Today I am looking into a couple of stocks that are down to see if they are value buys or value traps: Enbridge, Inc. (ENB) and Tile Shop Holdings (TTS). These companies could not be more different, but both are in the doldrums. Let’s examine the companies, their financials, and the latest news to see if we should buy, sell or wait for more news on these stocks.
Tile Shop Holdings (TTS)
Tile Shop Holdings does business as The Tile Shop and is a retail shop specializing in the sale of tile and stonework. This is the smaller company with a Market Capitalization (outstanding stock x the share price) of $158.477 million at today’s share price of $2.62 per share (down from its high of $8.20 per share). Initially, this seems like an attractive price since they offer a $0.20 per share dividend which would be over an 8% return right at the start! This naturally assumes that the company stays in business and that they do not reduce their dividend. For the company to be able to do so, they need to be profitable and have sufficient cash flow to maintain the dividend.
Let’s start with the basic financials that have been released to the public (from Yahoo Finance and the company’s Investor Relations section of their website). TTS’ income statement shows:
Revenue 2015 = $293 million, Net Income $15.7 million
Revenue 2016 = $324 million, Net Income $18.5 million
Revenue 2017 = $345 million, Net Income $10.8 million
Revenue 2018 = $357 million, Net Income $10.4 million
So far, there’s no indicator of what might drop the stock 70%. Perhaps if we examine the last four quarters.
9/30/18 Revenue = $63 million, Net Income $2.5 million
12/31/18 Revenue = $59 million, Net LOSS $1.1 million
3/31/19 Revenue = $62 million, Net Income $2.9 million
6/30/19 Revenue = $61 million, Net LOSS $0.2 million
The losses every other quarter look pretty bad, but to determine if this is their usual pattern, we’ll need to look at additional reporting.
12/31/16 Revenue = $77 million, Net Income $3.8 million
3/31/17 Revenue = $92 million, Net Income $20.7 million
6/30/17 Revenue = $89 million, Net Income $18.8 million
9/30/17 Revenue = $84 million, Net Income $2.4 million
12/31/17 Revenue = $79 million, Net LOSS $2.4 million
3/31/18 Revenue = $91 million, Net Income $13.7 million
6/30/18 Revenue = $93 million, Net Income $15 million
Without looking at anything else, we can see that the sales have been slipping and the company has not been cutting costs enough to keep profits stable. This does not give us a lot of hope in the short term for this stock to rebound a lot in price. However, if it can keep up the dividend, I’ll still get the 8% return, so let’s check out the balance sheet and the cash flow for 2015-2019.
I like to see robust cash, good cash flow and plenty of total assets to cover total liabilities. Since TTS is a store, let’s also take a look at the inventory. We find:
Annual:
12/31/15
Cash = $10 million; Inventory $70 million;
Assets = $245 million; Liabilities = $130 million
12/31/16
Cash = $6 million; Inventory $74 million;
Assets = $265 million; Liabilities = $126 million
12/31/17
Cash = $6.6 million; Inventory $85 million;
Assets = $271 million; Liabilities = $127 million
12/31/18
Cash = $5.6 million; Inventory $110 million;
Assets = $297 million; Liabilities = $151 million
Quarterly:
3/31/19
Cash = $8 million; Inventory = $111 million;
Assets = $430 million; Liabilities = $279 million
6/30/19
Cash = $4.4 million; Inventory = $107 million;
Assets = $417 million; Liabilities = $279 million
Not a beautiful picture. Inventory is swelling which could imply that TTS is not selling enough product. On the plus side, inventory is stone, so we don’t have to worry about it rotting. But the tile business is about meeting the fashion demands for housing, so it is possible for the stone to become less valuable because of changing tastes.
The total assets continue to grow – mostly because Property Plant and Equipment (PPE) surges from $135 million in 2015 to $283 million in 2019. This implies that the store count may be growing. Checking the annual reports shows that TTS had 114 stores with an average of 21,800 square feet as of December 31, 2015. By 2018, TTS had 140 stores with an average of 20,200 square feet. Many more stores. However, I note that TTS does not own their stores, they lease them, so that does not account for the rise in PPE. They do own regional distribution centers and the equipment in them to manufacture their products for their stores, but that number has stayed at four from 2015-2018. It is not clear why the PPE is surging, so that is an issue of concern.
