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ARCI - Appliance Recycling Centers of America


Patmo
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ARCI sells appliances under the brand Appliance Smart and also offers appliance recycling programs. At $2.7/share It's trading slightly below book value of $3 and EV/ttmEBIT 2.86.

 

I'm sorry I don't have much to say just yet as I didn't read everything I could yet. I do know that there's new mgmt in place as CEO retired and CFO is moving on to bigger things. New CEO is proactive and has already begun undertaking measures to increase top line and cut costs in the fat. Guidance is high 6-figure, low 7-figure cost savings for 2015. This alone would bring EV/15EBIT down to 2.5.

It looks like kind of a boring, crappy, low margin business at first glance, but cheap enough to warrant an investigation.

 

I'll do more digging later on and provide an update on my more relevant findings.

 

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I made some quick digging, and it looks like there was a big drop in share price on news that the company didn't pay California sales tax in 2011 or 2012, and could potentially have to pay them back. The company's only California operation is a recycling facility, one of 11 for the company. Recycling was 22.1 and 26.1% of revenues in 2012 and 2011 respectively. At a 10% sales tax rate, the company would owe a little over $530k in taxes assuming the California operation is of average size (eg. 1/11 of recycling revs). I double this charge in EV in case of additional fees and a hunch that California is one of the larger recycling operations for the co.

 

EV/ttmEBIT is still 3 factoring this charge. Very interesting considering new mgmt is being proactive in seeking out contracts and cutting expenses in the fat and the recycling business is very profitable and has a nice future. Appliance retailing business is actually a loser for the co, despite being competitive with the big retailers price-wise due to offering "special buys" (the otherwise good appliances that the appliance cos won't market, like out of box stuff, etc)

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According to the most recent 10Q California's audit is ongoing and now extends through 2013.

 

If you assume that 50% of the recycle sales eventually are audited by the various states in which ARCI does business (many states wait for a big boy like California to collect and then try to free ride on their work) and assume an average tax collected of 6% of recycle sales for each of the last three years you get approximately $40ml in taxed sales or $2.4ml in tax due.  This assumes no penalties but I doubt there would be penalties in this situation unless there is alot more to the story because of the social good associated with this sales activity.

 

Anyway, if you added $2.4ml to the current EV of $28.2 you get $30.6ml, with EBITDA of around $7ml, or 4.4x.  Regardless of your assumptions, I think this is part of the story.

 

With the absolute crap quality of new applicances today (designed IMHO to wear out in three or four years instead of the eight to twelve that prevailed just a few years ago) it seems like the opportunity to do more recycling could be on the rise, but of course that is just my specualtion.

 

I like that management owns about 20% and that their compensation is reasonable, with the top three officers taking home between 10-15% of EBITDA.

 

I passed on this years ago but am going to look at it again.  The CEO is 73 which I find interesting.

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According to the most recent 10Q California's audit is ongoing and now extends through 2013.

 

If you assume that 50% of the recycle sales eventually are audited by the various states in which ARCI does business (many states wait for a big boy like California to collect and then try to free ride on their work) and assume an average tax collected of 6% of recycle sales for each of the last three years you get approximately $40ml in taxed sales or $2.4ml in tax due.  This assumes no penalties but I doubt there would be penalties in this situation unless there is alot more to the story because of the social good associated with this sales activity.

 

Anyway, if you added $2.4ml to the current EV of $28.2 you get $30.6ml, with EBITDA of around $7ml, or 4.4x.  Regardless of your assumptions, I think this is part of the story.

 

With the absolute crap quality of new applicances today (designed IMHO to wear out in three or four years instead of the eight to twelve that prevailed just a few years ago) it seems like the opportunity to do more recycling could be on the rise, but of course that is just my specualtion.

 

I like that management owns about 20% and that their compensation is reasonable, with the top three officers taking home between 10-15% of EBITDA.

 

I passed on this years ago but am going to look at it again.  The CEO is 73 which I find interesting.

 

The CEO (who I believe was also founder/owner-operator type, not sure) retired and in his place is newcomer former COO who was initially hired in 2013. The CFO subsequently left recently as well, I suspect/speculate that he felt wronged in being looked over for the new guy. At any rate I like what the new CEO says he's been doing. I'm not sure how the company works and whether the appliance sale side can be dumped or whether it's a necessary evil for the company to do business, but the trend shows they have been and will continue to increase focus on the recycling side, which is (coincidence!) much more profitable.

 

Are there precedents for this kind of tax issue? Do companies have a chance at settling on this or is it just a black-or-white you owe or you don't, at the mercy of the governments? Also, the company only mentioned California investigating so far, I wonder if the co actually paid taxes or not in other jurisdictions. The co remains pretty cheap anyway as per your conservative calcs, but a $2ish mil charge would be nice to not have to pay.

 

Also, I get a drastically different EV outcome than you. Do you mind sharing what you put in there? Did you factor short term debt (line of credit)? My calc is almost 10mil lower than yours.

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  • 3 weeks later...

Looked at this one a few months ago. Another problem other than the lawsuit was the replacement business being highly concentrated on one customer that is only renewing in short term contracts. Top of page 5 of earnings call transcript.

 

http://seekingalpha.com/article/2404505-appliance-recycling-centers-of-americas-arci-ceo-edward-cameron-on-q2-2014-results-earnings-call-transcript?page=5&p=qanda&l=last

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  • 2 months later...

They are now doing a managed audit with CA.  Based on the lack of support so far from their customers I would raise my estimated cost of settlement to $4-5ml because I think interest if not penalties are now likely.  I notice there are now several shareholder suits pending . . . doubt they will go anywhere given the fact that the stock hasn't dropped since the non-reliance announcement.

