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Terra Nova Royalty Corp. 2Q 2011 earnings

August 27, 2011

On August 15th Terra Nova released their 2Q earnings. For me there were 5 take-away points in the press release:

  1. Earnings of $.19 per share in 2Q 2011,
  2. Book value at the end of 2Q of $8.91
  3. Name change to MFC Industrial Ltd. in Q 3 to better reflect corporate direction
  4. Dividend/spin-off of non-core assets to shareholders with a value of $1.63 per share in Nov. 2011
  5. Quote from Michael Smith: “We are pleased with our new focus on building a global commodities supply chain company together with all of our corporate changes and emphasis on expansion of our operations. We have now identified several strategic acquisitions that will complement our new business focus. This strategy is now underway….Our task now is to acquire and integrate new operations that will make us larger and, most important, more profitable….We are generally optimistic that 2011 will be a watershed year as we pursue our acquisition strategy. We have a much stronger financial base than many other companies our size, and years of experience in buying good assets and realizing value. With the current financial uncertainty in the market, we believe that many interesting opportunities may present themselves.”

Let’s look at each of these points individually.

  1. Earnings for the second quarter of this year came in at $.19 per share, about the same as the first quarter if one discounts the effects of non-cash one-time expenses in the first quarter (primarily options granted to management). Though the distribution of the income by segment was quite different in the two quarters I take this as some kind of indication as to the potential earnings power on the current asset base. Projecting from the past quarter, annual earnings might be in the $.76 range giving the stock at today’s price ($7.25) a PE of about 10.
  2. Book value increased $.09 during the quarter from $8.82 to $8.91 consistent with earnings of $.15 less the dividend payout of $.05 in June (the discrepancy is likely rounding).
  3. Interestingly, the company is once again reshaping itself. This time to focus on “building a global commodities supply chain business”.  Thus, another name change to MFC Industrial Ltd.
  4. And, consistent with the new focus (and the name change), the company will be shedding non-core assets. Let me quote the latest 6K: “We have completed a comprehensive review of our assets and identified some merchant banking and other non-core net assets in the amount of approximately $102.0 million, or $1.63 per share, which are not required for our future operations. We believe it is in the best interest of our shareholders to receive this value directly, by way of a special cash and/or spinout dividend or distribution.”On reading this, my expectation is that some combination of cash and/or shares in other companies with a market value of $1.63 per TTT share will be distributed. So they could sell off assets and realize $102 million (assets with a book value of more or less than $102 million if we read the chairman’s statement the way I have interpreted above) which would then be distributed to shareholders. Or, they might spin-off shares (with a market value of $102 million) that they currently hold in a publicly traded company to current owners of TTT shares (like the remaining KHD shares the company still holds), or some combination of the two. Let’s look at the balance sheet to see what these assets might be.

Most obvious candidates:

Current assets:

                                    Securities                                  $21.3

                                    Real Estate held for sale            $13.5  

                        Non-current assets:

                                    Securities                                  $16.9

                                    Investment Property                  $39.9

The Investment Property line with a value of $39.9 million and the Real Estate held for sale, I believe, is a real estate interest in Germany mostly acquired by Mass Financial in 2008 and, according to the notes to the financials, is on the books at market value. There isn’t much description of Investment Property except that it generates about $194 thousand a year in rent and nets about $90 thousand a year in profits, certainly not a great return. This could be sold or bundled into a REIT and spun-off to current shareholders (let’s hope for the former… I really hate illiquid stocks that are not core to my investment thesis)

That leaves us with at least $10 million still to identify. Management could be thinking about monetizing their optical/medical venture in China (equity method investments with a book value of $13.6 million), selling off some inventory, reducing receivables, etc.. In any case it’s all a bit fuzzy (like most things to do with this company).

There is, of course, the distinct possibility that my interpretation of the chairman’s statement is not exactly spot on. He could simply mean that the company intends to return $1.63 per share to TTT shareholders from cash, though I think this unlikely from statements he made regarding acquisitions. If the company is planning acquisitions then it will need the cash, as using shares for acquisition with the shares trading for less than book value makes little sense.

  1. It looks like after shedding the abovementioned assets the company intends to grow again, through acquisition.

What is my short analysis of the above? If, indeed, my interpretations are even somewhat correct, management appears to be focused on increasing return on invested capital (ROIC) by first focusing on reducing the book value (the dividend/spinoff) then growing earnings through acquisition. The $102 million payout will reduce book value by about 18% and increase ROIC from the current 8.5% run rate to 10.4%, a significant improvement. Then if the current cash hoard can be employed more productively than sitting in a bank with near zero return by implementing their new supply chain strategy (whatever that may really be), we should see an even more significant improvement in returns.

In any case, this is not a company that likes shareholders to know exactly what it is doing (see the insightful analysis by Clemens Scholl on seeking alpha who always has an interesting take on Michael Smith’s businesses). But I think if you stick with this one you should see some good returns over the next couple of years. For my part I have been increasing my position lately anytime the share price falls to the $7.00 level.

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