Looking at the cash flow (CF), we find:
Annual:
12/31/15
Operating CF = $60 mil.; Investing CF = -$19 mil.;
Financing CF = -$37 mil.; Net CF +$4.6 mil.
12/31/16
Operating CF = $54 mil.; Investing CF = -$27 mil.;
Financing CF = -$24 mil.; Net CF +$2.4 mil.
12/31/17
Operating CF = $46 mil.; Investing CF = -$41 mil.;
Financing CF = -$11 mil.; Net CF -$5.5 mil.
12/31/18
Operating CF = $18 mil.; Investing CF = -$34 mil.;
Financing CF = +$14 mil.; Net CF -$1.1 mil.
Quarterly:
3/31/19
Operating CF = $19.7 mil; Investing CF = -$11.6 mil.;
Financing CF = -$5.7 mil.; Net CF $2.4 mil.
6/30/19
Operating CF = $2.3 mil; Investing CF = -$5.6 mil.;
Financing CF = -$0.2 mil.; Net CF -$3.5 mil.
This is not a promising story either. The surge in financing in 2018 shows TTS taking on debt to help fund activities. Yet the Operating cash flow continues to dwindle even though they keep trying to grow through their investing cash flow activities. Of greater concern is that TTS pays $2.6 million per quarter and $10.4 million per year in dividends. If the Operating cash flow is the money coming in through business activities, $18 million in 2018 covers the dividend, but the $30 million drop in cash flow between 2017 and 2018 is very alarming. The operating cash flow of $2.3 million in Q2 of 2019 is below the dividend amount which is not sustainable! Unless TTS turns around its business this quarter, they will need to drop the dividend and there goes my 8% return.
So, what do I do? I certainly don’t buy TTS given the red flags of sagging sales, growing inventories, investments in PPE that I cannot track and do not seem to be paying off, increased liabilities and dropping cash flow. Even from the standpoint of personal values, I’m on the fence. I don’t have the money to support TTS by remodeling my bathroom and buying tile, so why would I buy more? On the other hand, I love an underdog story and I know that retail stocks are unfashionable. Could this be the exception success story? The financials suggest that is not the case.
I am very tempted to sell, but I consider myself a ‘buy and hold’ investor and I don’t want to be premature – even if this may make me late to sell. They will be announcing the next quarter’s results on October 16th, so I will wait for that and hope for the best (perhaps like a fool).
Meanwhile, let me move on to the second stock.
Enbridge Inc. (ENB)
Enbridge Inc. (ENB) is an energy company based in Canada that owns pipelines for oil (50% of Earnings before interest taxes, depreciation and amortization; AKA: EBITDA), pipelines for natural gas (30% EBITDA), and a utility that sells natural gas to consumers and businesses (15% of EBITDA). This is a much larger company than TTS ($158 million) with a market cap of $66.2 billion dollars at today’s stock price of $32.89 per share (down from it’s high of $38 per share). This stock has been steadily beat down like most oil company stocks for the past five years (it sold for over $50 per share in 2015), but it offers a $2.22 dividend per share which would return 6.74% at today’s prices. This is not as high as TTS’s 8.8% yield, but I suspect that this stock has significantly higher stability. Let’s look at the numbers and verify that idea.
As we did before, let’s start with the basic financials that have been released to the public (from Yahoo Finance and the company’s Investor Relations section of their website). ENB’ income statement shows:
Revenue 2015 = $33.8 billion, Net LOSS $37 million
Revenue 2016 = $34.6 billion, Net Income $2.1 billion
Revenue 2017 = $44.4 billion, Net Income $2.9 billion
Revenue 2018 = $46.4 billion, Net Income $2.9 billion
Well, if they are regularly making $3 billion a year, I would certainly consider this a stable business! The loss in 2015 explains the drop from $50, but the regular profits since then are reassuring. Let’s check the last two quarters to see if the story has changed.
3/31/19 Revenue = $12.9 billion, Net Income $2.0 billion
6/30/19 Revenue = $13.3 billion, Net Income $1.8 billion
This looks great! If the company normally makes ~$3 billion a year and has already made $3.8 billion in the first two quarters, it could lose almost a billion dollars over the rest of the year and hit last year’s numbers!
