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Algoma Central Corp: Does Boring and Weird Translate Into a Good Investment?
Niche businesses -- like Algoma -- can often quietly deliver excellent returns
Allow me to confess something. I have a weakness for little niche-y businesses, the kind of stocks that most investors don’t pay attention to.
Like any good addiction, there are good and bad parts to this. The good part is I get to find nice little businesses that I can tuck away for a long time, content in knowing it can quietly do its thing and continue to deliver solid returns.
I own a few of these currently, including Information Services Corp, Rogers Sugar, Gamehost, and OMAB (Mexican airports) on the U.S. side. I buy these when they’re cheap and tuck them away, often for a very long time. I’ve owned Rogers Sugar for almost two decades now, for instance, and it’s done extremely well.
I wrote about Rogers Sugar a few months ago. See below.
Imagine trouncing the market on a capital intensive commodity business. Love it.
The bad part about owning little niche businesses is that you don’t get bonus points for picking obscure investments. In other words, what’s the point if you can own a portfolio of Canada’s banks, telecoms, and railways and beat the market using that? The goal is total return, no matter where it comes from.
When I tell people my portfolio is 50+ stocks, usually the first thing they mention is the time commitment to monitor all those names. These naysayers are absolutely correct. Each stock takes up a little bit of real estate in my head, and I’m finding it a little difficult to keep up. I’m also coming to the realization that I own some stocks that were more C- businesses at A+ prices rather than A+ businesses at B+ prices.
It’s with this in mind that I take a look at new stocks to add to my portfolio, like today’s edition with Algoma Central (TSX:ALC).
Let’s take a closer look.
Algoma Central Corporation is one of the oldest companies on the Toronto Stock Exchange. Its been around since 1899 and has been publicly traded since 1959.
Algoma was originally incorporated as a railway company, built to service the corridor between Sault Ste. Marie and Hurst, a sparsely populated portion of Ontario that needed a train for some reason. I’m going to guess there were resources in that wilderness
At around the same time Algoma got into the great lakes shipping business, a business it dominates today. At various times it also diversified into lumber interests, commercial real estate, and ship repair.
These days, Algoma is a niche shipper, operating in locations without a whole lot of competition. Its main area of operation is the Great Lakes-St. Lawrence River waterway system, where it transports all sorts of commodities back and forth. Cargo breakdown includes 35% iron ore, 13% oil products, 12% stone, 8% coal, and 7% grain, among many others. Products are transported to and from the United States as well.
Typically, shipping is a business you’d be looking at if you want to set your money on fire. It’s capital intensive, commoditized, and prone to huge overinvestment when times are good. It takes years to build new ships, meaning new supply ordered when times are good inevitably hits the market when the sector has weakened. Nobody cares what ships hauls their stuff, as long as it gets there without getting stuck in the Suez Canal. Price wars happen. It’s a terrible business and I wouldn’t wish it upon my worst enemy.
Algoma is different. There’s virtually zero competition in the Great Lakes region. You can’t just move ocean-faring ships there and start up, either. Algoma has spent years buying a fleet that fits the specialized needs of the region. The company also has the advantage of being in the business for decades. It has cultivated relationships with customers that won’t be easily disrupted even if a competitor suddenly arrives on the scene.
Algoma currently has a fleet of 18 dry-bulk carriers, which service the domestic market. It also owns eight ships that transport petroleum products and eight ocean self-unloaders. Finally, it has a 50% interest in a joint venture with Nova, a Luxembourg shipper. The joint venture collectively owns 26 cement carriers and 17 mini-bulkers. Put it all together and Algoma has interests in 78 vessels operating mostly in niche parts of the shipping business around the world.
The company has been adding to its fleet over the last decade, increasing its total from 42 to 78 from 2012 to 2022. This has helped reduce the overall age of its fleet from more than 35-years-old a decade ago to just over 20 years today. This gives Algoma one of the youngest fleets among its competitors, and also translates into lower operating costs. It also means the company isn’t facing any sort of cliff where it desperately needs to add new ships to the fleet. These things have plenty of years left.
The business has experienced some ups and downs over the last decade, but has been consistently profitable. 2016 was a bit of a turning point; ever since both revenue and earnings have consistently headed higher.
The balance sheet is relatively solid as well. Long-term debt is a hair under $400M compared to total assets of $1.3B. Debt is used to acquire ships, meaning its perfectly reasonable to amortize the purchase of those long-term assets for a decade or more.
The Bull Case
The bull thesis for Algoma comes down to two things — valuation and its moat.
