Welcome to my Newsletter: The Value Road
Learning How to Become a Value Investor
Hello and welcome to my first contribution to my newsletter The Value Road. My name is Leland Roach and my approach to writing a newsletter may differ quite a bit from other newsletters. Sure I will be including stocks that I think are positioned to do well but my overall goal of authoring this is to teach others how to become value investors themselves. I don’t want the readers of our letter to just have random stocks thrown at them with a buy or a sell rating attached and possibly a couple ratios to rationalize our decision. I want to be able to spell out for our readers exactly what makes not just the stock under the microscope that day a buy but in fact any stock with qualities similar to that stock a possible buy, hold, or a sell. Most important of all I want our readers to come away from these articles with a clear sense of how one might mitigate risks when making a stock purchase. The first rule in the stock market is don’t lose money, which brings me to my introduction on what value investing means to me.
When it comes to investing people often ask “How much can I make from this trade?”. That’s a fair question to ask. After all we’re here to make money and increase our overall wealth. When however, you ask “How much can I make from this trade?” before asking yourself “How much can I lose from this trade?” you’re setting yourself up for some disappointments. That’s where our first rule of value investing comes in…. Don’t lose money.
To figure out how to solve our don’t lose money dilemma we need to reverse engineer the problem. What are the major ways one can lose money investing in the stock market? One of the fast and easy ways to lose all of your money investing is to invest in a company that’s going to go bankrupt. When a company files for bankruptcy their common stock almost always goes to zero. A company only files for bankruptcy when it can no longer pay its debts and therefore becomes insolvent. How do we make sure the companies we invest in don’t become insolvent? We invest in companies with either no or insignificant amounts of debt on their balance sheet. We also invest in companies that have asset surpluses that can be sold off should the company we’re looking at run into any unforeseen business problems.
There are many other positives to a business having an ample amount of sellable assets at its disposal. When a lucrative opportunity presents itself a company can fund this new business venture with the cash from asset sales. This would in turn help to boost a company’s profitability because that company could bypass interest payments they would otherwise have to pay had the company funded this venture with debt.
It's no big secret that economies take a turn for the worse sometimes and enter into recessions. Sometimes these recessions are particularly bad and almost every business and business sector in the market is experiencing a share price collapse. You’ve heard over and over and over again “Don’t sell! The market will bounce back.” but as you continue to watch your portfolio drop in value you get nervous. What do you do? When you invest in companies with no or insignificant amounts of debt those businesses can better withstand market downturns.
If you can imagine three theoretically identical companies entering a recession. Company One has $100 million in debt, company Two has $1 million in debt, and company Three has $1 million in debt plus another $50 million in assets. When business begins to slow Company One can only last for so long. You wouldn’t believe how fast corporate debt can skyrocket when a business enters into a stage of unprofitability. Company Two on the other hand, being almost debt free before a recession can take on a lot of debt to carry itself through. Company Three, instead of taking on debt in order to hold itself over until better days, sells off some its assets and uses the proceeds from these sales to tie itself over until the end of the recession.
After the recession is over, if Company One was able to stay in business it now has to use a rather disproportionate amount of its profits to service its debt and interest payments. In doing so Company One’s profitability will be severely reduced. Company Two on the other hand, having entered the recession with almost no debt, can take on quite a bit of debt and still be in relatively good shape once better business environments come to pass. Company Two’s debt and interest payments will hamper their profitability but company Two will exit this recession being much more flexible and competitive than business One because their debt load will be much more manageable.
Company Three on the other hand will likely exit this theoretical recession with the most competitive advantages. Since company Three exited this recession with no debt and interest payment beyond their initial $1 million of debt they are free to take purely profits. This gives company Three a huge competitive advantage over the other two companies. As company Three’s business results recover their increased levels profitability over their competition will become apparent. This generally leads to Company Three experiencing a faster recovery in share price post downturn as well as an outpace in overall growth as compared to companies one and two.
An example of a company with a large asset pile and minimal levels of debt
For my very first stock pick and our very first dive into a company we are going to be looking at Alico, Inc (NASDAQ:ALCO). ALCO is a company that’s a prime example of why having a surplus of assets at your disposal can help you weather out a financial storm. In fact ALCO is a possible example of how a company with enough assets can transition it’s entire business over from one operation to another.
