Greystone Logistics ($GLGI)
A cheap, off the beaten path microcap. Originally written in March 2019, updated in December 2019.
Overview
Greystone Logistics (OTCBB: GLGI) makes and sells 100% recycled plastic pallets. As one of the only major pallet manufacturers to have perfected the process of producing pallets from recycled plastic, Greystone is able to provide customers with pallets at significantly lower prices than its competitors who use higher cost virgin plastics.
The stock is levered equity moving in the right direction. Thanks to the company’s technological advantage, sales are growing rapidly, margins are improving, and debt is being paid down. However, the valuation does not reflect this progress. A continuation of current trends would lead shares to be worth $4.27 (versus the current price of $0.44) in three years.
Industry Overview
Pallets are the platforms on which goods rest when they are stored or shipped. 80-90% of all U.S. commerce is carried on pallets, and there are almost 2 billion pallets in circulation in the U.S. daily. Currently, most pallets are made of wood due to low materials costs ($8-10 per pallet) but there is a secular shift to plastic ($45-100+ per pallet) underway for the reasons noted below.
Durability: plastic pallets last 5-10 years, while wood pallets typically get damaged in less than a year; this makes plastic pallets particularly apt for closed-loop logistics systems, where pallets can be reused hundreds of times
Weight: plastic pallets are significantly lighter, reducing fuel costs
Hygiene: wood pallets absorb moisture and often breed bacteria, which requires maintenance such as heat treatment and fumigation
Export controls: many countries don’t allow wood pallets to be imported for health reasons
Uniformity: plastic pallets don’t have protruding nails and other deformities, which makes them better suited for automated warehousing
Eco-friendly: plastic can be recycled while wood is generally sent to the landfill
Pallets are typically purchased by product manufacturers pre-shipment or by logistics providers (anyone responsible for storing and shipping products). Although plastic pallets are significantly more expensive upfront, they pay for themselves over time. Walmart is beginning to switch to plastic pallets in its automated warehouses, and Costco already uses plastic pallets quite extensively. The market for plastic pallets is expected to continue to grow significantly as more companies make the switch from wood to plastic.
Greystone’s differentiator
Greystone’s pallets are significantly cheaper than most plastic pallets since they are one of the few manufacturers to have perfected the process of making pallets purely from post-consumer and post-industrial recycled plastic at scale. Recycled plastic is brittle by itself and requires special processing and additives to give it strength comparable to virgin plastic. Greystone is the market leader in this processing through a combination of patents and trade secrets. A Greystone fiberglass-reinforced pallet costs $40-45 vs. $100+ for a typical reinforced pallet made from virgin plastic. There is some quality difference which matters for certain applications, but does not for many others.
Since Greystone pallets are made from recycled plastic to begin with, they themselves can be recycled to produce new ones. Although any plastic pallet can be taken to a recycler, Greystone takes back the entire pallet (including any fiberglass reinforcement) and is able to offer more competitive rates than other recyclers. Conversations with industry participants indicate the average market rate for virgin plastic is $0.30-0.35 per pound while Greystone offers $15-20 for a ~50-pound pallet, which breaks down to $0.30-0.40 per pound for recycled plastic. This makes replacement pallet purchases cheaper for customers and at the same time locks them in with Greystone since their used plastic would be worth much less with another recycler.
Customers and Competition
In 2015, Greystone did $23M in sales and had one major customer (Miller Coors) that accounted for 56% of sales. In FY 2019, it did almost $72M in sales with three major customers. Conversations with industry participants indicate that these customers are MillerCoors, iGPS, and Walmart.
MillerCoors
Has been a customer for more than a decade
Uses only Greystone pallets and has about 3 million pallets in its closed-loop logistics system
Greystone buys back about 150K damaged pallets from them every year and re-sells back the same or more quantity. I estimate this generates a consistent $8-10M in sales every year
Good indication of what a “steady-state” (done growing their pallet fleet) customer looks like; about 5% of pallet inventory is replaced every year
iGPS
Largest plastic pallet leasing company in the U.S. and growing quickly
iGPS purchases plastic pallets and leases them to customers at rates comparable to wood pallets
Costco is a major customer (walk into any Costco, many pallets are from iGPS)
Greystone is iGPS’s sole pallet supplier (it is rare for a company of iGPS’s scale to single-source); iGPS benchmarked plastic pallets from every major plastic pallet manufacturer and went with Greystone, which highlights Greystone’s unique value proposition in price and quality
Greystone recently raised prices for iGPS, indicating pricing power even with the largest customer
Channel checks indicate that sales to iGPS will be $40-50M this fiscal year
Walmart
Became a direct customer at the end of FY 2018, after having used iGPS’s pallets
Currently switching to plastic pallets in one of its warehouses, and purchased $3.6M of pallets in the first half of FY 2019 alone (11% of sales)
This does not include a significant portion of the order that has not been shipped yet ($3.4M in deferred revenue)
Channel checks indicate that Walmart is satisfied with the quality and that Greystone will be near the top of the list for any further warehouse upgrades.
