RediShred Capital Corp V.KUT

online writeup

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RediShred Capital Corp

By

Petty Cash

Dean is the author of

Petty Cash

and writes on X @petty__cash.

 

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*Disclosure: I own shares in XX. I am not a professional. Please do your own due diligence. 

TL:DR

KUT (RediShred Capital Corp) is in what is perceived as a declining industry. The business is far from sexy, but it’s consistent and durable. The company is currently  trading at their lowest valuation in the last 5 years. Additionally, they are exposed to recycled paper prices and are lapping easier comps starting Q2 2024. Management is solid and there are not a ton of shares outstanding. All of their warts can be easily removed, which should propel the shares in 2024 and beyond. 

KUT reported on Monday and held a call Tuesday morning. There was nothing concerning about the call. I felt the tone was positive.

I have held KUT for a couple of years and am below water, so it may be best to skip this article. lol 

1 yr performance: -30%

Price: $2.73 CAD

Shares: 18.3 million (fully diluted)

Market Cap: 50 million CAD

Enterprise Value: 82 million CAD

Background

KUT operates the ProShred franchise and license business in the United States. The company was incorporated in 2006 and is headquartered in Mississauga, Canada. Primary services provided by KUT include, shredding and destruction services; offers electronic waste disposal services under the Secure e-Cycle brand name; sells recycled paper and other recyclable by-products, such as metals and plastics; and resells electronics. In addition, it offers digital imaging, scanning, and related workflow management services. How do they add value

So far this probably seems pretty boring and, in all honesty, KUT is not a company that will impress anyone on your pickleball team (if pickleball has teams) or at the company bbq. 

Despite what KUT looks like on the surface, they offer more than just paper shredding to customers. 

• They offer on site shredding vs. others in the industry offering off site shredding. This can be a scheduled or unscheduled (one-time) service. When the client chooses the on-site option, the customer will receive a certificate indicating their documents have been destroyed at the end of the service. The shredded paper is then bundled and the paper is recycled and sold. Revenue derived from paper recycling is subject to commodity paper prices.  

• They also offer e-waste recycling services, where they dispose of various electronic devices. The components are wiped clean and some are even remarketed and sold.

• Under the ProScan brand, they offer scanning services for physical documents. This service helps companies looking to digitize their documents. 

• Lastly, they get a small amount each quarter in franchise fees from the remaining ProShred franchises. 

The majority of their revenue comes from on site shredding services,  followed by Recycling (paper sales). The E-waste and Scanning portion of the business is starting from a small base but has grown nicely over the last few years. 

Growth Strategy

KUT has a  3 pronged growth strategy:

1. Expand the location footprint in the U.S. by way of franchising and accretive acquisitions. 

   1. The acquisitions tend to have a large earn out as part of the total cost. This limits upfront capital required. 

2. Maximize same location revenue (in particular, recurring scheduled services) and earnings for franchisees and corporate locations. 

3. Drive depth of service and earnings in existing locations by acquiring smaller “tuck-in” acquisitions that are accretive.

The acquisitions come from two sources, existing franchisees looking for an exit and independent operators in the industry. 

1. Existing franchisees are lower risk due to them having more modern equipment, lower integration risk, similar EBITDA margins to existing locations and largely recurring/scheduled revenue. Multiples are based on EBITDA 5-7x and usually carry about 2 million in revenue. These locations will come with their own trucks as well. KUT will use these to expand their geographical footprint and enter new markets. They have 14 franchisees left. 

2. Independent operators are less consistent. Multiples are usually asset based as the operators may not be profitable and have the same sophistication in their operations. They may be in distress and come with a much lower revenue base (100k-1mil). These acquisitions can be quite accretive as KUT can leverage existing routes to increase density and sell additional services to the customer base. There are over 700 potential independents that would be targets. 

Share Structure & Ownership

There are 18.3 million shares outstanding on a diluted basis. The CEO (Jeff Hasham) owns over 350k shares or about 2%. The board owns 16%. DKAM owns 14% and Bunky Holdings owns another 14%. 

Bunky Holdings (Moray Tawse) has been a large shareholder as far back as 2015. Moray Tawse is CEO of First National Financial. First National is a non-bank mortgage lender with a market capitalization of over 2 billion CAD. 

DKAM has been a holder for several years and mentions KUT regularly in their newsletter.

Management & Compensation

Jeff Hasham has been in the business a long time. He was CFO when KUT went public and was promoted to CEO in 2011. 