ALCO is one of the nation’s largest citrus producers. During the company’s fiscal 2023 81.3% of ALCO’s consolidated revenues came from Tropicana. While the company has been producing citrus since 1960, the last 20 years have proved to be continuously more and more challenging for the company as something called citrus greening descended upon the United States. Spread by the Asian citrus psyllid, citrus greening is a bacterial infection that greatly reduces citrus yields by leaving the fruit on the trees misshapen and sour. Citrus greening also causes much of the fruit to drop from the trees before it can even be harvested. Since citrus greening was first found in Florida in 2005 fruit production has dropped 75% and production costs have increased significantly. While it does look like there is finally a citrus greening therapy treatment that uses Oxytetracycline which looks to finally show some ability to mitigate this disease, citrus greening is still be far the biggest long-term threat to our citrus industry.
On top of the challenges posed by citrus greening, ALCO had two catastrophic weather events befall it in 2022. In January of 2022, arctic winds created a cold blast that lowered Florida’s temperature to below freezing levels. This not only caused ALCO’s citrus crop to experience premature fruit drop but this freezing also damaged ALCO’s trees. Later that year in September of 2022, Hurricane Ian struck Florida’s coast. Ian was one of the most expensive hurricanes to have ever hit Florida. This led to more fruit drop and damaged ALCO’s trees even further. This hurricane resulted in ALCO’s boxed fruit production decreasing by 51.5% the following harvest season (2022-2023). The damage ALCO’s groves experienced during Ian could take two to three seasons before fully recovering.
This led to a 56.7% decrease in revenues for the company from $91.95 million to $39.85 million and an 86% loss in net income from $11.89 million to just $1.66 million for ALCO’s 2022-2023 harvest season. With three quarters into ALCO’s 2024 behind it we can see that the company’s operating revenues have risen up 16.7% year over year from $39.17 million to $45.71 million. Despite the company appearing to be in the beginnings of a recovery from Hurricane Ian, inventory write downs from the grove damage obtained during Ian dramatically increased the company’s operating expenses forcing them to show heavy operating losses despite their increases in both boxes harvested and pounds solids produced.
ALCO has seen its share price drop and stay depressed since the beginning of 2022 when that January frost incident marked the start of a very rough year. Despite the increased overall citrus production and ALCO announcing a new three-year agreement to sell oranges to Tropicana at prices that are approximately 33% to 50% higher, the company’s share price is still far under the $30.00 to $41.00 a share range it traded at pre-frost and pre Hurricane Ian. It currently sits at $25.07 a share as I write this article.
ALCO is the perfect example of why having so many valuable assets can prove to be so beneficial. Despite this set of extremely tough circumstances ALCO has posted a positive net income every year since 2017. This is because ALCO had a surplus of land it was able to sell off while still conducting operations. ALCO was able to muster up $41.1 million in their fiscal 2022 and $11.51 million in their fiscal 2023 from the company’s gain on sales, almost exclusively from selling off this land.
While the price of Alico’s stock has gone down since Hurricane Ian, how much the stock price has fallen has been greatly reduced because the company had a safety net to fall on when the company’s normal business operations looked grim. They not only managed to summon up a positive net income every year during this time period but ALCO has had so much extra land that it has been able to sell that it actually reduced its long term debt by 23.4% between ALCO’s 2022 10-K and their most recent fiscal quarter. Reducing their debt from $107.8 million to $82.6 million.
When ALCO is finally able to put all of the aftermath of Hurricane Ian behind it I would expect the company’s share price to shoot back up into the $30.00 to $36.00 a share range where it mostly sat before the effects of both the freeze of 2022 and Ian had sunk the company’s share price.
This possible $30.00 to $36.00 a share price bounce back is not however the main reason I am placing a BUY rating on ALCO. If you take ALCO’s total asset value shown on their 3rd quarter 10-Q for 2024 ($414.6 million) and then subtract the company’s goodwill figure from that ( $2.25 million) you get an asset value of $412.35 million. We are subtracting this goodwill figure because goodwill is essentially a plug variable to account for the price above tangible value that a company paid for an asset. Basically, goodwill is a value that is unlikely to translate to actual cash in the event that a company was to sell off all of its assets. We then take our $412.35 million dollar asset value and subtract all of the company’s liabilities from this figure ($140.3 million) to get a net asset value of $272.05 million. To get an asset value per share figure we then simply divide this net asset value by the company’s 7.62 million shares outstanding. When we do this we end up with a net asset value of $35.70 per share. That’s a 42.4% upside from the company’s current share price of $25.07.