 

Still don't think the business is cheap enough. 

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  • 7 months later...

This company is now trading at 1/3 book value and 4x the average earnings of the past 4 years, as well as near all time low territory. This business is a bit of a crapshoot, it randomly posts amazing and shit years over time. Since 2007 the company averages $450k in net income, but swings from -4mil to +4mil. At any rate, the business grew pretty well under Jack Cameron, so it might be a positive catalyst that he got the retirement jitters and threw his hat back in the ring.

 

Reasonably positive developments would make it a 4-5bagger within the next few years. Given the risks involved I'm ready to throw the dice at this juncture, a small ball size. I may attempt to trade around on it if I see an opportunity, I've been meaning to try that out.

 

Anybody else?

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  • 2 weeks later...

I did some work on this and it is very cheap strictly from a valuation perspective.

 

Free cash flow (defined as CFFO-capex) is as follows:

FY13:  $1.2mm

FY14:  $2.7mm

TTM:  $1.4mm

 

Given a current market cap of 4.5mm, this equates to 3.6x, 1.62x, and 3.11x reported free cash multiples. 

 

FY11 reported (0.4mm) FCF which was due to $1.7mm in capex.  Capex has since been lower and consistent going forward: FY12 $0.8mm, FY13 $0.5mm, FY14 $0.8mm, TTM $0.8mm.

 

FY12 reported (0.3mm) FCF which was entirely driven by a seemingly one-off drop in recycling revenue

(recycling revenues have been as follows:  FY11 $33mm, FY12 $25mm, FY13 $41mm, FY14 $46mm, TTM $40mm).

 

D&A are also consistently more than capex spend.  Additionally, they are trading at about 1/3 book value which is always fun. 

 

Qualitatively, there are two main unknowns that are keeping me from pulling the trigger - the companies reliance on utility companies and the fact that I do not understand the competitive landscape of the market.  Both of these kind of go hand in hand.

 

Revenue generated from recycling is the key component of the business that makes this company attractive (the retail segment has very low margins and has been losing a little bit of cash).  The company generates recycling revenues primarily through short term contracts with utility companies energy saving programs (e.g. utility company wants their customers to use more energy efficient appliances to lessen capacity requirements and therefore hires ARCI to pickup the old appliance... and sometimes replace with a new energy efficient appliance). 

 

I'm concerned about the companies ability to continue to enter into these short term contracts with utilities companies.  The FCF is only as good as their continuous ability to win these contracts and I'm just not well versed enough in the industry to understand how competitive the industry currently is/will be in the next couple of years.    Additionally, as someone has already pointed out, they disclosed in Q3 2014 that one utility company comprised of roughly 40-50% of these types of revenues - not sure how great the FCF looks if that drops. 

 

Do you have any insight into this?

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I did some work on this and it is very cheap strictly from a valuation perspective.

 

Free cash flow (defined as CFFO-capex) is as follows:

FY13:  $1.2mm

FY14:  $2.7mm

TTM:  $1.4mm

 

Given a current market cap of 4.5mm, this equates to 3.6x, 1.62x, and 3.11x reported free cash multiples. 

 

FY11 reported (0.4mm) FCF which was due to $1.7mm in capex.  Capex has since been lower and consistent going forward: FY12 $0.8mm, FY13 $0.5mm, FY14 $0.8mm, TTM $0.8mm.

 

FY12 reported (0.3mm) FCF which was entirely driven by a seemingly one-off drop in recycling revenue

(recycling revenues have been as follows:  FY11 $33mm, FY12 $25mm, FY13 $41mm, FY14 $46mm, TTM $40mm).

 

D&A are also consistently more than capex spend.  Additionally, they are trading at about 1/3 book value which is always fun. 

 

Qualitatively, there are two main unknowns that are keeping me from pulling the trigger - the companies reliance on utility companies and the fact that I do not understand the competitive landscape of the market.  Both of these kind of go hand in hand.

 

Revenue generated from recycling is the key component of the business that makes this company attractive (the retail segment has very low margins and has been losing a little bit of cash).  The company generates recycling revenues primarily through short term contracts with utility companies energy saving programs (e.g. utility company wants their customers to use more energy efficient appliances to lessen capacity requirements and therefore hires ARCI to pickup the old appliance... and sometimes replace with a new energy efficient appliance). 

 

I'm concerned about the companies ability to continue to enter into these short term contracts with utilities companies.  The FCF is only as good as their continuous ability to win these contracts and I'm just not well versed enough in the industry to understand how competitive the industry currently is/will be in the next couple of years.    Additionally, as someone has already pointed out, they disclosed in Q3 2014 that one utility company comprised of roughly 40-50% of these types of revenues - not sure how great the FCF looks if that drops. 

 

Do you have any insight into this?

 

what you are missing is the massive debt load they have and the potential outstanding tax liability of $4m. They are also reliant on scrap commodity prices. Further, the activist who got a board seat last spring and was buying at $2.75+ less than a year ago is now selling for $1 after he had gotten to open up the hood? Not a good sign. I thought this one was potentially interesting too but seems like a better Ch. 11 candidate now. If they can somehow sell the Retail division for $10-14m (.15-.2x sales) they could hold this together. I don't know how likely that is though.

 

I also thought this was an interesting one and i looked at it last spring but once i saw Isaac Capital selling for $1 after getting on the board, my perspective changed completely.

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  • 3 weeks later...
  • 2 months later...

This company keeps putting out press releases just to say that business is going real well. A while ago they were talking about picking up a defunct competitor's customers, now they're saying they straight up can't keep up with demand. The market believes 0 of it, could be a solid buying opportunity. What do you guys think?

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  • 1 month later...

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