July 8, 2020

Today we are profiling a logistics company that is far under the radar of most investors, despite strong revenue growth, 100%+ earnings growth in its most recent fiscal year, and a mid-single-digit P/E.

Further, management and directors own 44% of the company’s stock, ensuring that investors are well aligned.

All the details are inside this month’s Issue. Enjoy!

Cabot Micro-Cap Insider 720

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Micro Caps Continue to be Ignored
This week, we profile Greystone Logistics (GLGI), a classic micro-cap company that is growing earnings 140% this year but only trades at 6.6x earnings.

Why is the company so cheap? Because it’s a micro cap!

If this company had a market cap of $1 billion or more, institutional investors would be all over it.

Luckily for us, we can wait patiently for the company to continue to grow its value. Once its valuation gets big enough, we will be happy to offload our shares to an institutional investor.

Year-to-date, micro caps have underperformed the S&P 500, as shown in the chart below.

Nonetheless, our recommendations have performed very well and, importantly, the long-term performance of micro caps as a group speaks for itself (18% annual CAGR).

I continue to find many attractive, growing micro caps trading at cheap valuations, and look forward to sharing them in future issues.

Our monthly webinar will take place this Thursday, July 9 at 2 p.m. ET. We will review all open recommendations and answer subscriber questions.

If you have any questions about any of my recommendations, I encourage you to reach out to me directly at rich@cabotwealth.com.

Now let’s get into my newest recommendation: Greystone Logistics.

New Recommendation

Greystone Logistics: A ‘Pallet-able’ Addition to Your Portfolio
Company: Greystone Logistics
Ticker: GLGI
Price: 0.81
Market Cap: $23 million
Enterprise Value: $41 million
Price Target: 1.58
Upside: 95%
Recommendation: Buy Under 1.00
Recommendation Type: Rocket

Executive Summary
Greystone Logistics (GLGI) is a micro-cap manufacturer of plastic pallets. It has historically grown revenue at a 34% compound annual growth rate and is on pace to grow EPS 140% this year. Despite such strong growth, the stock trades at a P/E of 6.6x. Management and directors own 44.1% of the stock and are well aligned with shareholders. My price target is 1.58.

Background
Greystone Logistics is an over-the-counter micro-cap company that specializes in manufacturing plastic pallets utilizing recycled plastic.

Pallets are devices used for moving and storing freight. A pallet is used as a base for assembling, storing, stacking, handling, and transporting goods as a unit load. It’s also constructed to facilitate the placement of a lift truck’s forks between the levels of a platform so it may be moved easily.

Pallets are used worldwide for the transportation of goods and they are primarily made of wood. An estimated 80% to 90% of all U.S. commerce is carried on pallets, which amounts to an estimated 1.9 to 2.0 billion pallets in circulation daily in the United States.

See below for examples of pallets that GLGI manufactures.

As shown below, GLGI stock has performed well over the past three years. The recent spike in the share price is due to a very strong quarter and the favorable current outlook.

Greystone Logistics Overview
Historically, GLGI has done an excellent job growing revenue, as displayed below.

While the majority of pallets are made out of wood, GLGI manufactures pallets made out of recycled parts.

While plastic pallets are more expensive, they are more durable and can be used many times, while wooden pallets are often just used once. Further, plastic pallets have the advantage of being more sanitary.

As a result, demand for plastic pallets has been growing faster than demand for wooden pallets, while demand for pallets as a whole has demonstrated strong growth.

From 2012 to 2016, the global pallet market grew at a compound annual growth rate of 4.7%, and the market is expected to grow at a compound annual growth rate of 5.4% between 2017 and 2025.

While GLGI has done an excellent job growing revenue, net income growth has been more erratic and that has been driven by volatility in the company’s gross margins.

However, GLGI’s most recent quarter suggests gross margin and net income are heading significantly higher.

Business Outlook
In April 2020, GLGI reported its fiscal third-quarter results.

While sales grew 15%, the most impressive aspect of Greystone’s quarter was its profit growth. The company reported that net income grew 750% to reach $1.964 million ($0.06 per share).

The key drivers of increased profits were 1) price increases for certain pallet lines and 2) improvement in production costs. These two drivers resulted in gross margin improving from 12.4% in the prior quarter to 20.9%.

In its 10-Q, GLGI wrote that the gross margin improvement was driven by “significant ncreases in pallet production levels resulting from installation of hardware and software to improve the flow of resin into molds on injection molding machines, the addition of a new pelletizing line which increases Greystone’s capacity for pelletizing plastic in lieu of purchasing plastic in pelletized form and price increases on certain pallets.”

