Every once and a while I like to put up guest posts on Ragnar. As such, here is one from once of my favorite people on Twitter: @vanckzhu We are both long the stock, and think that it is a really good price, for the flows of cash that should be coming. :)
Here is his original post: https://lightbluevalue.wordpress.com/2021/01/27/pmd-trucking-along-into-a-potential-big-catalyst-21-pt/
$PMD is a $39M market cap (similar for EV assuming PPP loan is forgiven) hair follicle testing company. It pioneered the first commercially-available drug test for hair in 1986, and states that they have the best hair follicle test on the market currently, 2-3x better than any other hair test. $38M in revenues in 2019, $25M on TTM basis ($5M in MRQ), historically operating margins range from 5% to 25%, although generally it hovers around ~20%. At peak Brazil was about 30% of revenues and was part of an expansion initiative, but Brazil sucked even in 2019 (revenues down nearly 30% y/y) and has since dropped basically to zero revenues. If we run-rate 3Q revenues to $20M, I think they can achieve 15-20% operating margins, or $3-$4M in operating income. So pretty cheap as is.
There’s four reasons for excitement today:
1. The federal government is in the process of requiring hair testing for the transportation department. If you read the public docs (link below), it appears that there’ll be ~3M hair tests once this fully ramps and hair tests appear to cost about $40 (maybe $20 goes to $PMD? just guessing…). Maybe $PMD takes 1/3 of market share, or 1M tests (although I think there’ll be some cannibalization as some trucking companies already require hair tests). $20/test…is $20M, which is quite material vs ~$30M in U.S. revenues in 2019. If incremental operating margins are 25-30%…that’s $5M+ in operating income and you can see how this gets pretty exciting pretty quick. https://www.federalregister.gov/documents/2020/09/10/2020-16432/mandatory-guidelines-for-federal-workplace-drug-testing-programs
2. Peter Kamin took a 5.9% stake in December. His historical investments have generally been excellent (loved what he did with $CLWY), and his MO is to buy legacy cash flowing businesses and really turbo-charge the earnings.
3. The 2Q:20 10-Q disclosed that they were approached by third parties and hence are undergoing a strategic review. That language dropped off in 3Q:20 strangely…but it seems that there does exist takeover interest. Quest Diagnositics would be a natural buyer IMO, since Quest also operates in Brazil in addition to the U.S. I think this actually is off the table now with Kamin invested.
4. Management was awarded 35K in options ($4.07 strike price) and 150K in RSUs on 11/11/20.
So I think in a “normal” world they return to $30M in revenues at ~20% operating margins (~$6M operating income), and we’ll likely see another $5M with the passage of the law. $11M in operating income, $41M current EV. I think fair value could push this to $120M EV or even higher, so this could be a triple to ~$21 even with the recent runup. Not to mention, Brazil could be worth something still, and Kamin could work some magic on the expenses side. We probably find downside support around where Kamin bought his shares, which ranged from $3.74 to $4.68.
I think this is a pretty good business assuming a “normal” environment. While they do have 9 patents, I don’t think the technology is the key competitive advantage (pops who is a chemist says the rough science is pretty straightforward). I think it’s really the process, reputation, and relationships in a regulated industry that’s built up over the decades. Historical returns on equity/capital/etc. are all pretty strong.
This business is economically sensitive and basically is levered to hiring levels of blue collar workers (those who operate heavy machinery such as truck drivers, oil and gas workers, construction workers, etc., where the legal liability for accidents is high). In 2009, revenues fell by 28% and operating income by 45% but the company remained profitable. COVID has been worse, and they’ve lost money in 2Q and 3Q. However, I think we should be somewhere around breakeven in 1Q:21, with trucking tonnage indexes inflecting back positive y/y (https://www.bulktransporter.com/fleet-management/article/21153185/atas-truck-tonnage-index-jumps-74-in-december).
While they’ve been losing money this year, there’s no credit risk here IMO. They were slightly net cash as of 9/30/20. There’s about $1.4M in income tax receivable credits coming in 4Q:20 and 1Q:21, and potentially a bit more PPP loans as well. Their 3Q 10-Q stated that they expect to have sufficient liquidity for the next 12 months, and that was filed on 11/10/20 which basically coincided with the vaccine announcements so their projections are likely conservative.
Risks
1. There’s some lawsuits about hair tests not being sufficient to disqualify job applicants, but the solution seems to be implementing an additional test (urine) when someone tests positive: http://masscases.com/cases/app/90/90massappct462.html
2. Competition. LabCorp and Quest are large. However I think $PMD’s ability to stay in business since 1986 (and is used as a lab by federal gov’t) demonstrates sufficient staying power.
3. Trucking hair test regulations scrapped. I view this as unlikely as this regulation has already entered public comment phase and some of the largest for-hire public trucking companies (Knight, Schneider, JB Hunt) are all pushing to require hair tests. The FAST act of 2015 mandates the development of hair testing as an alternative testing method. I do expect that implementation of the regulation will be delayed. As an anecdote, the timeline for the last major piece of trucking legislation on electronic logging devices suggests it could be another 5 years before actual enforcement:
1) June 2012: MAP 21 act passed
2) April 2014: Public comment period opened (we’re roughly 4 months after public comment period opened for hair tests)
3) February 2016: becomes law
4) December 2017: early adoption allowed, beginning of 2-yr trial period
5) December 2019: electronic logging becomes mandatory
Disclosure: Long
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