Did MFC Industrial Just Pull a Rabbit Out of Its Hat?

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When a company reports earnings it normally leads with revenues and profits (or losses) for that period, but that was not the case for MFC Industrial's (NYSE: MIL) third quarter report.  This burgeoning global supply chain management company led with what was an astounding increase in assets and book value. 

Digging deeper into the report, the company completed a previously announced takeover of Compton Petroleum Corporation.  The total cost of this acquisition to MFC was approximately $32 million.  According to earlier reports, Compton had a book value of approximately $224 million when last reported on June 30, 2012.  Compton was acquired by MFC at a price that was substantially below book value, primarily due to Compton being squeezed by its lenders. 

When the fair value of the net assets acquired exceeds the consideration paid, a company reporting under the International Financial Reporting Standards must report the entire amount as a gain on the income statement.  This was the case with the Compton acquisition.  With most investors used to seeing companies record large amounts of goodwill during acquisitions, this bargain purchase should be a welcomed change.  However, it appears the investment community continues to view this transaction and MFC with a significant amount of skepticism. 

The recording of the negative goodwill resulted in a gain of $230.1 million, which went straight to the income statement.  The addition of Compton’s net assets also boosted the balance sheet significantly.  The gain recorded on the income statement, while significant in its amount, is not the story here, as it was a one-time occurrence.  It is the increased value of the balance sheet that is the key to this report.

On many occasions MFC Chairman Michael Smith has told investors that the best way to value MFC is on a multiple of book value.  In this latest release, the company’s stated book value increased 46% to $800.3 million and total assets increased 58% to over $1.3 billion.  This pushed the net book value per share up accordingly from $8.98 as of June 30 to $12.79 per share as of Sept. 30, 2012.  Prior to the most recent boost in book value, MFC was trading at a 10% discount to book value.  Given this increase in book value, a 10% discount would put MFC shares in the neighborhood of $11.50 per share.

The stock is now trading at an amount that is below the closing price of the day prior to the announcement.   This signals extreme skepticism about the true fair value of the Compton assets.  The skeptics may have good reason, but MFC put a marker on its balance sheet that may serve as validation of fair value.  MFC plans to dispose of non-core Compton assets. and accordingly is carrying a separate value for these assets on the balance sheet in the amount of $126.7 million with an offsetting liability of $15.5 million.  Management expects the deposition of these assets to occur over the next twelve months.  An aggregate sale price that nears the net amount should give investors the confidence they need in the balance sheet to push the stock price higher.

The focus of MFC is on becoming a global supply chain management company through the prudent acquisition of undervalued assets.  This acquisition of an undervalued captive source of energy is just another step in executing that strategy.  Other major players in this industry are supply chain behemoth Glencore International (LSE: GLEN) and Hong Kong-based Nobel Group (NASDAQOTH: NOBGF)

Glencore was founded in 1974 by Marc Rich, which might be a familiar name.  Mr. Rich was indicted on federal charges for making illegal deals with Iran during the Iran hostage crisis, as well as for tax evasion.  Mr. Rich never returned to the United States while under indictment and was later pardoned by President Clinton.  Glencore has grown to be the largest commodities trading company in the world.  It has assets throughout the world in metals, minerals, energy and agriculture.  Most recently, Glencore has agreed to buy Xstrata Plc, the world’s largest producer of thermal coal.  The deal was just approved by Xstrata shareholders this week.

Similar to Glencore, Noble Group is a major trader and supply chain manager of various commodities in the area of agriculture, energy, metals and minerals.  The operations of Noble include production, processing, ports/terminals, shipping, storage, marketing and financing from 140 locations throughout the world.  The company missed third quarter estimates by a wide margin due to weak energy segment margins, which has been reflected in the current stock price.

At this point, it appears investors are going to take a “show me the money” approach to MFC, as shares continue to trade flat and below the price reached in September when the Compton deal was closed.  However, Mr. Smith has a long history of producing impressive returns by increasing book value with a deep value investment philosophy that rivals Berkshire Hathaway’s Warren Buffet and Leucadia National leaders Ian Cumming and Joseph Steinberg.  It would appear Compton may be a step in the right direction to continue this long history established by Mr. Smith.


ScavengerReport owns shares in MFC Industrial Ltd and Leucadia National Corporation. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway, Leucadia National, and MFC Industrial. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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