Importantly, the company expects gross margin to improve even further, driven by “the addition of a new injection molding machine in March 2020, to replace an older unit, additional hardware and software to regulate the flow of resin thereby increasing pallet production levels, completing the installation of an additional grinding machine to increase grinding capacity thereby reducing raw material cost through the ability to use lower priced unground recycled plastic, and completion of the robotics installation on two production lines.”

In terms of the outlook for the current quarter, management noted, “We anticipate some decrease in our production rates because of the impact to our workforce from some employees electing to stay home and declines in recruitment. We believe that the Company will have a solid quarter for sales and earnings despite the hardships created by the COVID-19.”

In GLGI’s fourth quarter, I’m expecting EPS of $0.03 and for revenue to decline by 5% given COVID-19 headwinds. If this forecast is accurate, GLGI will have generated EPS of $0.12 in fiscal 2020 and EPS growth of 140%. Despite this rapid growth, the stock is only trading at 6.6x earnings.

In fiscal 2021, I’m only assuming 5% revenue growth and 19% EPS growth to be conservative. However, the stock still looks cheap even assuming these modest growth assumptions.

Over the past four years, GLGI sales have grown at a 34% compound annual growth rate. As discussed above, I’m assuming COVID-19 will temporarily slow down that rate of growth, but I believe, looking out a few years, sales, gross profit, and net income will be substantially higher than current levels.

Valuation and Price Target
Despite rallying over 100% since its last earnings announcement, GLGI is very cheap.

It is on pace to grow EPS 140% in 2020 yet only trades at a P/E of 6.6x.

Over the past five years, GLGI has traded at a median P/E multiple of 10.5x. Applying a 10.5x P/E to my fiscal 2021 EPS estimate of $0.15 yields a $1.58 price target, implying significant upside.

Importantly, I think my EPS estimates are conservative and earnings will be significantly higher looking out several years once the COVID-19 pandemic is behind us. This would drive even more upside for the stock.

Make sure to use limits when buying GLGI as the stock is very illiquid.

My rating for GLGI is Buy Under 1.00.

Risks

1. Customer Concentration. Four customers represent 87% of revenue. If GLGI were to lose one customer, it would have a material negative impact on its business and stock price.
   
   • While customer concentration is certainly a risk, it appears that Greystone is doing a good job of diversifying and growing its business with its top customers. This suggests GLGI’s customers are happy with the service being provided.
2. Related Party Transactions. CEO Warren Kruger owns Yorktown Management. GLGI pays Yorktown $1.4 million per year to rent its grinding equipment and palletizing equipment. Yorktown also provides administrative office space for Greystone in Tulsa, Oklahoma for $4,000 per month. There have been several other related party transactions.
   
   • While I would prefer to see no related party transactions, Kruger’s 34% ownership of GLGI largely mitigates this conflict of interest as it’s in Kruger’s best interest to increase the share price of GLGI. Further, Kruger and another board members have personally guaranteed a $6.5 million loan to GLGI. This provides further alignment with common equity shareholders.
3. High Debt Level.
   
   • GLGI has $17.3 million of net debt. While this debt level isn’t overly onerous (less than 2.0x EBITDA), it is a relatively high debt burden for a smaller company. I’m comfortable that GLGI can handle its debt burden because 1) the company generates significant free cash flow (~$6 million through nine months of fiscal 2020); 2) the weighted average interest rate is ~5%; and 3) a significant portion of the debt is guaranteed by the management team and directors.

Recommendation Updates
Changes This Week
No Changes

Updates
HopTo Inc (HPTO) continues to bounce back and forth between 0.45 and 0.52. There was no news or SEC filings this week. As a reminder, hopTo reported first-quarter results on May 20. Sales declined 21%, which appears very bad at first glance. However, sales for hopTo are typically lumpy on a quarter-by-quarter basis. The 10-Q discloses that the decline was due to timing of revenue recognition and a larger order in Q1 2019 that did not renew. Most importantly, management noted that it expects “sales in 2020 to be similar to sales” in 2019. In other words, management doesn’t expect a decline in sales in 2020 despite the Q1 drop. This is the same language that hopTo used in 2019 (sales grew 13% in 2019). As such, I’m not concerned with the headline drop in sales in Q1.

One issue that I will continue to watch relates to the rights offering that hopTo closed in March. As part of the agreement, there was a backstop agreement whereby management and a consortium of accredited investors agreed to purchase at $0.30 per share up to $2.4 million of hopTo stock. Essentially, the backstop agreement is a massive insider buy and bodes very well for the outlook of the stock. That transaction was expected to close in April but the 10-Q indicated that it was not expected to close until May. We haven’t received an update on whether the backstop agreement has closed. If it fails to close, it will be a negative signal for the stock.

