MFC Industrial , formerly Terra Nova Royalty, has an interesting history and now specializes in global commodity supply chains – it delivers commodities and materials all over the world. It provides logistics, financial and risk management for the buyer and sellers of commodities. The stock has an abnormally low P/E for a company not in an awful industry or on the brink of failure. Adding to the confusion is the stock chart and the dramatic decline in the shares a few years ago. These two issues warrant further investigation.
MFC Industrial – A new platform for an old firm
MFC has a twenty-five year history, but has changed significantly in recent years. That said, management maintains its focus on unlocking value from undervalued or troubled assets. Shareholders have a compounded return of 20.4% over the past ten years. It has turned around and restructured firms it acquired. It spun off assets over the years, most recently in 2010 with KHD.
MFC was involved in many transformative transactions over the years. In 2010, the company in its current form emerged. The business changed its name that year to Terra Nova Royalty and decided to reorganize and focus on its resources businesses. Industrial services were separated from Terra Nova Royalty and KHD Humbolt International AG was formed. KHD shares were then distributed to shareholders and it trades in Frankfurt hence the dramatic drop in the share price in late 2010. In 2011, the firm's focus was now as a global supply chain platform and it renamed itself MFC Industrial Ltd.
MFC Industrial principally manages its Commodities and Resources segment for their own account. It is different than competitors since it is larger and can leverage its financial position to improve operations. In addition, MFC does commit capital and take positions in commodities. MFC invests in production assets and also purchases them from third parties. It owns a position in the Wabush iron mine, an iron ore mine in India, a metal refinery in Europe, as well as other operations. MFC often profits from trades where one of the parties has currency or credit risk that makes finding counterparties more difficult.
Acquisition of Continental Resources
MFC has a TTM price to earnings ratio of 2.42x, very low for any company not facing serious trouble. Even though it is a unique company in the resources and refining industry, shouldn’t it have somewhat of a similar valuation? Nucor also extracts iron ore and has refining operations and its PE is 16. Nucor’s PE is over 6 times the PE of MFC. Another iron and refining giant, ArcelorMittal , has a forward PE of 21. Both ArcelorMittal and Nucor are much larger than MFC with market values of $27 and $15 billion compared to $500 million for MFC, so they may warrant a slightly higher valuation but not 6 times higher.
However, this big difference in valuations from a PE standpoint is related to a one-time gain associated with the acquisition of Compton Petroleum. On September 12, 2012, MFC closed on the acquisition of Compton Petroleum for $33 million. Compton primarily operates in the Western Canadian Sedimentary Basin. Usually when a firm acquires a company, it has to account for the difference in price paid and book value by marking that down as goodwill. In this case however, Compton Petroleum’s book value significantly exceeded market value and MIL recorded that as negative goodwill. In 3Q12, MFC recognized $230 million on their income statement as a result of the negative goodwill, a one-time event. GAAP earnings were $4.14 per share in 3Q12, but after adjusting for the goodwill benefit, EPS was $0.46 per share.
The acquisition is still an interesting one beyond the accounting. It’s expanding MFC’s commodities business to include energy. Compton’s land is under developed, the debt structure is less than optimal, production volumes can increase, and there is room to reduce costs. On a first look, Compton appears to have suffered from a lack of development, attention and properly deployed capital.
MFC Industrial also acquired 60% of the shares of Possehl Mexico SA de C.V and 70% of ACC Resources both fully integrated commodity supply chain firms. MFC is consolidating the industry and rolling up smaller players onto their platform to create value for shareholders.
MFC Industrial is an interesting stock and similar to an investment in a private equity or hedge fund. The bulls believe in management’s expertise, that it can continue to extract value from acquisitions, successful engage in commodities contracts and trades for their own account. The track record over the years of a 10 year average annual return of 20% to shareholders supports management’s case to own the shares.
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