About 50% of his compensation is salary with the balance being a mix of long term and short term incentives. The value of his holding in the common is about 1.3x his total comp in 2022. The SVPs and CFO have similar compensation packages in regard to a mix of salary, short term and long term incentives via stock options. 

The company does a good job of explaining the compensation in my opinion. It’s worth checking out. Here is a screenshot from the MIC in April 2023. 

Board

There are 8 directors currently, with 6 being classified as independent. That is high in my opinion given the size of KUT. The former CEO is the chair. The independent board members own about 15% of the common, which is quite high for a Canadian microcap.

Director compensation is a mix of cash and stock options. Most of it cash and not egregious. The highest comes in at $70k (for the chair) and the lowest is $25k.

Balance Sheet

Given the high visibility of the business with most of the revenue being scheduled, they deploy leverage to increase ROE. The company uses EBITDA turns as the metric of choice to calibrate the appropriate level of leverage.  As of writing they are sitting at about 1.9x forward EBITDA for leverage. They want to keep the maximum to around 3x. They would have close to 20 million in borrowing capacity at this time. 

Income Statement & Cash Flows

As the business has scaled, margins have expanded. They have been able to keep EBITDA margins above 20% consistently since hitting their inflection point. 

The business requires a fair bit of capital expenses. They typically spend 6-9% of revenue on maintenance capital expenditures. That fluctuates quarter to quarter so it’s best to look at it on a 5-6 quarter basis. 

The above chart does not include swings in working capital. It should be noted that they have required a slug of additional working capital relative to revenue on the last couple of years. I believe this will reverse to some degree. 

Valuation

I have the company doing a bit over 17 million in EBITDA in 2024. This is without any acquisitions and stable paper prices. This puts them at about 5.2 EV/EBITDA. I have them at about a 5.5-6x FCF moving forward. 

Risks

There are risks with any investment. Here are the main ones that I identified:

• Capital Allocation 

  • This would look like them raising equity to execute the growth strategy at a poor valuation. Don’t get me wrong, I do think at some point they may raise equity again, but I would hope it would be at much better valuations than today’s price. 

  • I hope that they don’t kill any real rally in the share price by immediately issuing shares after a 20-30% run in the share price. 

• Paper Prices

  • The business is less and less effected by paper prices as they grow scheduled revenue and ancillary services. Having said that, if prices are volatile in a short period than KUT is affected. The incremental EBITDA from SOP price at 350 (Dec 2022) to 225 (today’s price) is material. When prices correct in a short time period, then the EBITDA margin delta is not very appealing to the public markets. Especially for KUT which is largely retail held. 

• Inflation

  • The main expenses for KUT are labour and fuel. Both can have bouts of rising prices. Over time increased costs can be passed on to the customers with some creative price increases. Another hedge is the price of paper itself. Paper prices tend to move with other commodities (like fuel) and somewhat provide a natural hedge, although they don’t move in lock step.

• Going Paperless

  • We are using less and less paper, or at least we have been. And maybe it continues. I don’t know. The current narrative is that this is a dying industry and that’s fine with me. They have grown scheduled revenue handsomely over the last 5 years and I really don’t expect that to stop. This is more of a perception issue with the stock in my opinion.

• Key Management

  • Though I’m not sure if it would completely kill the idea, but I do think they are very reliant on the current CEO. As with most microcaps, management execution is paramount here. 

• Economic Stability

  • I think it goes without saying that if there was some sort of financial crisis and offices were laying off workers, KUT would be affected. 

• Auditors Notes

  • There are notes in the audited statements regarding going concern. I am not concerned from a cash flow standpoint, but this is something that may affect borrowing costs and access to capital to execute the M&A plan.

Closing Thoughts

KUT has a straightforward path to more than double EBITDA. They have around 10 million possible from existing franchisees with most agreements expiring in the next 3 years. They have quite a bit more opportunity with independents that are not as streamlined, though the EBITDA opportunity is mostly post integration. There is also some continued organic growth via increased same location shredding revenue, scanning and e-waste opportunities. Putting those together I feel that KUT deserves a better multiple. 

The most recent quarter demonstrated that they don’t need to rely on paper prices to grow EBITDA. The base business is at a sufficient scale to grown profitably from here and an extra bump from recycling is welcome.

I think KUT fits nicely in a portfolio. It provides some diversification with little correlation to the capital markets (although it hurts when the indexes rip and KUT doesn’t). I think the current narrative has some room to shift and become more positive. The business has chugged along while the share price has stagnated leaving many investors fatigued as we watch our neighbors get rich on memecoins.

Thanks for reading.

Dean

*disclosure – long KUT.v

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