Gencor Industries, A Profitable Company Selling Below Net Current Asset Value

Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.

Gencor Industries (GENC) is a manufacturer of heavy machinery used in the production of highway construction materials, synthetic fuels, and environmental control equipment. The company's share price is significantly undervalued based on its value of assets and earnings potential. Taking a look at the company's latest balance sheet, we find (source: June 30, 2013 10Q SEC filing).

• Total Current Assets: 108,472,000


• Total Liabilities: 8,778,000


• Debt: Zero


• Shares Outstanding: 9.5 million (combined class A and B shares)

Using Ben Graham's Net Current Asset Value (Total Current assets minus Total Liabilities), we see that Gencor's NCAV is $99.7 million or $10.48 per share. Currently the shares trade at about $9/share on NASDAQ. Cash and marketable securities represent more than $90 million of current assets. Inventories are about $12 million. Even if you assume the inventories are worthless, the shares are still selling at a discount. That means that an investor who buys the shares on the open market gets the business and the company's other assets for free. Let's take a look at the value of those other assets and the company's earnings potential.

Other Assets

According to the company's latest balance sheet, the value of its property and equipment is $8.3 million after accumulated depreciation. This was not included in the current assets above, so shareholders will get this for free. The company's properties are as follows (source: 2012 10K).

Marquette, Iowa (Offices and Manufacturing): 72 acres and 137,000 square footage

Orlando, FL (Corporate Offices and Manufacturing): 27 acres and 215,000 square footage

I have no idea how much those assets are worth, but if someone offered me a share of them for free, I would not hesitate in accepting them.

What about a catalyst

Value investors look for a catalyst when they buy stock in a net-net company. I do not see any kind of catalyst that could boost the stock price in the short term. This could be a draw back for short term investors. However, I do not see a need for a catalyst for this investment to be successful. In the stock market price can be divorced from value for prolonged periods of time. Ben Graham's statement about the market being a voting machine in the short term and weighing machine in the long term may be of little comfort to investors who may need to liquidate their investment fast for personal reasons. For patient long term investors, Gencor does not need a catalyst since it is a growing and profitable business. Time is on the side of its shareholders as we will see below. Gencor's book value has been rising steadily. The company is more than a cigar butt because of its profitability. Hence, in the long term it does not require a catalyst for the investment to succeed.

Earnings Potential

Many companies sell cheaply compared to the value of their assets, but most are unprofitable currently. Many are pharmaceutical companies with minimal revenues. Gencor, on the other hand, has been a profitable business and very well managed as the table below shows.

	2005	2006	2007	2008	2009	2010	2011	2012
Earnings per Share	3.29	1.17	2.02	1.59	-0.27	0.31	0.02	0.47
Dividends Per Share	0	0	0	0	0	0	0	0
Book value per Share	5.2	6.34	8.72	10.3	10.02	10.35	10.38	10.87
Shares Outstanding	9.9	9.95	9.61	9.61	9.61	9.52	9.52	9.52

Source: Value Line

As you can see above, the company has generated positive earnings for the past seven of eight years. Equally importantly, they have used their earnings wisely. Book value per share has grown by $5.87 (10.87 - 5.2) since 2005. During the same period the company has earned $5.31 (1.17+2.02+1.59-0.27+0.31+0.02+0.47). This implies that Gencor has turned its accumulated earnings of $5.31 into wealth for its shareholders in the form of increased book value of $5.87. As we saw above the increased book value is mostly in the form of cash. In addition, the number of shares outstanding has fallen by about 400,000. Many companies' EPS fall short of their free cash flow. Many others squander their earnings through poor acquisitions (among other things) and subsequent write downs that lead to shareholder value destruction. Well managed companies like Google (GOOG), Microsoft (MSFT), National Western Life Insurance (NWLI) and Berkshire Hathaway (BRK.A) are able to turn their earnings into genuine shareholder value through dividends, share buybacks and increases in shareholder equity (book value).

Insiders

As a final check, let's take a look at the company's insiders. Are their interests aligned with outside shareholders? The company's founder, E.J. Elliott is its Chairman and CEO. According to the company's 2012 Proxy filing, current executives and directors own 17.8% of the common stock and 96.8% of class B shares (which have the same rights as the common stock with the exception of greater voting rights). There are approximately 1.5 million shares of class B stock and 8 million shares of common stock. The insiders own roughly 29% of the combined shares. Their interests are aligned with the shareholders' interests as reflected by the lack of significant insider sales. According to the same proxy, another beneficial holder, Sherry Houtkin, owns another 22.7% of the stock. Because of the high insider interest and the company's low market cap (about $85 million), purchasing shares in the open market must be done using limit prices and with great patience. The average trading volume is under 14,000 shares daily.

Risks

The company's management controls over 96% of class B stock, who in turn elect 75% of the company's directors. This situation may prohibit a potential sale and may result in a low stock price for a long time. Investors must ask themselves if they can be patient. Management is focused on running the business and not managing the stock price. This is perhaps why the stock price is so low despite the company's fundamentals. As Buffett says, management does a disservice to shareholders when they allow the stock to become very overvalued or undervalued. When the shares are undervalued, shareholders who are forced to sell (for personal reasons, etc.) are not treated fairly. Similarly, when shares are overvalued, new buyers are treated unfairly by overpaying for the stock. This is anathema to Buffett who views shareholders as fellow partners. Gencor's management has been efficient in managing the company but has not demonstrated any interest in boosting the stock's value. No dividends or share buybacks are planned. Individual investors cannot rely on potential activist investors to shake up the company since management firmly controls the voting shares.

Summary

Gencor is currently trading at a significant discount to the value of its liquid assets. In addition, the company has been generating profits and increasing shareholder value as evidenced by its rising shareholder equity. It has also been reducing shares outstanding. The company's insiders have a large stake in the company and have not been selling their stake in significant quantities. Caution is urged when accumulating shares in the market because of the company's low market cap, low float, and average trading volume. Short term investors should proceed with caution, as the stock price may continue to stay undervalued because there is no foreseeable catalyst.

Source: Gencor Industries, A Profitable Company Selling Below Net Current Asset Value

Disclosure: I am long GENC, BRK.A, MSFT, NWLI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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