Spruce Point Shorts US Concrete
Vocal NYC-based short seller Spruce Point Capital has had a busy week; it reiterated its short call on Kratos on Tuesday and yesterday (Thursday) published a bearish report on U.S. Concrete, Inc.
The firm said in a release:
“Spruce Point Capital Management is pleased to announce it has released the contents of a unique research report on U.S. Concrete, Inc. (Nasdaq: USCR) ("USCR" or "the Company").
Spruce Point has conducted a critical forensic and fundamental analysis of the Company, a roll-up of commodity ready mix concrete businesses, that is showing severe signs of cracking. Our report will detail why we believe USCR exhibits many identical characteristics to Caesarstone and China Integrated Energy, two of our most successful short calls where we identified abnormally stable gross margins, and unusual capital expenditures, which are inconsistent with commodity product businesses.
As a result of our investigative analysis, we have issued a "Strong Sell" opinion, and a long-term price target of approximately $7.00 to $23.00 per share, or approximately 60% - 90% long-term downside risk.
Our detailed research report is available on our website. We also encourage all of our readers to follow us on Twitter @sprucepointcap for regular updates. Please review our disclaimer at the bottom of this email.
Some of the key highlights include:
Previous Failure: USCR filed for bankruptcy after the financial crisis. The industry is difficult given the commodity nature of the products, intense competition, and need to be in close proximity to the customer due to material shipping costs
Deja Vu Leverage Rising Again: USCR’s Net Debt / EBITDA was 3.5x prior to the financial crisis sending it to bankruptcy, and is now 3.8x as of 3/31/18. USCR’s current liquidity (cash and borrow capacity) as a percentage of LTM revenues stands at a multi-year low and worse than pre-crisis levels
Becoming More Dependent on Shady Acquisitions: USCR has acquired over 20 companies since 2012. It recently outbid industrial giant Vulcan Materials for Canadian small cap Polaris Materials and purchased firms with alleged historical ties to organized crime
GAAP vs. Non-GAAP Strains and Cash Flow Issues Becoming Evident: In 2017 there were a record number of adjustments to results, and yet Adjusted EPS grew by just 4%. Despite promoting sales and Adj. EBITDA growth of ~20% in the past three years, operating cash flow has been declining for more than 3 years in a row. Recent guidance of 60% cash flow conversion from Adj. EBITDA has been terribly missed
Stable Gross Margins In A Commodity Business: Despite cash flow issues, USCR has reported stable gross margins at 21% for three years, which is a remarkable feat given it operates in a commodity business, and we find peers reporting between 9% - 12% margins over the same period
USCR Claims Mid To High Single Digit Organic Growth: Evidence suggests organic growth is overstated, and mostly a function of pass through commodity price increases. We note realized prices by USCR hit a 5yr low in 2017, and have continued lower in Q1’18. We find average organic volume growth from 2015-2017 to be approximately zero
Vehicle and Truck Property Accounts Suggest Overcapitalization: Since 2012, USCR financials show ~500% growth in the vehicle property account, yet physical trucks are up only ~100%. USCR claims truck prices are stable, and we believe many have been acquired used through acquisitions, so overcapitalization of costs is a likely explanation. We estimate $60 to $85m of excess costs are capitalized in the vehicle accounts
Aggressive Use of Capital Leases Growing Every Year: Capital leases flatter EBITDA and cash flow, providing incentives for management to favor capital vs. operating leases. Capital leases now account for greater than 50% of total capital spending. While aggressively increasing capital lease usage, USCR has stopped disclosing leasing details in recent 10-K annual reports. There are numerous examples of truck and vehicle accounting scandals tied to lease accounting ex: misclassifying operating vs. capital leases (Celadon), capitalizing normal maintenance costs (Roadrunner Transportation), and inflation of vehicle values (Heartland Express)
CEO Concerns and Rapid CFO and Auditor Turnover: A routine background check of the CEO reveals an undisclosed DWI arrest for reckless driving, calling into question his judgement. USCR is on its fourth CFO since 2012. Recent CFO John Tusa, Jr. resigned after serving a little more than one year. USCR is on its third auditor since 2012, and its current lead audit engagement partner just had an administrative consent order filed in Oklahoma for not being current in his professional education requirements
USCR Trading Near All-Time Cyclical High Valuation: USCR is valued at approximately 1.2x, 8.0x, and 15x 2018E Sales, Adj EBITDA and Adj. EPS. On the surface, shares “appear” cheap, but the Company offers no firm guidance, and analysts have been quietly and slowly cutting forward estimates. We have little faith in management’s reporting given our documented concerns. Spruce Point also never recommends buying into a commodity company near the peak of a leverage cycle: this is a recipe for disaster!
Two Ways To Value USCR Point To 60% - 90% Downside Risk: Given our analysis that shows distortions in USCR’s Non-GAAP figures, we believe the best way to value the Company is on Free Cash Flow. We expect further deterioration which began three years ago, and apply a 20x – 25x multiple to reflect a discount to the peer average, above average exposure to ready-mix, poor roll-up economics, and growing liquidity risk. Secondly, we adjust USCR’s book value for an estimated $60 - $85 million of overcapitalized costs to its vehicle property accounts and apply a 1.0x – 1.5x multiple range. These valuation perspectives indicate 60% to 90% downside or approximately $6.00 to $25.00 per share.”