Let’s begin with the moat. As mentioned earlier, Algoma has spent years shipping on the Great Lakes. It knows the business and has the relationships. The moat there is very real.
I’m not as convinced about the moat on the other parts of the business. Sure, it owns niche assets, but cement ships and short-haul tankers are hardly irreplaceable.
About half of the company’s earnings come from the domestic divisions. I view those earnings as pretty solid. I’m less bullish on the other half of the business, however.
Another thing adding to the bull case is Algoma’s largest shareholders. 30.6% of shares are held by Amogla Holdings and an additional 27.8% of shares are held by E-L Financial (TSX:ELF). E-L has two members on Algoma’s board of directors. Legendary investors Jarislowsky, Fraser own an additional 9.6%.
Amogla holdings is a bit of a black box that I was unable to crack, but it sure looks like E-L owns a bunch of Amogla as well. Algoma lists E-L as a 27.8% shareholder, but on its website E-L says it owns 37.4% of Algoma. But there is nary a mention of Amogla in E-L’s 2021 annual report. I found a list of Amogla’s holdings and the only thing it holds is Algoma shares.
It’s a mystery!
Edit: I found the 1997 management proxy circular online, which lists two Jackmans as being on the board and zero mention of E-L Financial’s ownership stake. This leans more towards my theory that E-L owns a bunch of Amogla. I also found this disclosure in the latest quarter’s filings:
It looks like Amogla is owned by the Jackman family. Mystery solved.
The overall point is, if you’re a value investor looking at Algoma, it’s good to have E-L, the Jackman family and Jarislowsky, Fraser on your side. They’re basically value investing royalty. And Amogla has owned its ownership stake for a very long time too.
The real reason why my interest was piqued about Algoma is the company’s valuation. It’s damn cheap, no matter what way you look at it.
Want to discuss earnings? Sure. The company earned a hair over $102M over its last twelve months, or $2.48 per share. That gives us a trailing P/E ratio of just 6.6x.
Forward earnings aren’t projected to be quite as robust, with analysts projecting the stock only earns $1.81 per share in 2023. That still puts shares at about 9x forward earnings.
Lumpy earnings shouldn’t concern investors a bit. They come with the territory. Besides, Algoma has shown they can increase that bottom line over time.
Algoma prefers free cash flow as a metric of profitability, and it’s also been strong. In 2021, the company earned $130M in free cash flow. Over the last 12 months it generated $109M in free cash flow. Divide that by 37.8M shares outstanding and free cash flow checks in at $2.88 per share, or a price-to-free cash flow ratio in the 6x range.
Algoma is also cheap on a more traditional metric, price-to-book ratio. Current book value is a hair above $19 per share, with the stock trading at $16.39 as I type this. I’m the first to admit book value is mostly useless, but in this scenario I think there’s some value in looking at it. We are talking about very tangible assets.
The company also has a nice recent history of dividends, including special dividends. It paid out special dividends in 2019, 2021, and again at the end of 2022. These special dividends equaled $5.15 per share.
Dividend growth has also been solid over the last handful of years. In 2016, the stock paid out $0.28 per share in dividends. In 2022, the payout had increased to $0.68 per share. And on Friday last week the company announced another increase to $0.72 per share.
With a payout ratio of approximately 30% of earnings, there’s plenty of room for dividends to go higher — provided that the bottom line continues to grow. As we’ve established, earnings can be lumpy, so I’d suspect management keeps a relatively tight cap on dividend increases, choosing instead to distribute extra cash via special dividends.
The current payout is 4.4%.
And finally, just like Rogers Sugar, this has been a solid business to own over the years. A $10,000 investment made 20 years ago with all dividends reinvested would be worth a hair over $85,000 today, good enough for a CAGR of 11.34%. Not bad at all.
The bottom line
I’m really torn with Algoma. I can see the good and the bad with this one.
The good is the company’s history of solid returns, investment royalty on the board making sure the company continues to invest its capital wisely, a dirt-cheap valuation, a solid dividend (especially with the recent raise), and I like the moat surrounding the Great Lakes shipping business. The balance sheet is pretty good, too.
But there’s some bad here too. Shipping has been a great business in the last couple of years. I fear the company is overearning here. The non-Great Lakes part of the company doesn’t have a great moat, at least in my opinion. Its certainly a capital intensive business. And the valuation doesn’t look so great if earnings fall by a third or half.
I think the good outweighs the bad here, I took a small position in this one for portfolios I manage for family members. I’d be looking to buy a little more if the company runs into some issues, too.
Disclosure: author owns Algoma Central Corp via accounts managed for family members
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