Tuesday, September 5, 2017

NACCO Industries: Hamilton Beach Spinoff

For the first time in a while there are a number of interesting spinoff situations on the horizon, one of which is NACCO Industries (NC) separating their small household appliances business, Hamilton Beach Holdings (HBB), from their legacy lignite coal mining business.  This split was announced in August with a quick turnaround for the spin to be done around the end of September.  From the surface this spinoff makes a lot of sense, why is a manufacturer of blenders and toaster ovens paired with a coal miner?  Who knows.  Both businesses should trade for different multiples and its no surprise that paired together they trade at a discount to peers.

NACoal/NACCO Industries (NC)
North American Coal Company (NACoal) is the coal mining operating subsidiary of NACCO Industries, despite being in the coal industry its structured as a fairly decent business.  Much of their operations are conducted in their "unconsolidated mines" segment where NACoal functions more as a service provider earning a small cost-plus margin arrangement and avoiding commodity related pricing risks.  How this works is their customers are large electric utilities that run coal fired power plants, often times these coal plants are located on top of or next to their coal power source.  The utility companies will finance and take on the cleanup cost liabilities for the mine, and will contract out the actual operations to NACoal.  There is no pricing risk as each mine exists to service one customer in perpetuity, their contracts are long dated, often times the length of the expected life of the mine.  For accounting purposes these mines are VIEs and since the customer has most (almost all) of the risk in the venture, NACoal is not considered the primary beneficiary and thus doesn't consolidate the results.

The business spits out a lot of cash, but it is declining albeit in a slow fashion.  What utility would invest significant sums to build a new coal fired power plant today?  Very few, if any.  Power plants last decades and even if the current political administration is coal friendly, I doubt many future ones will be the same.  As a result, NACoal's reinvestment opportunities in the coal business are pretty nil, they do have some small side businesses doing mining related services that operate under similar cost-plus arrangements and that's likely where any future cash will be deployed going forward.  Not great, but NACoal shouldn't be viewed as a royalty trust with a finite life.

In valuing the coal business, I think it should more closely resemble the multiple of an independent power producer versus the recently reorganized coal miners, most of which trade for 4-5x EBITDA.  The power plants NACoal services are primarily base load plants, there's some fluctuation in the results due to power demand/pricing, operational turnarounds, etc., but mostly its a fairly steady predictable business.  They should see some uplift in the coming years due to new contracts coming online (maybe the last of the new coal plants?) and something like fellow blog-name Vistra Energy (VST), which actually does its own coal mining, trades for around 7.5x EBITDA.  I think that's a fair multiple for NACoal given the drivers of the business, they did $35MM in EBITDA in 2016, 2017 will be higher, but we'll just go with $35MM, at a 7.5 multiple that's a $262MM enterprise value.

Hamilton Beach Holdings (HBB)
The spinoff will house a fairly popular small household appliance brand (they outsource all their manufacturing) in Hamilton Beach and then a struggling retailer that has little value in Kitchen Collection.  Hamilton Beach makes blenders, coffee makers, toaster ovens, juicers, indoor grills, etc., it sits mostly in that middle ground between a consumer staple and a durable, these aren't everyday purchases, but aren't large appliances that are big ticket items.  In terms of branding, Hamilton Beach sits in the middle again, they sell through Walmart, Target, Kohls, and Amazon, maybe not the best positioning to take, but they are moving more upscale with their recently launched co-branding efforts with the high end Wolf appliances.  That move upscale has flowed through in their results with widening margins and anticipated revenue growth for 2017 (much of their business is weighted towards the holiday selling season).

Kitchen Collection is a small household appliance retailer (they sell other brands in addition to Hamilton Beach) that operates primarily in outlet malls.  The concept has been hit pretty hard by declining mall traffic, NACCO has been closing stores pretty consistently since 2012 when they had 312 stores to just 209 today.  Kitchen Collection about breaks even and is likely of little value, hopefully they can manage the wind down as to not disrupt the overall HBB results.

There are a number of consumer brand rollups, Newell Brands (NWL) or Spectrum Brands (SPB) for example, that would be a logical buyer of Hamilton Beach at some point.  Both NWL and SPB trade for 14-15x EBIT, Hamilton Beach (with no contribution from Kitchen Collection) should do at least $45MM in EBIT in 2017, even putting a discounted multiple on the business of 12x would equal ~$565MM for the spinoff.

