The Idea List: Issue #7

This week I analyze Monarch Cement, Harbor Diversified, and Reckitt Benckiser

In this post I want to share three stock ideas that appear to be undervalued. These companies came from the “top of the funnel” of my research process, meaning they came from stock screeners, or recommendations from Twitter and Substack. What I want to do here is present some qualitative and quantitative metrics that determine if I should keep researching the stock or take a pass on it. Further, I want to do a basic valuation to verify that the company is actually undervalued. The end goal is to have some semi-vetted stock ideas that I can add to a watchlist and start doing more thorough research on.

Monarch Cement

Monarch Cement $MCEM is an operator of quarries and produces cement in the Kansas/Missouri area. In 2019 they shipped about 950,000 tons of cement, while in 2023 they shipped little over 1.3M tons. However it looks like growth in shipments has started to level off. The increase in shipments and price increases has caused revenue and profits to dramatically expand in the last few years. In 2023 Monarch generated $73.7M in income on $381.3M in assets, which is a great return on assets. Monarch Cement seems like a quality microcap company, and may have a moat due to the local nature of the customers since you cannot ship cement very far.

Since Monarch produces a commodity product that may suffer a decline in demand during a recession, I went back to see how their revenue held up during the 2008 recession. During the financial crisis, MCEMs sales declined in 2009 and 2010, ultimately ending up 30% lower than the previous peak. Given that Monarch’s sales have dramatically increased lately, I will try to be conservative and estimate a steady state operating earnings at $50M. Next I will apply a 25% tax rate, and divide the after tax income by an 8% discount rate to get an enterprise value of $469M. Adding back cash (they have no long term debt) gets an estimated equity value of $526M. Another interesting aspect of Monarch is that they own $57M in marketable securities. Adding the marketable securities to our equity value brings it up to $583M. MCEMs current market cap is $514M suggesting that the stock is modestly undervalued even though the stock has ran up in price recently. This is another quality microcap that I will add to my watchlist and hope I can buy at a larger margin of safety

Harbor Diversified

Harbor Diversified $HRBR is a regional airline that flies under the Air Wisconsin name and provides service to American Airlines. HRBR is currently priced at $1.65 an has a $71M market capitalization. The company used to provide services to United Airlines, but that contract was terminated and led to a dispute that was recently settled in court. The cancelation of the contract caused uncertainty, although there was some hope that Harbor Diversified would win a settlement in court. However, the courts declared that both parties do not owe each other anything, so that upside bonus did not pay out.

A consequence of this settlement is that Harbor Diversified needs to restate their financials, causing even more uncertainty in the stock. The main impact from the restatement is a decrease in accounts receivables, however the exact amount is unknown at this time. Based on this, I can calculate the NCAV of HRBR from their financials that were released in November 2023, but restatement may dramatically change these figures. With that being said, Harbor Diversified has $223.9M in current assets, with over half of that being cash and short term investments. Total liabilities is $114M, and I add back capital lease obligations which amount to $3.6M. This puts HRBRs NCAV at $113.5M, or $2.33 a share. Based on these figures Harbor Diversified is considerable undervalued, but I think it would be a good idea to wait to see how the restatement affects the NCAV

Reckitt Benckiser Group

In a change of pace from these small companies I keep looking at, Reckitt Benckiser $RBGLY is a $37B consumer staples company. The company is British based, but owns many familiar brands such as Lysol, Mucinex, and Enfamil baby formula. The company has recently decline around 30% due to lowering of guidance, seemingly minor accounting issues, and a lawsuit penalty due to contaminated baby formula. Currently the stock is trading around $10.50 a share. Revenue has been slowly growing, and gross margins are pretty consistent hovering around 23%. Reckitt’s return on assets are around its cost of capital, so it does not appear the company has a strong moat.

For this stock I will calculate its value based on the earnings power method that does not factor in growth. First I will estimate revenue at $18.3B, then use a 23% operating margin, which produces $4.2B in operating income. Next, I apply 25% tax rate, which gets an after tax income of $3.2B. I capitalize the after tax earnings using a cost of debt of 5.5%, cost of equity of 8%, producing a cost of capital of 6.75%. This gets us an enterprise value of $46.8B. Finally I add back cash and subtract debt to get estimated equity value of $37.6B, or $10.55 per share. Based on these calculations, Reckitt Benckiser seems to be fairly valued, which is a shame because I was hoping to get a consumer staples company at a discount.