Curious if anyone has thoughts on this one. Looks like an attractive risk/reward.

Greystone Logistics: Great Macro Trends and a Big New Customer Means Multibagger

-Microcap manufacturer of plastic shipping pallets trading at 5 P/E and growing fast
-Historic shortage of wooden pallets opens up new opportunities
-Will probably land Anheuser-Busch as major new customer, increasing sales 50%
-Great buying opportunity after cancelled going-private attempt


Summary
Greystone Logistics (GLGI) manufacturers plastic shipping pallets for a variety of businesses around the country. It has a market cap of only $11 million, yet they reported profits of $2.7 million over the past twelve months, and $2.2 million the previous twelve. I expect this expansion to continue. Their business of plastic pallets offers their customers substantial long-term savings over wood, an advantage which has recently improved further with supply and price difficulties facing the wooden pallet industry. There is good reason to believe that a test supply arrangement with Anheuser-Busch will develop into a major new customer. Despite growth and deep value, shares are trading at a temporary discount due to a cancelled attempt to go private. Fair value for Greystone is more than 100% higher.

Pallets are not a sexy business. They are not electric cars or cures for cancer. They are, however, a $9.5 billion industry and critical component in world transportation. And plastic pallets are a great business proposition for Greystone’s customers. Wood pallets are cheaper up front. A quality wooden pallet might cost $8, while a comparable plastic pallet might cost $60. The advantage for plastic is that they last much longer. A wooden pallet, on average, requires repair or replacement every three trips at an average cost of $3 (http://greystonelogistics.com/news_record.php?id=4). Plastics last more than 100 trips, often yielding return on investment in less than a year. This makes plastic pallets an excellent fit for closed-loop supply systems, in which pallets return back to their original warehouses. Wooden pallets will probably remain a preferred choice for one-way trips in which the pallets are not returned.

Plastics are also perfectly uniform, which is critical to highly automated production systems. They can be easily manufactured with RFID tags. Plastic pallet users don’t have to worry about splinters, nails, or insect contamination. As you might expect, plastic pallets have been adopted most commonly in industries such as food & beverage or pharmaceuticals, where cleanliness is important. Greystone’s prominent customers include the brewer Miller-Coors and pharma giant Pfizer.

Greystone has made great strides in the past 10 years. Sales growth has been steady, climbing from $6 million in 2003 to $24 million in 2013. The early years were difficult, as they did not have the sales volume to pay for fixed costs like real estate and administration. As a consequence Greystone has extensive net operating losses which will keep them tax free for some time. In 2011 they reached profitability, to the point where in the last 12 months they netted $2.7 million.



Wooden pallet shortage
Why doesn’t everyone switch to plastic pallets? In large part it has to do with inertia. Most businesses have always used wooden pallets, and they’ve gotten along just fine. They might not be in a position to make a large up-front investment in a new set of plastic pallets. In particular, the guy whose job it is to manage the pallet system doesn’t want to risk his job by leading his company into a large capital investment that he’s not certain will pan out.

Very fortunately for Greystone, many companies are being forced to reconsider their pallet supplier, whether they want to or not. The wooden pallet industry is experiencing historical material shortages. For the past couple years, the used wooden pallet market has suffered from a lack of supply. Here’s an article (http://www.mmh.com/article/pallets_a_core_problem) from 2012 asking where all the pallets have gone. Turnaround volumes were down 25%, and repair costs were up 33%.

Since then it’s gone from bad to worse. This article from two weeks ago describes in detail what’s been happening: (http://www.palletenterprise.com/arti...articleID=4126)
During the recession, the forest products industry stopped investing. A lot of sawmills closed, and others put off investments. This reduced the total industry capacity. In the past couple years, the recovery of the home-building industry has greatly increased its demands for the same hard wood that would be used in pallets. Railroads and other construction uses also needed more wood, and were willing to pay more than pallet manufacturers. Meanwhile the revival of American manufacturing and exporting has sent a great many pallets out of the country. On top of that, the extreme cold weather of this past winter has made timber harvesting and sawmills even less efficient, further tightening supply. “There are some areas where pallet manufacturers are working with essentially hand-to-mouth supplies… It was the first time I had seen this in 22 years of tracking the market... Customers – as always – are resistant to upward moves, but price resistance is pointless considering current conditions.”

I had a personal communication from a small private pallet supplier in Saint Louis, who said they are unable to obtain wood from their usual wholesaler at any price. They have former customers who haven’t called in ten years now calling and asking for pallets at any price, and they aren’t able to fill those orders.

The disruption of the traditional order of business, in which wooden pallet prices rise substantially, if they are even available at all, will be a major advantage for Greystone. Rising prices and intermittent supplies will be an excellent motivator for businesses to consider alternatives to their traditional wooden pallets.


