After the series on the Global Private Equity Report that I penned this week, I had a chance to talk to an associate who has experience in the field. We discussed what we might be doing if we were running a private equity fund now.
When you look across various sectors, the only one that is truly cheap on a survive-to-thrive-asset-value basis is the energy industry. While there are some energy bargains that I think will do well over the next five to seven years, I don't necessarily feel like I would want an energy-only fund.
We came up with a set of parameters that we think will produce private equity- like returns in the high-teens to low-20s over the next five to seven years. While the companies that our screen uncovers may not been purchased by a private equity fund or LBO shop, it is not out of the question, either. The parameters we used should be attractive to them.
I believe, however, these stocks will do well on their own merits and will provide fantastic returns for long-term patient investors willing to hold for the private equity time frame.
The stocks have to be cheap, based on the metric the private equity funds used. So I limited my universe to those trading in the bottom 10% of stock, as ranked by the enterprise value-to-earnings ratio before interest, taxes, depreciation and amortization ratio. They have to reasonably financed so the companies that make the list have to own as much as they owe and have a Z-score above 3.
We wanted some growth, so I limited the list to those companies that have at least 5% annual growth in EBITDA and book value. While they are not classic "Tim value stocks", there are some interesting names on this list that could be rewarding long-term investments.
I am a big fan of AGCO (AGCO) although it has never been cheap enough to make it into my book-value-based portfolio. The company makes farm equipment such as tractors, combines, hay balers, fertilizer spreaders and mowers. They also make implements used in farming, such as disc harrows, spreaders, tillers, cultivators and seed drills. If you use it around the farm, chances are AGCO makes it. While weak grain prices and a slow economy have pressured short-term results, there is a big world out there to feed and it's getting bigger all the time. The stock is trading with an EV/EBITDA ratio of just 4.5. The balance sheet is reasonable with a debt-to-equity ratio of just .3 and a z-score of 3.11. Book value and EBITDA have both grown in the double digits over the past five years.
The Andersons (ANDE) is probably best described as a conglomerate with deep roots in the agriculture industry. They operate in the grain, ethanol, and plant nutrient sectors, as well as in railcar leasing, turf products and consumer retailing.
They own grain terminals in eight states, including Ohio, Michigan, Indiana, Illinois, Nebraska, Iowa, Tennessee and Texas with grain storage capacity of more than 140 million bushels of wheat, corn and soybeans. The rail division has Rail Group has a fleet of more than 22,000 various railcars and locomotives that they lease, manage and sell.
The ethanol division has been driving growth and operates four ethanol plants in Indiana, Michigan, Ohio and Iowa that are capable collectively of producing 330 million gallons of ethanol. The stock is reasonably-priced, trading at a ZEV/ EBITDA ratio of 5.4. The balance sheet is solid with a debt-to-equity ratio of just .15 and a z-score of 3.1. Both book value and EBITDA have grown at around 14% during the past five years, so the company is growing.
K12 (LRN) is one of most intriguing companies on the list. The company makes courses and curriculum for home-schooled kids and also operates online charter schools. They also provide teacher training and support systems for schools around the country. The company has been controversial at times but the EV/ EBITDA ratio is just 4.6, and the company is growing EBITDA and book value at a decent rate. The debt-to-equity ratio is just .1and the z-score is 3.91, so the balance sheet if in fantastic shape. We should see massive changes to our education system in the years ahead, and this company could be positioned to benefit.
I believe these stocks can give you returns that look a lot like private equity funds if you are willing to adapt the PE mindset and hold them for five years or more. I would try, however, to increase my odds by buying during a broad market pullback.
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