Macro Enterprises — MCR

Share Price: $1.45 Mkt Cap: 43.7m 1 year avg daily volume: 32,000 shares

MCR is a Canadian microcap focused on pipeline and facilities construction/maintenance in the west- it’s essentially a collection of laborers and construction equipment. Projects are won through competitive tenders where the tenderers look at the reputation, safety record, and capitalization of bidders. Some of MCR’s past clients include: Spectra, Transcanada, Pembina, Encana, etc…

The company was founded in 1994 by current CEO Frank Miles, 53, and taken public in 2006 through the reverse takeover of public buyout fund Fulcrum Capital. Miles currently owns ~32% of shares while the rest of management owns an additional ~3%.

Strong Balance Sheet

The collapse in oil prices has been devastating to the sector, with share prices in the peer group down 85%+ from the peak; while MCR hasn’t been spared from the downtrend, it has done an excellent job at preparing the balance sheet for the cycle. Management was quick to pay back debt, reducing leverage to just equipment financing. The working capital ratio is currently 6x and half of current assets is cash. In addition to the working capital, the company was approved on a $115m line of credit in Q1, from TD, which remains undrawn.

The P&L is a different story

New projects and maintenance work fell dramatically in the first half of this year as companies scaled back capital programs and delayed discretionary maintenance work in response to free falling oil prices. Maintenance can’t be delayed indefinitely and MCR’s management has guided to a significant pick up in the back half of the year, saying third quarter results should be higher than the full first half of 2016. Most of this work will come from the company’s three management service agreements. Management also thinks it can return to cash positive earnings in the coming quarters.

Valuation

MCR appears to be trading well below its NAV, of which a majority is cash and equipment. The estimates for equipment values were obtained from the Ritchie Bro’s website, where historical auction results can be accessed. After speaking with management at MCR, I learned that most of the earth moving equipment is less than five years old, the light trucks and similar equipment are two to seven years old, and the pipelayers can be thirty to forty years old. I estimated the equipment value using the equipment list from its website (with a few adjustments as it’s dated) and auction data from Edmonton, AB auctions over the last twelve months. I believe that that the equipment book value is below market value, even in the current commodity environment. My estimate is that they could be worth $3 — $5m above book currently, although I tried to be conservative. Management has also suggested this, while a third party appraiser valued the assets at $30m above book in 2014. The majority of the value comes from several models of equipment:

Equipment

After cash, land and buildings make up the next biggest component. The last time land and buildings were sold was 2015 and it produced a significant gain. I’ve used book value as my estimate to be conservative.

Notes

Potential Catalysts

Meaningful development of the LNG industry in Canada would be a major catalyst for this company. Although Canada has been pretty slow with regulation, the government did announce its decision on Petronas’s Pacific North West LNG in September, giving it the go ahead. Low global LNG prices are likely impacting the project economics, which could lead to a final investment decision coming sometime later, maybe after the 2017 B.C. general election, however, even preliminary progress or a favourable tone will be viewed positively by investors. Management is already in discussions with several of the proposed projects and has stated that companies continue to request bids. The $115m term loan that was approved in Q1–2016 will give the company a lot of dry powder to ramp up operations if opportunities arise.

More medium term, and less event driven is the migration of production north in the Montney and Duvernay, regions where MCR already operates and would be well positioned to compete on projects. Depressed gas pricing is pushing producers into more liquids rich areas; the oil sands is structurally short condensate while numerous companies are looking at building PDH plants and other facilities to take advantage of stranded hydrocarbons.

So how does this go wrong?

If this commodity environment is prolonged, LNG gets delayed indefinitely, or production in Canada doesn’t migrate north, MCR’s balance sheet could slowly erode through operating losses and fixed costs. With management owning such a large stake in the company, it could lead them to try and hang in longer. I think the worst might be behind us though, Q2 was terrible — mixture of spring thaw and low commodity prices, but management stated that Q3 results should be higher than the whole first half of 2016.

My estimates on equipment values could be too high and/or equipment values could fall. I’ve done my best to use accurate and current estimates for the different pieces of equipment and feel I’ve been conservative, but MCR hasn’t disclosed the actual conditions, specific ages or running hours of the fleet. Furthermore, even if the current estimates are appropriate, we could still see resale values deteriorate. The composition of equipment should also be considered. Pipelayers are very specific machines with fewer markets than dozers and excavators, they also represent ~50% of my estimated equipment value. I would think that they have a higher risk of losing value.

Management could also take the company private with a lowball bid. The best opportunity to do that may have been at the start of 2015 when shares traded at $1.20. Management press released a statement saying that the company’s market cap was well below working capital, after which the stock quickly traded up to $3.00. That’s my only data point that suggests against management lowballing.

I may be totally underestimating just how dependent MCR is on rising commodity prices. My thinking is that even if oil/gas prices stay here, the value of the balance sheet should be reflected in the share price, plus some value for future potential. At the current discount, of .65x to liquidation value, investors are clearly speculating that the capital base continues to erode- which I don’t think is the case.

Other Considerations

The company has had numerous insider transactions over the years, with multiple taking place each year. Most of it has to do with equipment rentals/purchase and legal fees. As the company acquired more equipment (sometimes from insiders), the rental agreements largely went away. The company continues to get legal advice from Bull, Housser & Tupper LLP, where board member William McFetridge is partner. I don’t think these transactions are too concerning, I think it’s a small company using the connections of its board and management.

There is no formalized management incentive plan. The discussion on incentives: “These arrangements are relatively simple in structure and do not include any compensation or incentive awards tied to performance goals or short-term incentives.” 2015 Management Information Circular. Again, I’m not too concerned with this, management is well aligned with the company through its ownership.

Final Thoughts

I think this is an interesting situation. The company is trading below its liquidation value with almost no debt and most of the assets are in cash and fairly liquid equipment. Management has been running the company for over twenty years, through several cycles, and is the major shareholder. There’s also some probability of large scale LNG, migrating gas production, and even a rebound in commodity prices. Interested to hear others opinions.