We knew nothing about fibreglass before we found Vitreous. Listed on the TSX, this is a strange little Alberta company that we came across in 2013 and is so far the most interesting and fun story we have come across. It is a very simple, very well run business that has found a great niche. That said. after a meeting with a personable CEO, taking a plant tour, and spending many hours looking over old SEDAR reports you are bound to get a soft spot.
Company Background & History
Established in Airdrie, Alberta in 1992, Vitreous Glass purchases recycled glass (primarily beverage containers) which is then cleaned, crushed and sold as "cullet" to two main fibreglass insulation manufacturers in the province. The Company is run by the plant manager and the founder/CEO. Historically, the Company had two business segments: 1) waste glass processing, which it has done since company inception and is currently its only operations, and 2) a disastrous kitchen cabinet manufacturing and installation, which it started in early 2001 and divested in 2006. A business segment once described as "a complete mistake, just awful", its Kitchens business had erratic operating results and recurring losses; revenues in the few years prior to selling the business ranged from $4.5-$7.7m, with operating losses in the ~$300k-$700k range, and was ultimately sold for $500k. The Company also formerly had a small operation in Pennsylvania, which discontinued operations in 2004 due to lack of supply availability and horrible margins (“everyone works for free”).
Business and Economics
Before Vireous, recycled glass in Alberta was not actually recycled. The deposit system was implemented as a highway beautification effort and not for environmental reasons. For several years glass was collected and simply dumped into landfills. The Alberta government put out an exclusive contract bid for the glass it collects every year in an effort to reduce waste and create a new source of revenue. A group of investors came up with an idea and bid.
The idea is simple; Vitreous exclusively collects all of the waste glass from the Alberta Liquor Depot (slightly over 60k tons per year) and also buys smaller quantities from BC and Saskatchewan. Waste glass is transported via truck, which is then cleaned, crushed and sold as cullet to three fibreglass insulation manufacturers (two of which are large and have most of the market - Johns Manville/Schuller International Canada in Innisfail, and the Owens-Corning Fibreglass Canada plant in Edmonton), which use cullet as raw material in their production facilities. These three manufacturers produce all of the fibreglass building insulation made in Alberta; hence, demand for Vitreous' product is primarily driven by new-build real estate activity.
Vitreous has a contract to accept glass from the Alberta Liquor Depot (no such agreement with its other suppliers) and ships to its three main customers on a day-to-day basis. Since Vitreous' product is essentially on-demand on short notice, having a secure supply of waste glass feedstock is imperative. The drawback to this arrangement is that Vitreous must accept all waste glass regardless of its actual needs. A few years ago the Company actually ran very low on raw materials but is currently oversupplied (for context, during our site visit the Company had 31,000 tons of materials and an ideal level is 15,000). That said, the contract is at a very good rate. On the other side, it is also a fair agreement for the government. They like it as they don’t have to deal with the product at all. It is a raw material that takes up space that was useless before Virtreous and today it still has no material alternative uses.
The real costs in raw materials are in shipping, which are significant. Despite most of Vitreous' glass being sourced locally, the cost of trucking transportation is estimated to be at least 3x the cost of just raw materials in COGS. However, the benefit of this low value-to-weight ratio, long-haul transportation is generally uneconomic and therefore the Company receives little competition from out of the province. In effect, they have created a natural regional monopoly.
The fibreglass manufacturing process is energy and capital intensive, as it involves melting materials to a liquid form. These materials can be either glass or sand, and all of Vitreous' customers primarily use glass, as its melting point is significantly lower when compared with sand. If customers were to switch from glass to sand, or vice versa, it would require several months downtime and a re-tooling of its machinery, also creating significant switching costs. Like cullet, fibreglass insulation is expensive to ship long distances, given its low value-to-size (volume). Combined with what will be likely low long-term AECO gas prices for energy, we believe the probability of Vitreous' customers permanently moving its plants is quite low.
Insourcing by its customers has also not been an issue and is not expected to be. Vitreous' customers do not seem willing to in-source for several reasons despite the Company's very high profitability metrics, based on discussions with Pat Cashion. The main reason is that Vitreous' is an extremely well run reliable operation with fair margins that has not given its customers any reasons to in-source. We believe that its customers have likely entertained offers to purchase the Company, but these offers are probably materially below where the stock price is today. It’s simply easier to just work with Vitreous than to buy the Company.
Vitreous is well run and also prepared for manufacturing issues. The plant has spare parts for every major piece of machinery and any expected maintenance only takes approximately half a day. Additionally, in the past ~15 years, only one batch of unsatisfactory cullet has been returned. There are also logistical issues that Vitreous must deal with that its customers do not, such as finding storage for its waste glass in periods of low demand (as the Company must accept new raw inputs due to its contract), which allows its customers to focus on its main operations.
Although Vitreous passes on any increases in raw material costs to its customers, in-sourcing does not make sense as they would still be paying these increased costs. Vitreous has kept a fair consistent margin and its customers receive dependable just-in-time inventory from Vitreous. It really comes down to two key factors: 1) Having a worry-free, risk-free secure supply of waste glass feedstock is extremely valuable since demand is on very short notice. 2) Alberta is a small market with really only one raw material provider. It therefore follows that it is does not make sense to have multiple waste glass buyers that each compete to purchase and sell small quantities of feedstock. In other words, it is a natural monopoly.
Management
Vitreous is mainly owned by insiders. The founder/CEO Pat Cashion owns ~45% of the stock, and other Board members and their spouses own an additional ~10%. The CEO earns 20% of operating cash flow before income taxes (total annual cash compensation of $650k), but there do not seem to be any issues with unfair treatment of non-controlling shareholders. Overall, it is just a profitable but fair enterprise.
Valuation - A Fun Story, but Not Cheap Enough
We estimate the Company earns ~$1.4-1.5 million in FCF/year, based on estimated normal capex requirements of ~$200k/year and normalized operating cash flows of $1.6-$1.7 million, based on historical results. Operating cash flows have not fallen below $1.2 million since the Company sold its Kitchens business.
At its current price of $2.60/share (~$16 million market cap and EV), we do not believe Vitreous is cheap enough. However, the stock is extremely illiquid, and you occasionally have ~10%+ daily movements. We would certainly look to add this to our portfolios at under ~$2/share (~$12.5 million EV), which would imply a more acceptable FCF yield in the mid-teens.
With a weaker Alberta market due to lower oil and gas prices, there are some serious risks to short-term slowdowns in business since it is primarily tied to new construction builds, but if the stock declines significantly because of this, we would view this as an attractive entry point into what is essentially a natural monopoly.
That said, with enough capital, Vitreous may also be a candidate for an interesting LBO, either for a whole acquisition or to buy out the founder if he is willing to sell. Cost savings from the CEO's salary would increase cash flows by $650k, and it appears there is little succession risk from a management skills standpoint. Given Vitreous' stable free cash flows, it may make sense to use Vitreous as an investment vehicle. A fun idea indeed.