Walmart has 150+ U.S. distribution centers and one upgrade generated $7M in sales, so there is significant runway for growth
Greystone also sells through distributors and directly to smaller companies in one-off sales. This category has been growing steadily 4-5% year over year.
Greystone’s direct competitors in plastic pallets include Rehrig Pacific, Snyder Industries, Polymer Solutions, Buckhorn, and a few others. Conversations with industry participants indicate that Greystone is one of the largest players in the market (most larger competitors, like Rehrig Pacific and Buckhorn, have multiple product lines while Greystone is focused only on pallets).
Management
Greystone’s CEO is Warren Kruger. Before Greystone, Kruger co-founded a financial services company, MCM Group, grew it to 250 employees, and sold it to Cendant. He then acquired, grew, and sold Century Ice to Packaged Ice Corporation. He has been an owner-operator throughout his career.
Greystone was originally a public shell company, which Kruger used to acquire the plastic pallet business in late 2003. At the time, sales were $6M annually. Kruger has since grown the business over 10x and has not sold any shares. He owns 34.5% of the company and has in fact been a consistent purchaser of shares in the open market. His most recent open market purchase was in September 2019, at higher than current prices. His stake is worth $3.8M, which is 15x his annual total compensation of $248K.
Kruger and another director (Robert Rosene, who owns 17%) have personally guaranteed $6.5M of Greystone’s debt and have put up their own real estate as collateral on the rest in order to lower interest expense. How many public company officers are willing to do that? Almost all expansion has been debt-financed to avoid dilution (share count has increased 11% over the last 7 years). Insiders own 57% of the company in aggregate, and are clearly invested as shareholders.
Valuing Greystone
The first major value driver will be continued top-line growth.
MillerCoors
I assume sales remain steady at around $9M annual into FY 2022.
iGPS
Conversations with management indicate that iGPS’s demand is voracious; they are buying pallets as fast as Greystone can produce them.
Greystone plans to acquire two more injection molding machines (in addition to the 13 they currently have) to support iGPS demand.
These two machines will support an additional ~$14M in annual sales (13,000 pallets per month per machine x 12 months x 2 machines x $45 per pallet).
Almost all injection molding machines for iGPS have been acquired through capital leases with iGPS on which payments are tied to the number of pallets produced and sold to iGPS; this shows that iGPS anticipates continued strong demand.
Sales to iGPS went from $0 to $45M in four years; I anticipate that sales will hit $65M in FY 2022 (driven by the purchase of two more machines and increased throughput on existing machines).
Walmart
I assume Walmart renovates another warehouse each year into FY 2022.
At $7M per warehouse, this is $7M in sales in FY 2022.
Distributor sales/one-off orders
I anticipate continued 5% YoY growth.
Increase from $12M in FY 2018 to $14.5M in FY 2022.
Additional large corporate customers
Recent wins with iGPS and Walmart position Greystone well to win more large business. iGPS gives Greystone free customer exposure.
Any company with a closed-loop logistics system is a potential customer as they make the switch from wood.
I anticipate Greystone bringing on one more large customer, adding $5M in sales in FY 2022.
The base case estimate for FY 2022 sales based on the above is $100M. Management has indicated that they expect to hit $100M in sales within two years.
The second major value driver will be margin recovery to previous levels.
FY 2014 gross margin was almost 23%, while 3Q19 gross margin bottomed out at 10.3%. Management attributes this to growing pains and not to pricing pressure of any sort. For example, Greystone ran out of recycled resin refinement capacity last year, which required the company to externally source expensive recycled resin. New machinery to increase resin refinement capacity just arrived.
iGPS pallets have also turned out to be much more labor intensive than anticipated, requiring four employees to produce 500 pallets a day per injection molding machine. The company has ordered automation equipment which will be operational for two machines in the next 2-3 months, reducing labor need to two employees per machine and increasing throughput. If this is successful, six other machines will be fitted with similar automation equipment over the next year.