Since this is quite solid, I’m going to go straight to the Balance Sheet and the Cash Flow statements to see how well they support that attractive 6.6% dividend. Since this is an oil transport company and not a retail store chain like TTS, we’ll be checking different metrics to understand their business. Instead of Inventory, we’ll be looking at Net Receivables (money owed by customers) which is a larger part of their assets.
Annual:
12/31/15
Cash = $1.0 billion; Receivables $3.9 billion;
Assets = $84.5 billion; Liabilities = $62.2 billion
12/31/16
Cash = $1.5 billion; Receivables $5.0 billion;
Assets = $85.2 billion; Liabilities = $59.8 billion
12/31/17
Cash = $0.5 billion; Receivables $6.8 billion;
Assets = $162 billion; Liabilities = $92.3 billion
12/31/18
Cash = $0.5 billion; Receivables $6.1 billion;
Assets = $167 billion; Liabilities = $93.5 billion
Quarterly:
3/31/19
Cash = $702 million; Receivables $6.4 billion;
Assets $167 billion; Liabilities = $92.6 billion
6/30/19
Cash = $708 million; Receivables $6.1 billion;
Assets $165 billion; Liabilities = $92.0 billion
Again, this is a solid result indicating a solid company. ENB has almost a billion dollars in cash on hand, doubled their assets (from $84.5 billion to $165 billion) and only increased their liabilities by 50% (from $62.2 billion to $92.0 billion). Additionally, they seem to be paying off $0.5 billion each quarter from their debt without reducing their cash significantly.
Of course, Enron and Worldcom showed great revenue and profits before they imploded under a cloud of fraud. However, while accounting shenanigans can obscure issues for the balance sheet and the income statement, it is almost impossible to manipulate the cash flow. After all, the money in the bank is fairly easy to check for even the most basic auditor. Therefore, let’s check the Cash Flow to see if it shows the same great results or hints at trouble.
Annual:
12/31/15
Operating CF = $4.6 bil.; Investing CF = -$7.9 bil.;
Financing CF = +$3.1 bil.; Net CF -$145 mil.
12/31/16
Operating CF = $5.2 bil.; Investing CF = -$5.2 bil.;
Financing CF = +$0.8 bil.; Net CF +$874 mil.
12/31/17
Operating CF = $6.7 bil.; Investing CF = -$11 bil.;
Financing CF = +$3.5 mil.; Net CF -$975 mil.
12/31/18
Operating CF = $10.5 bil.; Investing CF = -$3.0 bil.;
Financing CF = -$7.5 bil.; Net CF +$50 mil.
Quarterly:
3/31/19
Operating CF = $2.2 bil.; Investing CF = -$2.2 bil.;
Financing CF = +$99 mil.; Net CF +$120 mil.
6/30/19
Operating CF = $2.5 bil.; Investing CF = -$1.3 bil.;
Financing CF = -$1.2 bil.; Net CF +$10 mil.
The dividends are also shown on the cash flow as $3.8 billion in 2018 and $1.6 billion per quarter in 2019. Although ENB is investing heavily in infrastructure ($11 billion in 2017!), pipelines are not cheap, so I’ll give them the benefit of the doubt for now that the investment will pay off. After all, unlike TTS, as they plow money into the company, revenues and operating cash flow actually increase. The operating cash flow more than covers the dividend obligations, so even in somewhat hard times, I believe that ENB will be able to pay that 6.6% dividend. This one is a potential buy!
From a personal values standpoint, I am favorable towards oil. I understand it is unfashionable to look kindly on the companies producing the sources of greenhouse gasses that contribute to global warming. However, while I believe in global warming, I don’t blame the oil companies more than I blame the consumers. How many protesters do we see wearing nylon clothes (petroleum based), drinking water from plastic bottles (petroleum based) in front of their electric cars which are likely powered by fossil fuels? Afterall, coal, petroleum and natural gas account for 64% of the fuel used for power generation. That’s not really a defense, just an observation that our world is not yet set up in a way for us to avoid using oil and natural gas.
Therefore, I am bullish on buying ENB. If I was simply trying to pick between two stocks to buy, ENB is the clear choice. In my particular position, my greed wanted me to double down on TTS for that fat 8.8% dividend, but their financials simply don’t support it. They are also not so terrible that I am trying to liquidate right away. They are almost there, but I am falling prey to the psychological aversion to losing the money I already invested when I bought the stock at $8 a share. For now, I’ll just post this analysis and look into buying ENB.