When assessing a company’s asset value it is always important to keep in mind what assets a company could actually sell if it needed to. ALCO’s balance sheet is pretty straightforward and therefore a good example for introducing readers to the basic concepts of value investing. Many companies have assets they would have a hard time selling off or at least selling off at full value should a company need to do so in order to shore up cash.
When an oil drilling company begins to become unprofitable because of a drop in the price of oil it may try and sell off some of its oil rigs in order to come up with the needed capital to sustain its business. The only problem is the company would probably have to sell off its oil rigs at a lower cost than their balance sheet may imply they are worth. This is because a drop in the demand of oil will also bring about a drop in the demand for the oil related assets needed to drill. On top of this, if an oil rig sits for too long unused it becomes increasingly more and more expense to start it back up, further decreasing the value of the asset. While companies are supposed to adjust the value of their assets when they become impaired there is a lot of room for subjective judgement in a valuation like this. When an industry is on the decline these valuations can move faster than the impairment charges for them can properly reflect.
When it comes to ALCO you might ask yourself… If the citrus industry is having all of these problems with citrus greening, and Florida’s citrus industry is still hurting from Hurricane Ian, Could ALCO actually sell its orange groves? In ALCO’s specific case the answer to that question is almost certainly yes. If a company owned land in the middle of nowhere, far away from an economic center, they may have a lot of difficulty selling off their property. ALCO on the other hand owns land in Florida, one of the fastest growing states in the country that also just so happens to own a great deal of land right next to the fastest growing metropolitan area in the country Fort Myers. ALCO is actually currently in the process of getting some of this land entitled to be sold off for housing. The company is also actively assessing the rest of its property to assess what the best use of that land would be.
ALCO is the perfect example of a company that has had its share price beaten down over the past couple of years but still has the potential for a promising future. This is due in a very large part to the company’s owned assets giving the business the flexibility to pivot its operations right when it needed to do so. It is so important to read through a business’s 10-Ks, 10-Qs, press releases, and earnings releases so you can get a sense of a company’s willingness to sell off parts or all of its business if the land they own is worth more than the business they run. If ALCO’s management was not actively getting land entitlements and talking with land use professionals it would make ALCO’s ability to realize the full value of its property very improbable and an investor could get stuck sitting on a stock for years without it ever moving much.
Investors often call this a value trap. The easiest way to not get caught in a value trap is to actively read all of the financial statements and press releases a company puts out. If the company is actively hiring people to assess their assets or has just gotten some of its properties entitled to build on the stock may warrant further research. This is why patience is probably the most important virtue a value investor can have. Throughout your time as an investor you may stumble across an array of companies that have large asset values. These net asset values in and of themselves are not enough to warrant a buy rating however, having a large net asset value should be considered the one of the first prerequisites for buying a stock in most cases.
Going Forward
In future newsletters I will be going more in depth on how to spot companies with large net asset valuations. I’ll be going over where to look for these stocks. I’ll also be going over how GAAP accounting can lead to hidden asset values on a company’s balance sheet. I hope these newsletters will not only give our readers some good stock picks but also a good sense of understanding how to find and pick stocks yourselves. Despite an army of internet and TV market analysts trying to sound like geniuses to justify their place in the job market, making good investments does not have to be rocket science. Making good investments will however take a bit of your time to learn. Fortunately, once these lessons are learned you can use them for a lifetime. My investment philosophy comes from the 1930’s and is still working for me today.
Unfortunately when TD Ameritrade sold off their brokerage accounts to Charles Schwaab I lost my unrealized gains history but since that switch I have beaten the S&P 500 gains for 2023 and 2024.
While I can never guarantee anyone’s success due to a large portion of investing being strictly patience and temperament, I will always advocate for asset value based value investing. It has absolutely changed my life and the way I look at the possibilities of my financial future and I really hope those reading this will continue their journey into learning how to value invest.
That is all that I have for you today but I plan to add to additions of this newsletter frequently. Each piece adding towards the goal of educating the reader on value investing and the many advantages it has to offer the every day person. So long for now, I hope to teach you something new next time we meet.
Disclosure: I am long Alico (ALCO) and will buy or sell my shares anytime following this article. This is not financial advice. I am not a financial advisor. Do your own research.