Anheuser-Busch: The Great White Whale
In December, Greystone reported extremely positive news: they had manufactured and shipped pallets to sites in the Anheuser Busch system as part of a test evaluation. (http://finance.yahoo.com/news/greyst...110000303.html) Busch, of course, is the largest brewer in North America. Greystone’s largest customer Miller-Coors sells 30% of US beer; AB sells 50%. Miller accounted for $15 million of Greystone’s sales in 2013; if AB were to adopt plastic pallets on the same scale, it would add $25 million to Greystone’s top line, literally doubling sales. At gross margins of 22%, profits would triple to $7.5 million. And remember, Greystone’s entire market cap is $11 million!

Since the December press release, Greystone has been tight lipped about the results of AB’s test evaluation. (This is in line with a management that generally has not concerned itself with managing market expectations.) However, there are three hints that Greystone has been successful:

-Loan covenant includes specific terms for AB. On February 5th, Greystone refinanced a long-term loan. As is customary, the new loan includes covenants which limit Greystone’s dividends, specify a minimum EBITDA, etc. One of the covenants specifies when an account payable is considered to be in default, and specifically names Anheuser-Busch (http://irdirect.net/filings/viewer/i...448814000508/1)

-Unusual inventory rise in the most recent quarter. The figure below shows Greystone’s inventory reports going back to 2010. Inventory is generally managed quite tightly, with little variation from quarter to quarter. This past quarter, though, it spiked up to $1.9 million. Which is more likely, that GLGI’s inventory controls went off the rails this quarter, or they began to build up inventory in anticipation of shipping to a large new customer? Here’s a hint: the last time the had a large inventory build, in February 2012, the following quarter they set a new sales record and posted profits 150% higher than any previous quarter.



-Repayment of deferred compensation and preferred dividends. For several years, Greystone’s CEO deferred his salary. Greystone also deferred payment on preferred shares owned by the CEO and another insider. In connection with the refinancing of the term loan on February 5th, Greystone agreed to finally repay these deferred liabilities. Those are the actions of a company that has recently come into a lot of money. (These liabilities were on the books and will not be a surprise in next quarter’s filings.)


A Highly Invested CEO
No description of Greystone would be complete without mentioning Warren Kruger. Kruger took over the company in 2003 when it was on the verge of bankruptcy. Under his leadership, Greystone purchased its plastic pallet factory and began its current business strategy. He is in many ways an ideal micro-cap CEO. He personally owns 30% of the outstanding shares (other insiders own another 18%). He draws a reasonable salary, which he voluntarily deferred for several years. There are a number of related-party transactions on the books, but they all appear reasonable. Perhaps most impressively, he and another insider personally guaranteed Greystone’s bank loan. A small company with a large debt load like Greystone would ordinarily pay 10% or more on their debt. Because of this personal guarantee, Greystone pays only 4.5%. That saves the company at least $500,000 a year in interest costs. Find me another public company CEO willing to do that.

There’s a very informative presentation from Kruger (pretty much the only promotion I’ve seen from him) available here. http://microcapclub.com/2013/01/micr...ogistics-glgi/


The negative: lots of debt
Greystone is not a perfect company. It has liabilities of $17 million against assets of $13 million, for a book value of negative $4 million. Ordinarily this level of indebtedness would be extremely dangerous, especially for a small company. High interest payments would eat up most of the operating profits, and the slightest hiccup could cause violations of loan covenants and begin a death spiral of even higher interest rates. However, thanks in large part to insiders’ personal guarantees, Greystone is in a far safer position. What’s more, they’ve made substantial progress in paying down the debt. Two years ago, their book value was negative $8 million. Even without a major new customer, they’ll be book-value positive in two years, continuing to throw off plenty of cash.


Great buying opportunity
In June of 2013, Greystone attempted to go private by a reverse stock split. (http://irdirect.net/filings/viewer/i...7261313000287/) The plan was to effect a 10,000-1 reverse split, cashing out fractional shares at 50 cents per original share. At the time, GLGI was trading at 0.39, so this offered a major arbitrage opportunity. Speculators rushed in to buy lots of 9,999 shares in order to capture the difference. As frequently happens with privatizations through reverse splits, the speculators purchased so many odd lots that the cash cost to the company rose far higher than it would have been before the split was announced. With its balance sheet already highly leveraged, Greystone rescinded the going-private offer on February 5th, 2014.

Since then, the share price has been depressed by arbitrageurs exiting their positions. How can you tell? Looking at the level 2 quotes, you very frequently see offers to sell 9,999 shares. Nearly half of my current position has been filled by orders of exactly 9,999 shares.

