- By Geoff Gannon
I've often talked about the importance of focusing on those businesses you - personally - can understand. Today, I want to use my research into NACCO (NC) as an example of that. NACCO is a holding company - it used to own the forklift company Hyster-Yale (HY) till it spun that off in 2012 - that now owns two major businesses: NACoal and Hamilton Beach Brands (expected to trade under the ticker "HBB"). This is a controlled company (it has super voting class "B" shares that are owned by descendants of the founding family) that has been diversifying away from coal for a long time.
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I believe the company stopped the underground mining of bituminous coal ("black coal") in the 1980s. However, the company is still involved in surface mining of lignite coal ("brown coal"). Brown coal is the poorest quality coal with the lowest heat content. For this reason, it's not something you ship far. This makes it less of a nationwide or worldwide commodity and more of something that you would only want to produce in quantity for one or more big, local customer under a long-term supply contract. Hamilton Beach Brands mostly consists of the range of Hamilton Beach small appliances (blenders, toasters, slow cookers, coffeemakers, etc.) Americans are familiar with (you may not remember the brand, but you've definitely seen it) from shopping at Walmart (WMT) and Amazon (AMZN). A while back, I heard that NACCO was planning a spinoff to be completed some time in the third quarter of 2017 (so basically now). This fact wasn't surprising. I had some slight familiarity with NACCO because I had researched Hyster-Yale as a stand-alone stock.
The thing that first drew me to NACCO was simply that it was a spinoff. I've had two good experiences with spinoffs: Hanesbrands (HBI) in 2006 and BWX Technologies (BWXT) in 2015. I still own BWX Technologies. It's about 25% of my portfolio right now. I also had a good indirect experience with another spinoff: Energizer Holdings (ENR). I didn't buy that stock as a spinoff. But reading about the spinoff once the company was trading on its own got me interested in the company, its history, etc. So I am always looking for the possibility that a business I like will be spun off. It doesn't happen that often. And sometimes a planned spinoff never occurs. NACCO had planned to spin off Hamilton Beach twice before (this was about 10 years ago) and didn't complete the spinoff on either occasion.
I've sometimes looked hard at a potential spinoff (or breakup of some kind) that never happened. For example, I've studied Hawaiian Electric (HE) for years in the hope that they would somehow separate their utility business (which I'm not interested in) from their bank (which I am interested in). I wrote a report about Bank of Hawaii (BOH). So I know the Hawaiian banking market. I like the Hawaiian banking market. And I'm always looking for a way to get a piece of the Hawaiian banking market at a good price. Hawaiian Electric has come close to splitting the bank from the utility - but, so far, it's never happened. So all my research into that stock has been for nothing. This can happen with spinoffs. You want to be prepared. So you just have to accept that sometimes you research a situation that never materializes.
I said I wanted to get into the Hawaiian banking market "at a good price." Obviously, I could just buy Bank of Hawaii. But the market knows that bank's a good bank, and it tends to trade like it's a good bank. I don't want to pay a high price for a great business. I still want a good price even if the business I'm buying is a great one.
That "at a good price" part is why you look at spinoffs. The kinds of companies I like best tend to be "predictable" companies even if they don't meet GuruFocus' statistical definition of that title. For example, I own Frost (CFR), which I think is a predictable bank if you look under the hood and ignore the fluctuations in the Fed Funds Rate. It's the Fed Funds Rate that is unpredictable. The bank itself is predictable. And I think BWX Technologies is predictable, too. It's just that BWXT hasn't traded as a stand-alone company for very long yet. Once BWXT has been trading for five or 10 years as a stand-alone business - everyone will recognize what a high quality, predictable business it is. It'll be too late to buy the stock at that point. That's the attraction of spinoffs.
It's not just spinoffs. Sometimes other corporate events pull back the curtain on a previously hidden good, predictable business. A few years ago, I wrote a report on Breeze-Eastern (since acquired by Transdigm [TDG]). Breeze-Eastern had a wonderful core business of selling the original equipment (and more importantly, the replacement parts and maintenance) on search and rescue hoists for helicopters. That business had always been a pretty predictable one. But Breeze had bought a bunch of other things, loaded up with a lot of debt and then unwound all that buying and paid off all that debt. This made the company's past history look murky. That's good. That's actually what you want if you're a value investor who likes a good, predictable business. You want something to be obscuring the qualities you see in the business. I find this is better than betting on turnarounds. Instead of finding a business that has tended to be good in the past but is now facing some problem and needs to be put back on course - you find a business that is already good but can't be recognized as such just yet.
I'm looking at NACCO now. NACCO is spinning off Hamilton Beach. So does that mean Hamilton Beach fits that description?
