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Macroenterprises Case Study

Macro Enterprises Inc. (OTC:MCESF) constructs pipelines and other facilities for the oil and gas industry in Canada. See also their presentation from May 2017. The company is listed in Canada under ticker symbol MCR. The reporting is also in Canadian Dollars. Therefore all financials here are reported in Canadian Dollars.

Once, when oil was in bubble mode in 2007, such oil service companies were much in favor among investors. When oil prices crashed in 2015 and 2016 the sentiment reversed to extreme pessimism.

So on Wednesday May 18, 2016 I bought Macro Enterprises Inc. for 1.76 dollar at the bid price. Why the bid price? If everyone is extremely pessimistic about a stock it does not make sense to give money away by bidding the ask price. Indeed, within hours after my purchase it dropped another 10% to 1.6 dollar. In the next months it continued dropping until it bottomed at 1.32 dollar.

If it had stayed there a little longer I would have bought more. What I did not do is selling low on negative emotions. I did not sell with the intention to buy back lower either. If I do that I am afraid a favorable announcement follows.

Instead I follow Benjamin Graham's selling rule: sell at 50% or after 2-3 years. I have never found statistical research on his selling rule. I think it makes sense though since it combines fundamental undervaluation with another strong stock market force: momentum.

Why I bought despite grim business expectations

When I invest I like it when a company trades below liquidation value. As a proxy for liquidation value I use the current assets minus all liabilities or shorter: net current asset value or NCAV. At the time of my purchase, the company was not really trading below NCAV. But that is also the main reason I did not buy more even when it got as low as 1.32 dollar. On the company's conference call, another investor asked a question about non-current assets, so I was certainly not the only one interested in Macro Enterprises' liquidation value.

My conclusion was the company traded for about 2/3 of its liquidation value. This 1/3 discount to liquidation value is kind of the minimum you need for a good investment in a depressed stock.

When I first came across Macro Enterprises I also found it as a low EV/EBIT stock with a strong balance sheet. Apart from stocks trading below NCAV, I also look for companies with low EV/EBIT stocks and strong balance sheets. When I bought the shares the EV/EBIT multiple was about 2.5. Combined with the discount to liquidation value and the prospect of rebounding oil I found that very attractive. On average such stocks have great returns.

Moreover the company provided extra safety. During the conference call management suggested that the company intended to support the stock.

Since this investment was denominated in Canadian dollars I had to also consider whether the Canadian dollar was undervalued or overvalued. The Canadian dollar was indeed undervalued relative to the British pound, the US dollar and the euro. I kept making monthly currency valuation overviews. Between my purchase date and today, the CAD has risen from 1.3 to 1.21 in USD terms. This adds to my gains. I don't think the CAD has much more to rally relative to the USD. (See also my monthly currency articles my latest statistically favorable currency ideas. Going forward the CAD is a bigger risk for the US investors in Macro Enterprises than when I got in.)

Why Macro Enterprises disappointed despite the surge

The company kept their promise to buy back some shares but not many. It was not enough to offset their massive repricing of employee options to 1.63 dollar last November. This will cost the shareholders an estimated 2.44 million dollar or 4-5% of the market cap at the time of repricing.

I have nothing against repricing of options. But will it be reversed if oil goes up again? I do not think options are a good instrument for rewarding managers of companies depending much on commodity prices. In any case with repricings, management of Macro Enterprises does not really have a good incentive to correctly predict the oil price. I do not consider Macro Enterprises shareholder friendly.

Unfortunately, Macro Enterprises swung to a loss in the second half of 2016. At a certain moment the company did not have any new orders but survived on maintenance contracts. Even today the bulk of the revenues come from such contracts. But last quarter was profitable again and the company hopes to start working on new pipeline orders later this year.

The future for holders of shares of Macro Enterprises Inc.

Service-providing companies can grow very fast if the circumstances are good. They can scale up faster than manufacturers or (software) product developers. They just need to hire new people rather than build a new factory or develop a new product.

Certain investors consider such NCAV stocks or net-nets almost buy-and-hold net-nets. For example investor Jeroen Bos invests in companies trading below NCAV providing services. He hopes companies can scale up fast like Macro Enterprises might. Unlike me, he does not sell at 50% profit but holds his stocks until they are fairly valued compared to their competitors. (I'd like to recommend his book, with examples similar to this story about Macro Enterprises.)

The circumstances might indeed be just right for Macro Enterprises. After a couple of years of stagnation demand can pick up quickly. Especially after a shake-out where typically only the better managed and better financed companies survive. After such an industry shake-out there is less competition. That results in more projects won that can be more profitable as well.

Last week the company announced it is discussing an order for a pipeline of 85 km. During 2016, the company reported $3 million dollar of business development costs “for large scale projects that management is optimistic will proceed.” So shareholders could have known something big was in the sales pipeline. We will never know but I would not be surprised if the option repricing from last November was related to these business development costs.

Why I sold Macro Enterprises Inc.

