First published in The Globe and Mail on June 8, 2011
Gain since first recommend 3 months ago: 77%
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The nice thing about busted stocks is that they thumb their noses at the index. The market can do whatever it wants: A badly broken stock on the mend will tend to go up. It’s always nice to have a few of these in your portfolio because you can count on them to put a little green on your screen when you’re otherwise seeing red.
Intertape Polymer Group is a broken stock on the mend. Once quoted at $45 a share, it can be had for less than a twentieth of that.
But the stock has done well over the past few months, handily outpacing the market. And that trend will likely continue, which is why I consider it a stock well worth owning, and why I own and continue to buy it.
Intertape makes tapes (duct, masking, etc.), films, wraps, liners and a variety of other plastic products. It’s been around since 1981 and has more than $700-million in annual sales but a market value of only $107- million. Those numbers make it look very cheap but they are, to a point, justified.
Like a lot of highly successful small companies, Intertape was heartily encouraged by investment bankers. It grew rapidly by acquisition in the nineties and early part of the past decade. And as often happens, that strategy didn’t work out well. The company ended up stuck with too many assets, too little efficiency and a confused corporate strategy.
In 2006, founder and chief executive officer Mel Yull retired from the corner suite and a new management team was brought in. They struggled with rapidly rising input costs (natural gas, oil, paper, rubber, resin, etc.), but did manage to attract a takeover offer of almost $5 a share – a slight premium to the stock price then – from a private equity firm.
While management embraced the deal, Mr. Yull and another large shareholder killed it. Senior management was expelled and Mr. Yull took over, just in time for the financial crisis, which was especially hard on Interta pe because it carried a lot of debt (and still does).
But the firm survived and last year Mr. Yull’s son Greg took over. The junior Yull is very focused. Growth, he says, can be overrated. “I don’t care if we grow as long as we grow in high-margin areas.”
The company is moving away from commodity products with slim profits and concentrating on items with fatter margins. Intertape invests in research and development, and this year cranked out a number of new products. The “size matters” attitude is gone. The recent closing of an Ontario plant lowered revenue but added $4-million to earnings because the plant had lost money.
So the CEO has made some progress in the year he’s been at the helm. But there’s much more potential upside. Three factors will drive this stock price.
The first is the stock’s expanding multiple – the amount investors are willing to pay for Intertape’s earnings (which are pretty consistent when you look beyond the noise of writeoffs). The multiple has gotten bigger but it still has room to grow.
The second is more sales and earnings. The ticket to boosting the top line is a gradually improving economy
And with respect to earnings, Intertape is getting a lot of help from an 800-pound gorilla named 3M.
That juggernaut is one of Intertape’s biggest competitors in a lot of the products it makes. As the economy roiled and commodity prices crushed margins, 3M decided not to raise prices on its tapes and other products. It can afford to do so because it gets a premium for its stuff thanks to its brand name.
Because 3M is the market leader, no one else could raise prices. But that’s changing: 3M is raising prices, its rivals are following suit and there are more hikes likely to come. That really expands profits. Management’s goal is to get gross margins to 18 or 19 per cent over time. They’re only about 12 per cent now, and so that kind of an increase would multiply earnings.
The third driver is the possibility of cooling commodity prices. You can decide for yourself how likely that is. There are some who say the end of quantitative easing will help. We’ll see, but that would be gravy. The stock should do well, regardless.
It’s always easy to think you’ve missed the opportunity in an investment that’s up 50 per cent in a short period of time. That’s not true. The shares of broken companies go up by multiples as they fix themselves, not fractions.