Originally Posted by SparkyTheClown View Post
I’ve recently finished accumulating a number of Cavalier (CAV) shares. I thought I would post on Sharetrader my thoughts as to why Cavalier Corporation represents deep value and likely to gain more over the next two years.
In a strongly performing sharemarket like the NZX, most NZX listed companies look like they are at full or fair value, without the adequate margin of safety that a value investor would demand.
Cavalier is presently one of the few stocks out there today that offered me sufficient margin of safety in an NZ equity investment.
Here are the reasons why I liked CAV enough to buy in:
1. It’s a cyclical “smokestack” stock, which was punished throughout the GFC, but has pulled itself together and is well primed to take advantage of the improving economy in NZ, and the hopefully improving economy in Australia (still yet to see signs of growth but not getting worse). CAV is “well positioned” to improve as construction and discretionary spending improves.
2. CAV has addressed concerns with its balance sheet by paying back debt. While debt remains high-ish, it has come down from 42 to 36%, which is probably ok for the foreseeable future (I’d prefer under 30%). Inventory has also improved, down from $63m to $57m.
3. CAV has addressed concerns with a deficiency in its business, which was the lack of a synthetic/nylon carpet. Wool used to be the favoured textile, now nylon is more popular. It has recently released to some market interest the “Habitat” range of synthetic carpets, at price points that suit medium to medium-high price buyers. This carpet is made by Cavalier but yarn supplied through a partnership with Invista.
4. CAV earnings are forecast to improve dramatically in 2014 as it pulls out of a difficult trading environment and some significant redundancies and scale-backs. It has mothballed excess production capacity and its workforce is 21% less than in 2011. Operating leverage has dramatically improved as a result. Earnings growth is forecast by brokers to improve from 9.7c actual in 2013 to around 22.5c in 2017 (assuming terminal growth rate of 3% in 2017). This suggests growth of around 18.5% per annum for the next five years, with big growth expected next year, and more normalised earnings growth thereafter.
5. CAV is trading on a dividend of around 3% based on a shareprice of $1.80, but I forecast this to improve to around 5% for next year on the basis of improved profits and cashflow. Its current 2013 dividend is 4cps (100% imputed), and it is forecast to double to 8cps according to broker reports I have seen.
The two favourite metrics I like applying to assess the rationality of a share price is the Ben Graham Intrinsic Value score, and the Peter Lynch YPEG score.
Using the Ben Graham Intrinsic Value formula, I get the following based on current EPS of 9.7c in 2013:
12% growth = $2.40
16% growth = $3.03
18% growth = 3.34
Using the Peter Lynch score of P/E divided by long term growth of 16% plus dividend yield of 3.1%, I get 18.5/(16+3.1), or a final score of 0.97 . Lynch seems to think anything under 1 is good value, anything under 1.2 deserves a sniff. Naturally, if you use the higher growth rate of 18%, then the score looks better, being around 0.87.
So applying my usual 40% margin of safety to an intrinsic price of 3.03, I get a margin of safety buy price of $2.16, which is roughly 34-36c more than the price I’ve been acquiring at. Using the Ben Graham IV calculations, I see around 67% upside on current known earnings and 16% growth.
Negatives:
a) Cavalier is only worth $120m market cap. It is not very liquid, and it took me several days to get the holding size I wanted. Obviously, if I needed to get out quickly, I’ve got a problem. But if someone else wants to get a sizeable holding into CAV in a hurry, then they will drive up the price ferociously.
b) Debt – if the cost of interest rises significantly, then CAV will find the higher debt to be an imposition on future earnings. Reducing the debt may be a bigger priority than reducing the dividend. 1c foregone in dividends equals almost $1m in debt repaid.
c) Carpets are substitutable and subject to competition. People can have wooden floors, tiles, rugs, and polished concrete instead of carpets. And even if they choose carpet, they can then choose a number of brands, and not just Cavalier.
d) Carpets are somewhat elastic in demand compared to other products in the building sector. People can choose to defer carpet replacement, but they can’t defer a leaking roof or perishing weatherboards in the same way.
For all that, I think there is at least almost 70% upside in CAV. Again – this is a value play based on anticipated improvements in the economic cycle, not a secular growth story on a company immune to economic fortunes. If Australia's construction picks up in the next 12-18 months, then CAV will sing.
Disclaimers: I am not an authorized financial advisor. I’ve posted what I have done, not want I want you to do. If you act on the comments of an anonymous poster on the internet called “Sparky the Clown” then you will have some explaining to do to loved ones if the investment goes sour. Do your own research. I am unavailable to enter into discussion on this post, but hope that it spurs on others to consider this company’s merits, or otherwise
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Originally Posted by winner69
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