It might. Hamilton Beach is a known "name" brand in the U.S. I wouldn't say it has any particular positioning as a premium brand of small appliances or as standing for something in particular. I haven't met anyone yet who believed Hamilton Beach has mindshare. But it has one of the broadest arrays of small appliances, and it has some of the most shelf space at Walmart of any small appliance maker. And yet the business is capital light (the manufacturing is all outsourced to China basically). The Hamilton Beach name hasn't had a ticker of its own. Instead - to buy the business - you'd need to buy into something called NACCO. If you picked up NACCO's 10-K, you get a very long description of NACoal and all of its risks and such before you ever get to hearing about Hamilton Beach. Investors interested in a consumer products company might not want to invest an equal amount of their capital in a coal company. And going back further, you'd have been investing in Hyster-Yale too. So Hamilton Beach wouldn't be an easy business to invest in. It was public. But, unless you wanted to own some forklifts and coal mines - it wasn't something you were going to buy.
What is Hamilton Beach worth?
I'm honestly not that sure because I pretty quickly eliminated Hamilton Beach from consideration for my own portfolio. This isn't because Hamilton Beach is a bad brand or will be a bad stock when it trades on its own. It's simply that Hamilton Beach is outside my "circle of competence," as Warren Buffett would say.
How do you know your circle of competence?
You start by asking two questions.
What do I know well? What have I researched before?
Many of my good investments have been in companies with little or no competition. I am terrible at evaluating retail companies. The average analyst who covers consumer products companies will understand Hamilton Beach better than I will. I don't follow Walmart or Amazon as closely - nor do I feel I understand them as well - as many investors do.
NACoal is different. The company is involved in operating lignite (again that's "brown") coal mines for a few major customers. These customers are usually power plants of some kind. They sit very, very near (in some cases, basically on top of) the coal deposit that NACoal is working. I was able to confirm this to my satisfaction by going online and getting satellite images of NACoal's five biggest mines. Using those images, I can see where the customer's plant is in relation to the surface mining activity.
I've never researched a coal miner before. However, I have researched two companies related to coal mining. Brink's (BCO) is the armored car company. What you may not know unless you've read that company's 10-K is that the corporation that is now Brink's was once involved in coal mining. It has obligations related to its former coal mining operations. There is a retirement plan related to union workers (which Brink's expects to have to pay into 10 years from now), and there is a fund for black lung victims. That fund involves lifetime benefits. So it's definitely a long-term obligation.
The company I researched that is more directly related to coal is Babcock & Wilcox. I told you I own shares in BWX Technologies. That is the nuclear side of the old Babcock & Wilcox. It mostly builds nuclear reactors for U.S. Navy submarines and aircraft carriers. It also maintains nuclear power plants in Canada and provides a bunch of nuclear-related services (often related to America's nuclear weapons program) for the U.S. government. The other side of Babcock was the coal part. Babcock & Wilcox's expertise was in steam. They were historically the best around at doing steam on a very, very big scale. Two kinds of projects tend to involve steam on a big scale: nuclear power plants and coal power plants. Most other ways of generating power don't involve much steam.
A huge risk for Babcock & Wilcox (pre-spinoff) was that coal power plants in the U.S. would close as environmental regulations required them to invest in capex right now (so pony up more cash) while natural gas prices were cheap. Some plants can switch from coal to natural gas. And even when that isn't possible, coal power plants and natural gas power plants may be in competition in a local area. This is different than say nuclear. A nuclear power plant - once construction is complete (this phrase is key) - is going be a lower ongoing cost way of producing electricity than either coal or natural gas. Nuclear power plants don't experience downtime for economic reasons. They have downtime for maintenance. Coal and natural gas is different. At one price for natural gas, you'd operate the plant. At another price, you wouldn't. So natural gas is often your marginal source of electricity supply. It gets turned on and off, built or shut down first.
After the spinoff of Babcock & Wilcox Enterprises (BW) from BWX Technologies (the renamed Babcock & Wilcox that was left over), I sold my shares in BW and kept my shares in BWXT.
Was this because of concerns about U.S. coal power plants?
Actually, no. I sold because I was concerned Babcock was concerned. Not because I, myself, was as concerned.
Let me explain that.
Babcock's coal business in the U.S. was largely maintaining boilers it had built. That's a good, repeatable business. Over time, the amount of maintenance work was going to decline. But you aren't going to go out of business quickly by relying on a shrinking base of maintenance contracts. How do you go out of business quickly?
As an engineering company, it's pursuing business you shouldn't. And I was really worried about Babcock expanding into things like waste-to-energy projects and doing more work in other countries. Babcock had done things other than coal before. And it had done work outside the U.S. But when I looked at the company, the part I felt most sure of was coal in the U.S. After the spinoff, BW seemed to be moving aggressively in the direction that I wasn't sure of. It's not that going into different kinds of energy and more emerging markets is necessarily worse than coal in the U.S. - it's just unproven. And if an engineering company makes mistakes like giving a quote that turns out to be way less than what the project will cost to deliver - things can go very bad. So I haven't talked about this before, but that's really why I was looking for an opportunity to sell that part of the Babcock breakup. I could see that business turning into something less predictable that I didn't want to be a part of.
In the case of NACCO, I think I do - at the right price - want to be a part of NACoal. I just don't know if I want to be a part of Hamilton Beach.