If the stock falls back to 0.44 or lower, I would likely upgrade to Buy. Hold

Liberated Syndication (LSYN), a recent recommendation, continues to trend down with no news. LSYN is a profitable podcast and website hosting company with $10 million of net cash on its balance sheet, growing at a double-digit clip. As the business does not require much capex, it generates significant free cash flow. Despite its high business quality, sticky revenue and secular growth trajectory, LSYN trades at just 8.2x 2019 EBITDA and 10.0x free cash flow (excluding cash). An activist recently won a proxy fight with management and has undertaken a strategic review for the company. The conclusion is expected to be announced soon. My 6.00 target implies significant upside. Buy under 3.35

Medexus Pharma (PDDPF) reported excellent fiscal fourth-quarter results recently as we expected. As a result of the transformative XINITY acquisition, Medexus generated adjusted EBITDA of $4.2 million in the quarter or $16.8 million on an annualized basis. Better yet, revenue grew organically by 27%. So clearly there is significant growth ahead. One other positive is that Medexus bought back 919,000 shares (~9% of shares outstanding) in the past fiscal year, including 139,400 in the most recent quarter. Based on Medexus’ run rate EBITDA of $16.8 million, the stock is currently trading at an EV/EBITDA multiple of 6.0x and an EV/Revenue multiple of 1.0x. It’s even cheaper on forward estimates. Specialty pharma companies trade at an average EV/EBITDA multiple of 16.5x and an EV/revenue multiple of 3.4x. Buy under 2.50

P10 Holdings (PIOE) was up this week on no news. PIOE reported earnings on Thursday, April 30. Revenue grew 8% y/y due to additional fundraising by RCP Advisors. Cash earnings stayed flat y/y at $0.04 although that was due to costs related to acquiring Five Points and almost acquiring another private equity manager. RCP Advisors noted it has already raised $165 million of additional capital commitments for its private equity funds. It will launch two more funds this year and Five Points will also begin a new fundraise. Excluding one-time costs, PIOE will generate $0.27 in cash earnings in 2020. As such, PIOE is trading at 9.3x 2020 free cash flow. Given the stock’s strong fundamentals and attractive absolute and relative valuation, I recently increased my buy limit to 2.50. Buy below 2.50.

Riviera Resources (RVRA) was down slightly on the week with no news. The next catalyst for the stock would be the announcement of a sale of one of RVRA’s assets. This would likely result in another distribution for investors. RVRA continues to be an attractive long-term holding. It has minimal debt and is generating positive free cash flow. Further, it has a valuable asset in its Blue Mountain midstream business. Once the energy market turns (it’s starting to show signs of turning), Riviera will be well positioned to benefit. BUY Under 2.25

U.S. Neurological Holdings (USNU) was up slightly this week on no news. USNU operates as a holding company in the United States. It is engaged in providing medical treatment and diagnostic services that include stereotactic radiosurgery centers, utilizing gamma knife technology, and holds interests in radiological treatment facilities. USNU reported Q1 2020 earnings on May 15. The company generated $0.02 of earnings and $399,000 of free cash flow in the first quarter, and as a result net cash on the company’s balance sheet increased to $1.7 million or $0.22 per share. USNU did note that revenue declined 12% in the quarter driven by fewer procedures being performed due to the outbreak of COVID-19. Eventually, I would expect deferred procedures to resume. USNU stays at Hold this week, but if it drops below 0.20, I would upgrade it to BUY under 0.20. HOLD

Watch List
This month, my watch list remains the same: DMLP and SOFO. I continue to research both companies.

Dorchester Minerals (DMLP) is an oil and gas royalty company that pays out all of its earnings to shareholders. It has no debt and so it has no risk of bankruptcy. The lowest quarterly distribution that DMLP has made over the past 10 years was $0.15 in 2016 (the last time energy prices were depressed). At DMLP’s current price, it’s trading at a trough yield of 5.0%. I will continue to research this name and may recommend it in a future issue.

Sonic Foundry (SOFO) is a video software company that specializes in solutions that cater to the education market. The company has struggled over the past three years but appears to be very well positioned to increase sales in the COVID-19 world as many schools will be embracing remote classes. Further, the chairman of the company recently tried to take the company private at $5.00 per share, but relented when minority shareholders complained that this price was too low.

Recommendation RATINGS

*Includes 0.75 distribution

Glossary
Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Rich Howe owns shares in LSYN, HPTO, PIOE, PDDPF, and RVRA. Rich will only buy shares after he has shared his recommendation with Cabot Micro-Cap Insider members and will follow his rating guidelines.

The next Cabot Micro-Cap Insider issue will be published on August 12, 2020.

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