. Unlike other MSOs, which have generally allocated minimal resources to R&D and instead focused on vertical integration due to existing regulations, Cronos has prioritized the development of its intellectual property and brands. The company holds a leading position in edibles with a 20% market share, whereas the nearest competitor only has 6%. As for the distribution network, Cronos has secured a global exclusivity deal with Altria which boasts tens of thousands of retail channels in the US. These factors suggest that if full cannabis legalization occurs, Cronos is likely to benefit disproportionately compared to its peers. The downside appears to be well protected by CRON's substantial net cash position of $850m, which more than covers the current market cap. Additionally, the company possesses several hidden assets that could potentially be monetized. These include CRON’s 6% ownership stake in one of the largest private MSOs PharmaCann (stake valued at $49m) and a 10% stake in publicly-listed medical cannabis provider Vitura ($13m). Full CRON write-up on Value Investors Club (free guest account is required).
Franklin Street Properties (FSP, $212m)
Franklin Street Properties is a small office REIT trading at a substantial 70%+ discount to the estimated NAV. FSP appears likely to be liquidated within the next couple of years. Since 2020, FSP's management has been actively pursuing an asset disposition strategy, with the sale of assets worth $852m (versus the current EV of $607m) and the repayment of a majority of the company's debt. Currently, another $163m worth of assets are under contract to be sold and additional asset sales are expected in the coming year. These asset dispositions are expected to reduce the debt to minimal levels, creating a path for shareholder returns through a liquidation. Author’s valuation of FSP’s individual properties indicates that the market NAV of the remaining assets, including contracted assets and after debt repayments, is $7.54/share. In a potential wind-down scenario, equity holders are likely to receive approximately $6/share to $7/share in liquidating distributions vs the current price of $2.05/share. There is also the possibility of the company being acquired. The opportunity exists because FSP is an orphaned security with no natural equity holders given the shrinking asset portfolio and minimal dividends. Earlier this year, the REIT was removed from the S&P SmallCap 600 and Russell indexes, which prompted a further sell-off. Full FSP write-up on Value Investors Club (free guest account is required).
DLH Holdings (DLHC, $202m)
DLHC is a US government contractor that primarily offers services in the healthcare and technology sectors. DLHC shares are currently available at 8x 2023E EBITDA. This is an attractive valuation for a high-quality roll-up with stable, long-term contract-based revenues and robust free cash flow generation (20% 2022 FCF yield). The company boasts a multi-year track record of growth, with historical sales growth in the high-teens, driven by both organic expansion and value-accretive acquisitions. DLHC’s peer group (includes BAH, CACI, ICF, SAIC and LDOS) is currently valued at 12x-16x 2023E EBITDA multiples. While the comps are significantly larger, DLHC has displayed superior EBITDA margins and best-in-class organic and inorganic growth. Valuing DLHC at 10x 2025E EBITDA would suggest a price target of $20/share, indicating a potential 37% upside. The opportunity seems to exist as DLHC is a $200m market cap company with relatively low trading liquidity, resulting in limited interest from institutional investors. Several catalysts could help unlock the valuation discount compared to peers, including further value-accretive M&A, a continued focus on debt reduction (currently 4x net-debt-to-EBITDA) and potential index inclusion. Incentives are well-aligned as insiders own over 40% of the company. Full DLHC write-up on Value Investors Club (free guest account is required).
The Monarch Cement Company (MCEM, $510m)
MCEM is a cement company that specializes in the production and distribution of Portland Cement and ready-mix concrete. Monarch Cement is a robust business with an impressive track record of profitability and growth, boasting a 10-year revenue and EBIT CAGRs of 6% and 20%. Investors currently have the opportunity to acquire this asset with a significant economic moat at a modest valuation of 5.5x 2023E EBITDA and less than 10x net income. Monarch Cement also trades a few P/E valuation turns lower compared to most other publicly traded cement producers. The opportunity exists as MCEM is a family-run business operating in a boring industry. However, unlike many other family-controlled companies that are run for the benefit of insiders, MCEM's management has consistently demonstrated sound capital allocation, paying a healthy dividend and regularly repurchasing shares. Another reason for the undervaluation might be the recent boost in Monarch's earnings due to high cement prices and strong demand from construction and infrastructure projects. However, while the cement industry is cyclical, MCEM is undervalued relative to peers. A potential catalyst for unlocking value here could be the sale of the company at a substantial premium to the current share price levels. Full MCEM pitch from Alluvial Capital Management.
Newpark Resources (NR, $626m)
Newpark Resources offers temporary worksite access services/products through its Industrial Solutions segment and provides drilling, completion, and stimulation fluids for the O&G industry through its Fluid Systems segment. Recently, the company initiated a strategic review for its Fluid Systems business, with options including selling the entire segment or winding down its working capital. A potential divestiture of the low-margin, cyclical and capital-intensive segment would transform Newpark Resources into a capital-light and high-margin power infrastructure rental and services business. Assuming that the sale of the Fluid Systems segment can generate cash proceeds in the range of $180m-$220m (in line with the segment's working capital), the Industrial Solutions business currently carries a modest valuation of 5 times its 2025E EBITDA (after corporate overheads). This is significantly below segment’s peers that are valued at 9-11x. Applying the same valuation to NR’s Industrial Solutions segment would imply a share price target of $10.90-$15.44/share (50%+ upside). NR's stock appears to be mispriced due to its lack of sell-side coverage and the market's perception of it primarily as an oil and gas services company. Full NR write-up on Value Investors Club (free guest account is required).
Some really interesting investment ideas include Monarch, in particular🙏👍