Looking For Toll Bridges
I’m often attracted to companies that retain a conceptual “toll bridge.” A “toll bridge” business is one of the two exceptional types of businesses often discussed by Warren Buffett as being able to deliver superior long term returns. A “toll bridge” business is one that individuals or companies must use in order get where they are going.
Companies of this type can come in many shapes and sizes. They could be the exchanges on which companies are listed, like the NYSE, CME or the Nasdaq. If you are involved in the buying or selling of securities, you are paying a toll to the exchange whenever you make a transaction. Another example of a “toll bridge” in my mind is Matson Shipping. If you have to move goods to or from Hawaii, there is a very high chance that you will be utilizing Matson at some time during this process. The historical operations of the Daily Journal Corporation also provide a salient example of this, as legal issues must be published as a matter of law and thus guarantee profits.
One company that I believe retains this quality is Mine Safety Appliances (MSA). The company has a long history, provides essential products to numerous industries and has a robust history of dividend growth, making it attractive for long term holding by investors. This company’s “toll bridge” quality is that people will always need to use safety equipment to protect themselves.
What Mine Safety Appliances Does
Founded in 1914, Mine Safety Appliances develops and produces products used to protect workers engaged in occupations that are hazardous to one’s health or person. In addition to equipment for use on one’s person, the company manufactures detectors and thermal imaging cameras. The company enjoys a global presence and serves markets which include mining, oil and gas, security, construction, the military and police and fire departments. The company also produces and distributes products to independent contractors and individuals with a “do-it-yourself” outlook.
While you might not know the company by name, you will see it’s products everywhere. The company’s products include the V-Gard Cap, one of the most widely used and popular hardhats in the United States, the Advantage line of respirators and the Cairns line of Firefighter helmets. The company’s equipment also protects patrons of mass events, including the Olympic Games and New Years Eve in Times Square.
The Numbers on Mine Safety Appliances
With a market capitalization of $1.85 billion, the company is a small one. Currently priced at $49.28 per share against a book value of $13.40, the company trades at a significant premium to its assets, a premium that is justified given the company’s history of increased earning power, high returns on equity and significant dividend growth over a long period.
The company currently pays a dividend yielding 2.41%, which has grown significantly over the years (increasing by a factor of ten in less than twenty years, from .03 cents in 1995 to .30 cents currently in addition to growing for over 50 years). The company’s payout ratio stands at .66, a number that I believe is acceptable though high given the fact that the company is able to return a significant amount on its assets (last reported at over 6%) through retained earnings. More encouraging is that the company paid shareholders a special dividend in 2012 in order to mitigate tax uncertainty, indicating both shareholder friendliness and that the company’s balance sheet is strong.
Insider ownership in the enterprise stands at slightly above 24%, a very healthy amount especially when contrasted against the fact that the company has been operating for nearly a full century.
A Conceptually Strong Niche Business
One of the reasons that I like this company is the fact that it benefits significantly from regulatory pressures. While regulation often has the potential to adversely impact industries through higher operating expenditures, Mine Safety benefits. After a disaster such as a mine collapse or a factory fire, industries are often pressured by governments or unions to increase their safety measures to protect their workers and thus are forced to expend more money in safety products, benefiting Mine Safety Appliances considerably.
Another growing area of business that the company has been able to harness is the demand for more security. The company’s detection products are utilized to monitor areas for hazardous chemicals, providing security forces critical data in order to overcome accidental or intentional threats. The company’s SAFESITE system is deployed by national security professionals at high profile events.
I also believe that the company’s competitive position in the emergency and fire safety segment is one that is worthy of note. Over the course of the company’s history, Mine Safety has acquired numerous companies that specialize in the production of fire fighting gear including respirators and helmets. While other areas of its business are vulnerable to macroeconomic factors such as a decline in demand for raw minerals or a slowdown in construction, there will always be the risk of fires and thus the need to protect firefighters.
Riding the Coat-Tails of Other Industries
The company’s total sales by revenue segment, per the company’s most recent shareholder presentation are the following:
Oil, Gas, Petrochemical: 33%
Fire Service: 25%
Construction, Utilities, Manufacturing: 22%
The company is situated to benefit significantly from a global increase in both development (requiring more mining and heavy industry) and an increased focus towards addressing unsafe working conditions in construction, mining and oil gas operations in the developing world over the long term. The company also generates only 29% of its revenue in emerging markets, something that I believe is extremely encouraging and is primed to grow as I believe the company will experience significant growth in this space over the coming years.
Something which I believe is even more encouraging is that despite the fact that the businesses that Mine Safety serves may be adversely impacted from increased regulation, Mine Safety is well situated to benefit from increased regulatory activity – as companies will have to invest more heavily in protecting their workers.
The Sweet Spot: Positioned For Acquisitions and Potential To Be Acquired
Examining the history of the company, it becomes quickly apparent that the company has made significant efforts to expand its product portfolio through acquisitions which it has engaged in with frequency for more than five decades. Examining the nature of these acquisitions, the company has invested into companies that produce products which are either innovative or carry a large amount of consumer favor through being well established with high brand value among the niche markets that they serve. I believe that by virtue of the company’s small size and free cash flow generation that the company is well situated to conduct future acquisitions of this nature as it expands its global presence.
Given the small size of Mine Safety and its highly profitable niche business, I also think that this company represents an attractive entity to be acquired by a larger company in the sector given the low interest rate environment and Mine Safety’s proven record of increased earnings power. One company that I view as a potential future suitor is Snap-On Incorporated (SNA), with a market capitalization of $6.7 billion, a robust record of growth and significant free cash flow generation ability. The company also caters to many of the same markets (construction, mining, resources and government) that Mine Safety does, increasing the potential for synergies.
For investors that do not have a tolerance for volatility or those who have a short-term orientation, Mine Safety Appliances will be a hard stock to own currently, especially for those seeking to establish a position at current levels. The company trades at a significant premium to its book value and thus there is the potential for a significant drawdown in the price of the company. While the company continues to grow through acquisitions and organically, current share prices are nearing all time highs and as such, I would advocate caution be employed.
One must also be appraised of the fact that this business “coat-tails” several industries. While there will always be a demand for safety equipment that is likely to grow, this demand can only grow with an increase in industries. Should industries such as oil gas or mining experience a slowdown, demand will slow for the company’s products. Investors must also be aware of the fact that a portion of the company’s sales are derived from governments for military and domestic applications. A reduction in government spending or the emergence of a superior product in the marketplace could lead to reduced earning power of the company.
I believe that Mine Safety Appliances occupies an excellent business niche that benefits considerably from both industrial development, government regulation and the ever-present need for safety products. For investors willing to exercise patience and dollar cost averaging, I would highly recommend adding this company to a watch list and doing further research into what would merit a compelling entry point. At current levels however, I am not a buyer. In the event of heavy selling pressure during a period of broader market turmoil – this company is near the top of my list as an excellent candidate for purchase going forward.
I believe that paying 3 times book, approximately $40 per share represents a good price to pay for a business which I think is excellent, as investors are receiving a baseline yield closer to 3% that has a history growing in a robust fashion. I will also carefully monitor the company to see if any repurchase programs are instituted which will help guide my purchasing decision.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.