Add the two pieces up, $262MM for the parent and $565MM for the spinoff, minus $54MM of net debt (which is at the parent) and you get an estimated equity value of ~$775MM versus a current market cap of $475MM.  Another way to put it, the market is likely putting little to no value on the coal business despite its asset light nature and consistent cash flows.

Other/Risks
  • This is a family controlled company, there will be a dual share class at HBB as well, which speaks to some of the discount.  Maybe HBB should be 10-11x then?  Still cheap.
  • NACCO did another spin in 2012, Hyster-Yale Materials (HY), which performed great post-spin but has since normalized.  Different business, different time, but I think it shows the lift in multiple possible at HBB after it gets free of the NACCO conglomerate discount.
  • There are two mines that are consolidated at NACoal, one is shutdown and in runoff which is causing some impairments and messy accounting, the other, Mississippi Lignite Mining Company is run in a similar fashion as the unconsolidated mines, however NACoal is on the hook for the operating costs.  The majority of the capex for the business is related to operating the consolidated mine.
  • Management is pitching the spinoff partially as a talent planning event, current CEO Al Rankin Jr (part of the controlling shareholders) is stepping down as CEO, elevating the two executives who currently run NACoal and Hamilton Beach to CEO of each respective company.  Rankin will then become Executive Chairman of Hamilton Beach and Non-Executive Chairman of NACCO Industries, not quite the same as "going with the spinoff" but noteworthy and sounds like he'll have more of an active role in the spinoff than the parent.
  • HBB certainly has some private label risk, some Amazon risk, etc., but doesn't appear to be immediately in the cross-hairs of either.  On the positive side, its a way to "play" the millennials finally moving out of their parent's basement theme, increased household formations, and other demographic tailwinds.  Additionally, HBB's business is mostly domestic, they're making a push to expand to developing markets where there is growth in the middle class.
Disclosure: I own shares of NC

15 comments:

  1. Great idea. I made good money in the Hyster spin. Is there a management presentation that breaks down the transaction?

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    1. I don't believe so, here's the letter management put out:
      https://s22.q4cdn.com/351071137/files/doc_news/documents/2017/08/Doc-7-FINAL-FINAL-AMR-letter-to-all-constituencies-082117.pdf

      And then HBB did file an S-1:
      https://www.sec.gov/Archives/edgar/data/1709164/000119312517262713/0001193125-17-262713-index.htm

      The more I noodle on HBB, 12x is probably the wrong multiple, maybe more like 9-10x EBIT, but anything above the 7x the combined entity is being valued at today and it should be a net positive.

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  2. Thanks, found those, you have done a lot of work pulling out the key information. Agree with you on being more conservative on HBB. But this has good chance to be a good one, given the complete lack of similarity between the businesses.

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  3. I would add to the risk section the possibility that the spin-off doesn't happen. NC announced a similar spin-off of Hamilton Beach in 2007, re-affirmed a Q3 2007 spin-off date on their Q2 earnings call, and then cancelled the spin later in August.

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    1. What was the reason the previous spin fell through? Do we know the likelihood it closing this time?

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  4. You mention there are a few spinoffs coming up - which are you referring too?

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    1. I haven't done complete work on these but I find CNX, LQ, WYN, and SRC all pretty interesting from a high level.

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  5. Also looking at it. If it could sell KC for zero, it'd be worth even more. This is more likely to go through bc unlike previously Rankin wants to retire.

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    1. They're technically already doing that (paying someone -- closing costs -- to take KC off their hands). But it doesn't always work where you can just do an immediate gin-and-rummy style capitalist excision of a part. Since the two brands are somewhat associated, closures have to handled with care

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  6. Did you sell off or reduce some positions to add these new positions?

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    1. I participated in the TPCA tender offer, so I no longer own that, and then the MRLB and SNBN deals closed, otherwise I haven't sold anything.

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  7. One risk mitigated, looks like it's actually happening: https://www.streetinsider.com/Press+Releases/NACCO+Industries+Declares+Hamilton+Beach+Brands+Holding+Stock+Dividend/13304881.html

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    Replies
    1. Yep, this idea is working quicker than expected.

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  8. I attended management luncheon today for the coal business. I think that it will be interesting see how market values HBB and coal post spin.

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