The announcement caused the stock to pop. Such a pop upon news is often a good moment for selling. I succeeded in selling my shares at CAD $2.7. It was this pop causing the stock to have increased more than 50% above my purchase price. When such an event occurs buyers are initially very eager but their enthusiasm usually rapidly fades. It is important to use the selling opportunity when it is still there. So while normally I try to sell at the ask price I was a bit more flexible with Macro Enterprises.

I could have bought it back cheaper but I did not do this. The reason I didn't buy more is simply because it was due to the reported negative earnings, and the fact that the discount to liquidation value was gone. A ratio that is still attractive (but not very low) is Price/Retained Earnings. This predicts returns better than Price/Book. Using a price of $2.54 dollar and after correcting for option overhang and preferred shares, this ratio is 1.5.

Often a stock goes down 20% or so after a quick 50% gain. That allows me to get in again. Moreover after a quick 50% gain another 50% gain is less likely than it was before the first 50%. Of course there are many exceptions but I think I play my game better this way. If this trading won't increase my returns than it makes still sense to expect it does increase my risk adjusted returns.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Additional disclosure: Macro Enterprises can best be traded on the Canadian exchange: ticker MCR.

Since 1977, Macro Enterprises Ltd. (Macro) has been providing specialty construction services in New York City, Long Island and the surrounding areas. Founded more than 35 years ago, Macro specializes in performing pile driving, drilling, shoring and underpinning work across the region. George Morris PE, current president of Macro, leads the growing business, along with his two sons, Scott Morris PE and Brian Morris PE, as well as partner Robert Feulner. With a team of approximately 30 employees, Macro is a competitive force in the heavy construction industry.

The business has kept up with technology and built up strong experience in the industry. Clients have come to rely on Macro for innovative solutions to uncommon challenges. The business is vertically integrated, offering a broad range of skills, as well as value in performance. “We are engineers and contractors performing design-build work,” George explains. “We strive to come up with engineered solutions that work economically and physically.”

Building value for customers

Macro operates from a single location in Massapequa, N.Y., and services clients throughout New York City, Long Island and also frequently travels into New Jersey and Connecticut for work. In recent years, the crew has provided a wide range of value-engineered solutions to diverse clients in the region. The company is consistently working with clients and strategic partners to provide lasting, innovative solutions that save money for these institutions in the short-run and over time.

“Recently, we redesigned the pile foundations for Brooklyn College,” says George. “Through value engineering, we were able to save the college more than $1 million on a $3 million job. The architect and engineer had designed drilled mini piles, which are expensive and time consuming to install. We were able to provide an acceptable redesign using augered cast in place piles that allowed for quicker installation, which saved the owners seven figures.”

One of the team’s most challenging projects to-date entailed the support of excavation work for St. Francis Hospital on Long Island. Land scarcity has become a serious challenge in the region, especially for hospitals that are constantly expanding.

“The hospital was running out of space,” George explains. “So they had to put the new parking garage underground. We performed a 55-foot support of excavation to allow for a five-story underground parking garage. There wasn’t much room, so they had to build it close to existing buildings and in this case, an existing church. We used an auger technique where we were able to install a shoring system without any pile driving impact noise or vibration. This kept the hospital operating as it needs to without disruption or negative effects on patients.”

Market potential

The team’s recent work on the Bay Park Sewer Treatment Plant may open more doors for the team in the future. “Our work at Bay Park involves doing pilings to support facilities,” George elaborates. “Bay Park Sewer Treatment Plant is in an operating treatment plant surrounded by a residential area. Engineers didn’t want any vibrations or noise from pile driving. We installed augured cast-in-place piles that screw into ground. There is a hollow stem that grout is injected through under pressure as the auger is being withdrawn, in such a way as to exert a positive upward pressure on the earth filled auger flights, as well as a lateral pressure on the soil surrounding the grout filled pile hole forming a high capacity pile. Pile driving noise and vibrations are eliminated.”

The sewer treatment plant is an ongoing project with several components. Several contractors will work on the plant in the coming years. Now that Macro has a foot in the door, George is optimistic that his team may be involved with more of the work there.

The company has built strong connections with strategic partners. The business relies on a network of suppliers to provide essential equipment and materials. “We work with suppliers who have a good reputation,” George notes. “We have narrowed it down to suppliers we know we can depend on. In turn, we know our general contractors can depend on us.”

Despite an organized and well-structured business, George explains that his team, like many other contractors, faced low volume in recent years due to the recession. Recently George has seen major improvements in the market and the company has a strong line of projects down the pipeline.

“We’ve been busy,” George says. “We don’t see much changing here over the next few years. We just want to continue doing what we do best while continuing to modernize as the years progress to stay up on current trends.”

Macro combines quality, integrity and innovation, harboring a unique reputation in the industry. Clients have come to depend on the team for projects that require distinct problem-solving capabilities. Three engineers lead the business, so each project is approached with a technical mindset and creative attitude. Macro Enterprises Ltd. gets the job done, regardless of constraints on time, space and practice.

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