One of the best times to buy a stock is when someone else is selling it for reasons unrelated to its fundamental value. In this case, a lot of people bought in with very little regard to the underlying business, expecting to cash out a 25% profit in a few months. Now GLGI doesn’t fit their investment wheelhouse, and they’re cashing out at a discount price to invest in something else that does.


Valuation
Fundamentally, this is the kind of business that Warren Buffett would have bought in the early days of Berkshire Hathaway: it’s very reliable, it produces a lot of cash, and has great management. What would be a fair value for Greystone? Let’s assume for a second that Anheuser Busch doesn’t become a customer. Even without them, we’ve got a profitable company that is likely to continue to expand at 10% or better per year. Its customers are mostly domestic and mostly noncyclical (beer, pharmaceuticals), so it is insulated from major risk factors like Ukraine and China. In a bull market like this, a P/E of 20 would be conservative. It does have substantial debt, and it trades on the pink sheets, so let’s trim that back to a P/E of 10. That would be a share price of $1.00, 144% above the current price. Then you have the major upside potential of adding a customer like AB. If that deal does go through, Greystone should do far better than double.

Interesting write up.

Chep also makes plastic pallets, Menasha has its Orbis Division that makes them too, MeadWestvaco makes them...

Do you have more information on GLGI's competitive advantages compared to other plastic pallet manufacturers, especially the big boys like Chep, Menasha and Snyder Industries?

I don't see competition being a bad thing here unless it leads to price wars as it appears that the industry is set to continue growing and them just maintaining their market share should allow them to grow.

It's difficult to get a handle on the competitive landscape. GLGI is the US leader in 100% recycled plastic pallets. They have a few design patents which describe how they use fiberglass rods to strengthen the pallets.

Most of the IP is in trade secrets. Converting their raw material of old car bumpers and pill bottles into a pallet is more than just melting everything and injection-molding it. There was a ramp-up period of several years a decade ago while GLGI figured out a lot of the technical hurdles.

The biggest point, though, is that they've already achieved success. Even if they just keep sales and profits constant, the shares are super cheap.

I find that statement hard to believe given Rehrig Pacific's 300+ employees and 7 manufacturing plants.

Rehrig doesn't do recycled plastic. Using post-consumer recycled plastic is a selling point for a lot of companies.

You make this Warren Kruger sound like quite the hero. I wonder what exactly his personal stake is in the company at this point and whether the insider transactions actually scare off investors rather than reassure them.

What kind of contract does GLGI have with Miller-Coors? Based on your numbers Miller represents something like 70%+ of GLGI's revenues. Kind of scary to have that much of your business tied up in one customer.

You say GLGI will "probably" land AB as a customer. I like all of the inferences you make but what % chance do you put on this event occurring if you had to estimate a %?

this argument is a bit thin. I like the writeup, but would also like to know more about competition dynamics.

and does greystone have all off miller coors`s business or is the more room to grow with them?

Finally total assets and liabilities isnt that useful a measure. id look more specifically at working cap and long term debt.

overall good writeup though, probably good find.

This is very much Kruger's company. He and other insiders own nearly 50%, along with some preferred shares. Is that a positive or a negative? Well, it incentivizes him to personally guarantee the company's debt. On the negative side, there is certainly the opportunity for self-dealing. There are a number of related-party deals detailed in the 10Qs, but all of them seem appropriate. It's not like, say, Star Scientific, where the company was paying $20M a year to the CEO's private-jet holdco. Net-net, investors would probably be more comfortable with a more conventional ownership structure, but I think that knocks down the appropriate PE by 10%.

MillerCoors is a big part of their business, no doubt. They've diversified it from 75% of sales to about 50% last Q. Another negative. But the numbers are headed the right way, and fundamentally, you don't find a company with a 5 PE without a few warts.

I think there's an 80% chance they get some business from AB. They won't get all of it, at least not at first. But depending on AB's corporate priorities, they might decide to gradually convert their current pallet system to recycled plastic as the older pallets need replacement.

They have all of MC's business, and are trying to diversify their sales.


There are no liquidity issues. They just refinanced their debt in February and had enough cash to pay out long-deferred compensation and preferred dividends. Net equity is a reasonable measure for their ability to pay common dividends or acquire other companies (neither is going to happen anytime soon).

so did this post cause it to jump 8% today or?

"Today we use only 100% recyclable materials throughout our product lines. We have employed strict recycling and energy efficient practices in our manufacturing and our products are designed to contain as much as 100% recycled material, depending on customer requirements."

Also, if you send back damaged product, they recycle it into future production runs and give you credit towards your next purchase.

At my last job we bought 6-figures worth of RP's products annually as a B-Corp because of how they lined up with our environmental goals.

net equity is a pretty useless measure in non balance sheet plays. cash flow and current debt levels to cash flow is what determines ability to pay dividends and make acquisitions. its all about the ratios.