NACoal's value comes mostly from the earnings of unconsolidated mines. These mines are fully owned by NACoal but are not consolidated on the books (their revenue, costs, etc., don't appear on NACCO's statements). The mines are funded with nonrecourse debt. The mines sell their production on a cost-plus basis per ton. If the plants they sell to demand less coal, the mines make less money. Otherwise, there is no commodity risk, macroeconomic risk, etc. The mines make the same profit per ton of coal delivered, and that profit adjusts for inflation over time. The contracts are supposed to expire anywhere from about 13 years from now till about 28 years from now.
Risks include the possibility that the customer will not have much demand for coal. If the customer terminates the agreement or defaults, they would be obligated to pay book value to buy out the unconsolidated mine. Remember, NACoal owns 100% of the mine. So the customer would be paying NACoal a termination fee of sorts. I've tried to do research into this, but I just don't know how substantial this would be in some cases. NACoal's own capital contribution to these mines is tiny. But since it isn't consolidating the equity interest of its balance sheet, it's possible I'm not seeing book value that's actually significant. Also worth mentioning is that I would be buying stock in NC (that's NACCO) which is not the same thing as NACoal which in turn is not the same thing as the various unconsolidated mines.
All of the unconsolidated mines have debt that is nonrecourse to NACoal, and NACoal itself has debt which is nonrecourse to NACCO. After the spinoff, NACCO will mostly be just NACoal and an additional subsidiary called Bellaire, which is really just old mining liabilities. Bellaire detracts value from NACCO. Anyone looking at NACCO stock would have to take this into account. I dug up some legal documents on Bellaire but am not knowledgeable enough on the issues to quantify how much the legacy liabilities housed in Bellaire will ultimately cost NACCO shareholders. So although I've read documents you haven't (if you've only read the 10-K), the end result is the same as if I'd just read NACCO's disclosure on Bellaire in the 10-K.
The other huge risk in NACCO is that one of the mines is consolidated. NACoal actually puts up the capital for this mine. This mine still has the same sort of cost plus contract. But actually owning the mine is different from operating a mine someone else owns. There's also a guarantee the company gave related to another mine. In that case, the company could be on the hook if a customer fails to meet certain obligations to its lenders. So there are three unusual risks: Bellaire (legacy liabilities), the consolidated mine and this one guarantee NACoal made.
The other risk is the more normal business risk that customers will shut down plants and terminate their agreements. In other words, you'll lose customers. It's a risk. But that's business. Hamilton Beach has a risk of losing Walmart. NACoal's biggest customer isn't bigger relative to NACoal as a whole than Walmart is to Hamilton Beach as a whole. So, yes, a customer's plant shutting down is a risk. But it's a risk I'm used to seeing with any sort of business that has big customers. If a customer terminates, they'll be buying out the mine associated with the contract. So it'll be like shrinking the company. It's bad. But it's not the same thing as having a mine you actually own and no demand for your coal. And NACoal can win new contracts. In fact, it has a five-year plan that envisions a large increase in earnings from unconsolidated mines. I don't know if the company will hit this target. But it's entirely possible that NACoal could win as much business as it loses over time. I'm more comfortable with cost-plus contracts that can be terminated if the customer buys you out than I would be investing in a company that owned a higher quality ("black") coal mine and sold it as a commodity that could be shipped.
Finally, NACoal has diversified into operating draglines for lime rock quarries in Florida. I once owned stock in an aggregate company called Florida Rock (it was acquired by Vulcan Materials), and I did a lot of research on U.S. Lime (USLM) and continue to follow that stock and the lime industry in the U.S. It's an industry I like a lot.
What makes NACoal easier for me to analyze than Hamilton Beach?
I've had experience researching companies with long-term contracts, cost-plus contracts and limited competition due to location. Basically, NACoal's mines and the plants they supply should be mutually dependent. So, yes, if these plants fail the mines will fail, too. But as long as the plants stay in business and keep needing coal, they should always get that coal from the associated mine at pretty much a guaranteed real profit per ton of coal delivered. NACoal should be free from price competition.
For these reason, NACoal looks to me like the business I can understand and Hamilton Beach like the business I can't. This is, of course, subjective. One, I could be wrong. And two, other investors - like you - might have way more experience researching retailers, consumer products, small appliances, etc. You may know a lot about Walmart and Amazon. I know next to nothing about those businesses.
I've had more experience researching businesses that take stuff out of the ground and don't move it very far because it's heavy and not worth much per pound. So NACoal is inside my "circle of competence" and Hamilton Brands is outside my circle of competence.
Right now, I don't own shares of NACCO. I might buy shares of NACCO after the Hamilton Beach spinoff. Depending on the price of each of the two separately traded stocks, I might do anything from buying NACCO to buying Hamilton Beach to doing nothing. My decision will come down to price. But, putting price aside, the piece I'd be interested in owning is NACoal not Hamilton Beach.
Ask Geoff a question
Disclosures: Long Frost, BWX Technologies.
This article first appeared on GuruFocus.
- Warning! GuruFocus has detected 2 Warning Sign with NC. Click here to check it out.
- NC 15-Year Financial Data
- The intrinsic value of NC
- Peter Lynch Chart of NC