Saxon Energy Services Incorporated (TSX:SES) is an international oil
and gas drilling and services company. The Company originally had a
focus on Latin America, with operations in Ecuador, Venezuela,
Colombia and Peru. However, the recent acquisition of Drillers
Technology created a more balanced operating base. Of Saxon’s 37
drilling rigs and 16 workover rigs, 60% of its fleet is now based in
South America and 40% in North America.
As
deep-value investors, it is usually difficult for us to purchase
energy services stocks due to premium valuations. However, we were
able to add two companies to our portfolios during the current cycle.
The cheapest stock we could find was Drillers Technology, which was
depressed due to an elevated debt load and history of inconsistent
operating performance. However, we did our work and determined that
the debt was manageable and that the operations were beginning to show
an improvement. The second cheapest stock we could find was Saxon
Energy Services, which was cheap due to its international exposure.
However, we believed that the market’s relative discount on the stock
due to geographic or political risk was too great. Imagine our
surprise on October 4, 2005 when Saxon Energy announced a takeover
offer for Drillers Technology.
We
think the deal was a win/win for shareholders of both companies for
several reasons. Although we received a premium on our shares of
Drillers Technology, Saxon did not overpay for the assets; Saxon
issued shares to pay for the acquisition and at the same time solved
Drillers’ debt issues. The merger created a balanced operations base,
which reduced the geographic and political risks. Finally, the
addition of Dale Tremblay, Michael McNulty and Tim Braun from
Precision Drilling provided greater depth to the management team.
This will enable the company to take advantage of international and
domestic growth opportunities.
We
have valued Saxon Energy Services based on a net asset value
approach. Using precedent transactions and estimated replacement
value, we believe that between US$5 million and US$6 million per rig
is an appropriate measure to use. Based on this range, Saxon has a
net asset value between $4.00 and $4.60CDN per share. But the shares
were cheap on another metric; we calculated that the stock traded at
roughly 3 times its 2006 estimated cash flow. On balance, we
concluded that Saxon was cheap both relative to its peers and on an
absolute basis. We believe that Saxon’s strategic expansion plans and
lower political risk should become more fairly reflected in its share
price in 2006.
JOHN B. SANFILIPPO
John B. Sanfilippo & Sons (NASDAQ:JBSS) is one of the leading
processors and marketers of tree nuts and peanuts in the United
States. Based in Elk Grove, Illinois, the company sells all major nut
types consumed in the U.S. including peanuts, pecans, cashews, walnuts
and almonds. Through various acquisitions including the purchase of
the H.H. Evon Nut Company in 1974 and Fisher Nut in 1994, JBSS has
grown to be the second largest nut company in the United States. It is
estimated that JBSS has a market share of 10% in a very fragmented
market.
JBSS remained a private company until 1992, when it issued stock to
the public at $12 a share. Post IPO, JBSS shares failed to gain
traction. It wasn’t until 2002 that investors began to take notice.
Due to the widely successful marketing of high protein/low
carbohydrate diets such as Atkins and South Beach, Americans began
consuming peanuts, cashews and almonds like never before. In 2003,
JBSS earned $1.61 per share, which was twice the amount it earned in
2002. In 2004, earnings subsequently reached $2.32 per share.
Investors were watching as JBSS’s stock rocketed through $50 a share,
reaching an all time high of $54.90 in December 2003. By the end of
2004, however, it had become apparent that interest in Atkins and
South Beach had waned. To make matters worse, tree nut prices, the
company’s largest cost, were soaring. Earnings fell to just $1.35 in
2005 and shares of JBSS eventually fell below $20 a share. For the
first quarter of fiscal 2006, JBSS reported its first loss since 1999.
With that announcement in late October 2005, JBSS’s stock plummeted
22% or over $4 that day, closing at $13.44 per share.
Today, with its shares trading at $12.30, JBSS appears to be a
bargain. The stock is trading at a 33% discount to its book value of
$18.42 and at approximately eight times next year’s estimated earnings
of $1.65 per share. Book value is likely understated given that JBSS
owns quite a bit of real estate, most of which was purchased in the
1980’s and early 1990s. The company is planning to consolidate its
operations by building a new larger central facility. Given the
expected short payback of the project, the cost savings could be
materially accretive to earnings in a couple of years. As far as tree
costs are concerned, management expects prices to fall as newly
planted crops are harvested in the coming years. Finally, given the
company’s low stock price, the costs and time required complying with
Sarbanes Oxley, and the favourable prospects for the company, the
Sanfilippo family could take the company private. If it did, we feel
it would be worth considerably more than what the stock is presently
trading for in the market.
Irwin A. Michael, CFA