Thank you for the thoughtful answers.

Do you know what kind of contract GLGI has with Miller? Can Miller get out of it tomorrow if they find another supplier with minimal penalties or are they locked in for 5 years or....?

Ah, RP's website doesn't feature that so prominently. I think there's a bit of marketing-speak going on. Greystone says it's the leader in "100% recycled" pallets, which they may be. They have one plant with about 100 employees, so since all of their production is 100% recycled, they likely produce more total 100% recycled pallets than RP.

Greystone does a similar "pop-bottle credit" thing where consumers can return broken pallets for a credit. It's one of the reasons why Miller is likely to stay with them: their current pallet pool represents a multi-million dollar asset that a competitor would have to replace in order to make a credible bid.

What did you think of RP's product, in comparison to wood pallets or anything else you've worked with?

I don't believe the details of the contract are publicly available. My guess is that Miller could end the contract with 90 days notice or something like that. Two big reasons they should stay: 1) conservatism -- pallets are a small but absolutely necessary component for the manufacturing process. Miller's got something that has worked well for them for several years now. If you're the guy at Miller making the pallet purchasing decision, are you going to take the risk of changing suppliers (and risking your career if it goes wrong) just to save 10%?
2) Pallet return credit. Greystone offers a credit for its customers to return broken pallets. By now Miller has built up a huge supply of pallets, so that the credit amounts to a multi-million dollar asset. A competitor would have to replace that in order to make a successful bid.

I remember looking at this before to possibly take advantage of an odd lot for reverse split. Didn't bother acting on it since the company is so small and was not the best financially positioned back then. Maybe I'll take a look at it again.

Bump...strange and possibly intriguing developments in progess: http://seekingalpha.com/article/2272...a-major-merger

will spend the time to read the full post, haven't read a single thing yet so small disclaimer.

But I spent a lot of time shipping things from USA to China. Wood is quickly being phased out as China cracks down on what type of wood can be used for imports. To prevent things like bugs, fires etc. As it stands you have to have specifically treated wood just to make it through customs inspection - but more and more end customers and now even certain ports in China are requiring plastic.

I like where this stock is seemingly headed, but how did this company get in so much debt originally?

Revenue is decreasing. Sales for fiscal year 2014 were $15,405,169 compared to $16,705,437 in fiscal year 2013 for a decrease of $1,300,268.

Number of employees is decreasing. Greystone had approximately 81 and 94 full-time employees as of February 28, 2014 and 2013, respectively.

Negative cash-flow.

They're borrowing money from people in their board of directors: Greystone had a working capital deficit of $(2,419,782) at February 28, 2014. Excluding a note payable and accrued interest to Robert B. Rosene, Jr., a member of Greystone's board of directors, Greystone would show working capital at February 28, 2014 to $1,408,374. To provide for the funding to meet Greystone's operating activities and contractual obligations as of February 28, 2014, Greystone will have to continue to produce positive operating results or, if necessary, explore various financing options. However, there is no guarantee that Greystone will continue to create positive operating results or be able to raise sufficient capital to meet these obligations.

Substantially all of the financing that Greystone has received through the last few fiscal years resulted from loans provided by certain officers and directors of Greystone and bank loans which are guaranteed by certain officers and directors of Greystone.

They've been in business for 45 years and lost money. At least they have no income taxes to pay.

http://biz.yahoo.com/e/140414/glgi10-q.html

Parttimepro

Any updated thoughts on this one? Down big on earnings today.

This was an awful quarter. Pallet sales were down 20%. Operating income down 50% Y-on-Y, net income down 85%.

The original thesis was that they would get a big new customer in Anheuser-Busch. Much of their costs are fixed, so the addition to top-line revenues would flow down to the bottom at great margins. This quarter they did the opposite, losing sales but still paying those fixed costs.

There were good reasons to believe in a new customer back then, particularly the inventory build-up. Even if they hadn't landed a new whale, their consistent profitability was reason enough to expect they'd dig themselves out of debt in a few years. But now that they've gone from a 4 P/E to a 30? No longer a compelling opportunity.

While I'm not excited about these results I think the market is overreacting. Their business model is never going to have consistency. When customers (mostly MillerCoors) break pallets, they order more. If they don't break as many one quarter, they don't order as many. Not much GLGI can do about that. The massive net income drop was from MillerCoors and tax changes (which says nothing about their underlying business, I've always looked at "normalized" taxes for them anyway). If they announced MillerCoors dropped them that would obviously be a major issue, but quarterly swings are to be expected.

The main thing I've been paying attention to with GLGI is their non-MillerCoors sales which has now shown four straight quarters of >20% YoY growth.