Comparables and ValuationRegarding valuation, it is helpful to look at comparable companies. Alaris is a Canadian royalty co that "lends" larger amounts to much larger and lower risk companies. It trades at 18x free cash flow. To put that in perspective, assuming our $0.05 is free cashflow for GRC, we trade at less than 8x FCF! At 18x FCF, GRC would be $0.90 not $0.375.
Yet, our return on capital is much higher. We strive to get and do get 25% and they get just under 15%. On page 7 of the most recent MD&A, they show the return on capital performance on a trailing and rolling 12 month basis, which includes royalty payments, gains from buyouts and writedowns. It is the best measure of how the capital is performing. It currently sits at a whopping 35.8% or $358K per million. Over the last 12 months, on a montly basis, the rolling 12 month trailing returns are 25% plus or minus a bit.
Why does GRC trade at such a discount? I belive the market doesn't understand or appreciate the GRC model. See my earlier post on that. But, equally important is the fact the Company has not managed its capital markets strategy very well. First, in November 2015 when the Co increased the dividend to $0.07 on an annual basis from $0.05, it was an aggressive and risky move as the performance had been driven in part by lumpy buyouts which juiced returns. They cannot be depended upon on a linear and regular basis. But, if they called the extra $0.02 a special dividend in addition to the regular $0.05 dividend rather than refer to a new 7% dividend, it would have been more reasonable and in tune with reality. This misstep causes investors to lose confidence as the dividend was reduced a short while later back to $0.05. Had they done it the other way, no one would have batted an eye. The only difference was two words - "special dividend". As a result, the multiple is lower. It is painful learning experience.
Next, not all investments get bought out at a premium. Some underperform and may even recover. It just so happens that one of the Co's large investments was indirectly dependent upon the oil price which tanked as we all know. As a result, it had to be written down at as per the Co's rigorous accounting standards. It was written down at the Year end and investors went crazy. In addition, a follow on investment to help the Co while the price of oil recovered also had to be written down as the investee had not fully recovered. However, we also know oil had doubled off the low and many are calling for much higher oil prices. It may be written back up and result in a "windfall". But it is not a windfall, it is just a non cash adjustment. Ofcourse, the investee company may also be able to start paying the royalty payments again which would be a real improvement to cash. Still, these things happen in the SME world. It is typical. Yet, there has been a lack of appreciation and overreaction to these events. As Mgmt learns and continues to deliver the "goods" as set out above in the form of healthy return on capital, the valuation will move toward its comps such a Alaris. FYI Alaris has also made bad investments but they are more costly as it works on a 14% return on capital and makes much larger investments so its mistakes are more costly. But, it stil trades at 18x cashflow. That would be $0.90 for GRC. Food for thought.