My sense talking to management is that sales growth has been so extraordinary that they’ve been struggling to increase production fast enough. In fact, they’ve been selective in accepting new business in order to keep up. This has caused the margin decline.
As the new equipment comes in and the company continues to gain experience in manufacturing the iGPS pallets, management anticipates that gross margins will revert significantly closer to 20%. This should happen over the next 12-18 months as margin improvement is the #1 priority for the company right now. Gross margin has already improved from 10.3% in 3Q19 to 12.7% in 1Q20. We do not need heroic levels of margin expansion to do well here; margin simply needs to recover to previous levels. My base case estimate for gross margin in FY 2022 is 18%.
The third major value driver will be deleveraging.
Up until 3Q19, Greystone was taking on debt to finance growth CapEx. At peak, they had $29M net debt on $3M in book value. The last two quarters, they have generated enough cash to pay down debt at a rate of around $1M per quarter. On a $12M market cap, this $1M/quarter transfer of value from creditors to equity holders is significant. Deleveraging should also allow Greystone to command an improved multiple.
Valuation
Since Greystone does not have any publicly traded direct competitors, the U.S. containers and packaging industry (Damodaran’s list) are used as comparables. Most of these companies trade between 10-15x EV/EBIT. Greystone itself currently trades around 11x EV/TTM EBIT ($46M EV on $4.1M TTM EBIT) even though it is growing significantly faster.
For all of these scenarios, I assume SG&A remains at 6% of sales and there are 30M fully diluted shares outstanding at the end of FY 2022.
Base case:
$100M in sales in FY 2022 and gross margin improves to 18%. Greystone continues to deleverage and net debt decreases by $11M to $16M (11 quarters of deleveraging).
FY 2022 EBIT is $12M. At a 12.5x EV/EBIT multiple less debt of $16M less $5M in preferred shares less $1M in NCI, market cap is $128M. Share price is $4.27.
Bear case:
Recession scenario in which management is unable to keep costs under control.
Sales decrease 20% by FY 2022 to $60M. Any further decline is highly unlikely due to continued replacement demand (sales declined ~25% in the last recession).
EBIT falls to $0 and EBITDA is around $4M. Interest expense is $2M annual. Maintenance CapEx is $2M in a lean scenario.
At worst, this is a bankruptcy; at best, covenants would be tripped and debt would be renegotiated. Equity could be wiped.
Bull case:
Greystone lands multiple large customers or Walmart/iGPS sales grow faster than expected.
$135M in sales in FY 2022, gross margin improves to 20%. Net debt decreases to $10M.
FY 2022 EBIT is $20M. A 15x EV/EBIT multiple less debt of $10M less $5M in preferreds less $1M in NCI gives a market cap of $284M. Share price is $9.46.
This is levered equity; the different scenarios reflect this and positions should be sized accordingly. If sales fall off a cliff, the equity could be a zero. The largest risk is the iGPS business dissipating. From talking to management, my opinion is that this is a relatively low-probability event, but not impossible, especially in a recession scenario.
Why does this opportunity exist?
Greystone is tiny (~$12M market cap), taking it off the radar for many funds. There is no sell-side coverage, and it does not trade on a major exchange. There are no earnings calls, and no investor presentations; just 10-Ks and 10-Qs. Greystone also does not have any publicly traded direct comps.
Most investors who do find Greystone see a highly levered nanocap with an undifferentiated product in an industry with low barriers to entry. I, on the other hand, see a business with a competitive advantage that has grown rapidly and has runway for continued growth. A continuation of current trends in margin improvement and debt paydown will soon be reflected in the stock price.
Risks
Customer concentration
MillerCoors, iGPS, and Walmart were responsible for 84% of sales in the first half of FY 2019. The loss of any of these customers would be largely detrimental.
Greystone’s value proposition and recycling program make this less likely, but this is still a very real risk.
Management behaves unfairly towards minority shareholders
Given insiders’ high % ownership, a take-private attempt via a private equity recapitalization or a management buyout at a lowball price is possible.
Key man risk
Given CEO Kruger’s role at Greystone, his departure would be detrimental to the company.