First published in The Globe and Mail on July 15, 2011
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Bennett Environmental is an unlikely cash cow. The company is in the business of treating contaminated soil by burning it. This doesn’t sound like a high-margin business, but it is. In good times, Bennett’s plant can post profit margins north of 50 per cent. Most of that cash flow is gravy for shareholders because the plant needs very little maintenance.
And yet, despite this lavish profitability, the stock trades for next to nothing. Notwithstanding more than $1.60 per share of cash in the bank and no debt as of the end of the first quarter, Bennett’s stock is quoted at $2.20.
That strikes me as pretty good value, and I’ve been a buyer of the stock lately. I’m not alone: Noted value investor Irwin Michael, who runs the successful ABC Funds, has also been a big buyer. In the last few months he’s amassed an 18-per-cent stake in the company. That’s a pretty big bet and I don’t think he’s doing it to earn 10 or 15 per cent. The story, which I’ll spell out, has a lot of potential upside. And the nice thing is that the stock is not that sensitive to the general economy or the direction of the stock market, a theme touched on last week.
First the history: once a stock market darling – the shares were $28 seven years ago – Bennett blew up. The company’s revenues fell as Superfund, a U.S. government program set up to pay for the cleanup of contaminated sites, dried up.
Bennett was then accused of a conspiracy to defraud the Environmental Protection Agency, which ran Superfund, to which it pleaded guilty and for which it paid a $1-million (U.S.) fine. The founder and chairman resigned. The stock plunged.
A new and very able CEO, Jack Shaw, was brought in to turn the floundering company around. He did yeoman’s work, cutting costs, getting rid of unneeded assets, raising funds and securing a big contract that generated a lot of cash. By the beginning of this year Bennett had $65-million in cash and was looking to deploy it in an acquisition that would add more consistent revenues.
However, a big shareholder, Second City Capital Partners, was getting impatient. After a bitter but brief proxy battle, most of the old board was bounced, including Mr. Shaw, and replaced with fresh faces. Lawrence Haber, a former financier and lawyer, is the new chairman and interim CEO while the board looks for a permanent head.
With the proxy battle over, the company can focus on the two things that will build wealth for its owners. The first is to land more remediation contracts. Bennett’s business is very lumpy. While treating contaminated soil can be very profitable, the plant needs a certain amount of dirt to run efficiently. Capacity is 100,000 tonnes a year; break-even production is about 20,000 tonnes or so.
In 2009 and 2010, the company ran its plant at about 70-per-cent utilization and earned roughly $1 a share. Put another way, Bennett produced almost $40-million in free cash flow. The market value today is about $90-million. That’s value.
But the plant hasn’t run in months, as there are less than 20,000 tonnes of inventory.
The contracts will come – Bennett’s technology is, by and large, the preferred method of treating soil – it’s just not clear when, although there could be a big contract win this summer. And with $9-million in tax losses, a lot of those future earnings will be protected from the reach of the taxman in Ottawa.
That explains why the stock is so cheap. It’s hard to value lumpy, irregular earnings. But the earnings will come for those who aren’t fussed about quarterly performance.
As for those who are, there’s also good news. That cash hoard will eventually be put to use – in fact Second City had suggested a couple of merger or acquisition targets before the proxy battle (which the old board didn’t think were good fits).
I’m guessing something could happen relatively soon, perhaps an acquisition of a similar business but with more consistent earnings, which would increase the multiple that investors are willing to pay. The upside on the stock, in my view and that of others I’ve spoken to, is potentially big. The downside, given the cash balance, looks small by comparison.