OFI, a cheap food company triggered by potential refinance

**zhao_xing** Mon Feb 20, 2006 11:52 pm

OFI, a cheap food company triggered by potential refinance
Two weeks ago, I bought OFI at $3.02 per share.

OFI is a dirty cheap stock whose real value is hidden by its extremely high interest expense. At current price $3.25 per share, OFI is traded at 13.5 times of its 2005 earning, or 8 times of its 2005 free cash flow. In my standard, this valuation is relatively cheap (or fairly valued), but not dirty cheap. However, the tricky part in this OFI play is that OFI's future earning would increase around 50% simply by refinancing its 13.5% rate debt into 7-8% rate, which will correspondingly give its stock price 50% upside room to run.

Overhill Farms is a California-based small food-processing company. Its produces entrees, plated meals, meal components, soups, sauces, poultry, and meat and fish specialties. The company makes its value-added food products according to contracts with its customers and sells these products to customers in retailers, foodservice, and airline industries. Some of OFI's big customers and revenue percentage OFI got from them are listed below:

Panda express 31%
Jenny Craig 19%
American Airlines 7%

After spin-off from TreeCon Resources in 2002, OFI's financial results have been hurt-ed by the aftermath of post-911 because airline industry used to occupy significant percentage of OFI's revenue. After several years' endeavor, OFI now got more and more market share from its restaurant customers (eg.
Panda express, Jenny Craig), and now airline customers only account for less than 20% of its total revenue. According to my personal knowledge, OFI's two biggest customers, Panda expree and Jenny Craig, are all doing business very well and growing very fast. Therefore, I expect OFI's 2006 revenue will be at least no less than its 2005 number ($163M).

In 2005, OFI made 14M EBITDA and 3.6M earning, below are some valuations about OFI.

Revenue $163M
EBITDA $14M
EBIT $12M
Interest expense $6M
Net Income $3.6M
Free cash flow $6.7M
diluted share 15.7M

OFI has huge debt($44M) compared with its market capitalization value. One notorious thing is that these debts are charged at 13,5% interest rate and will be due on this Oct. Last April, OFI announced that it is looking for strategic alternative or refinancing these debts. However, nine months passed and there is no more news about refinance. Market worries about the coming due debt, and OFI's stock price performs not very well recently.

In my opinion, I believe refinance should not be a big deal eventually as long as OFI can keep its current strong operational performance. My assumption in this play is OFI can refinance its current debt rate from 13.5% to 7-8%. This will reduce OFI $2~3 M interest expense, and increase earning by $2M, which can reach $5.6M as OFI's 2006 earning,
Unlike chicken or beef producer (eg. GKIS or PPT), value-added food processer usually is not at cyclical nature. A brand-name food-processing company usually can be traded at 12-15 * earning or 8-10*EV/EBITDA, Here is the target price I get for OFI

1) at 12 * earning, 5.6M*12/ 15.7M =$4.3/ share.
2) at 15* earning, 5.6M *15/15.7M =$5.4/share.
3) at 8*EV/EBITDA, (8*14M- 35M(est debt at the end of 2006)) /15.7M =$4.9 /share

Conclusion: hold OFI for 1-2 years, target price is $5/share at a very conservative base. If OFI can grow its EBITDA to 16~18M in 2006, then my one-year target price will be as high as $6-7 per share.

**goog** Wed Feb 22, 2006 12:18 pm

Could you please explain why didn't they do refinance in these several years and why this is not the case any more? Thanks

**zhao_xing** Wed Feb 22, 2006 4:35 pm

Quote: Could you please explain why didn't they do refinance in these several years and why this is not the case any more? Thanks

Great question.

My answer is OFI's operation performance was not good enough to do refinancing unitl 2005.

OFI didn't generate too much positive cash flow in 2003 and 2004.

Its operation was affected by a major facility consolidation in 2003, and sale from airlines continued to decline after 911.

Going forward, I would expect OFI's operational performace will be much better than before. (1) The company's capital expenture will be small in next 1-2 years. (The company's current production capacity is new and big enough for next 1-2 years' sale growth).
(2) Revenuefrom airline industry is not as significant percentage as beore.

**zhao_xing** Wed Feb 22, 2006 4:48 pm

OFI owns two debts now.

1) $28.9 million secured senior note payable to Levine Leichtman Capital Partners II, L.P. ("LLCP") with interest rate 13.5%
2) $15.9 million term A note payable to Pleasant Street Investors, LLC ("PSI"), with interest rate 1.5+prime rate(7.5%)=9%.
* PSI is a subsidiary of LLCP.

One bad thing is these loan are not owned by bankers but by a hudge fund.
After reading OFI's SEC filings, I make a conclusion that LLCP is really a "shark borrower" for OFI. LLCP bought OFI's other loan from the bank and try to control and squeeze benefits from this unfortunate company.

LLCP not only charges extremely high interest expense, but also steals a lot of common shares from OFI.

LLCP owns 31% of OFI, which make it not only the creditor but also the biggest sharehoders of OFI.

**zhao_xing** Wed Feb 22, 2006 4:57 pm

Fortunately, OFI made wonderful performance in 2005, which make possible for OFI to finish all of these nightmare caused by these unreasonable debts.

My assumption is that OFI can keep current strong operational performance, which I am quite confindent.

As Blast said, "everything is about valuation". I believe the overall environment for OFI will be become better and better.

**zhao_xing** Wed Feb 22, 2006 5:01 pm

Quote: LLCP owns 31% of OFI, which make it not only the creditor but also the biggest sharehoders of OFI

recently, dut to the conflicting interest, the Principal of LLCP resigned from the board of OFI. LLCP also announced a private sale of all of its OFI shares.

I think LLCP is going to take profit in this game. They already made too much from this OFI game.

**zhao_xing** Wed Feb 22, 2006 5:12 pm

Main risks

1. heavily concentratd on few customers. Any loss of big customer like panda express or jenny craig will totally change OFI's valuation.
This is my biggest concern for long term investment in this OFI game. However, currently, I am not so worried about this issue.

2. Potential default on coming due debts. Historically, OFI has already defaulted many times to LLCP and got exemption from LLCP. I think the worst situation for this liquidity problem is to keep current high interest expense for OFI, which has already been priced in OFI's stock price.

**dark** Mon Feb 27, 2006 9:30 am

OFI
I think you are too optimistic about refinancing.

Usually for small companies, even 13.5% borrowing cost is normal because of the default risk lenders have to take. I think it is not possible for OFI to get 7-8% rate loans.

**zhao_xing** Mon Feb 27, 2006 1:14 pm

I think you are right and I was a little bit too optimistic on this issue.

In recent roadshow, OFI's CFO disclosed that commercial banks still are not interested in OFI, which made me a little bit disappointed. He also mentioned that OFI's future loan will be still from a private equite fund (but with significantly lower rate).

I expect this future rate will be higher than 7-8% but lower than 13.5%.

Even without refinancing, I believe OFI is still a cheap one. OFI generated $7.4M free cash flow for last 12 months. at a conservative 10*FCF pricing, you will get 7.4*10/15.7=$4.7/share.
In the future, I expect OFI can generate more and more cash flow as high rate debt is paid down gradually.

I admit this stock is not a conservative pick. OFI has too concentrated consumers, and is highly leveraged. leverage is double-edged, It can wipe out your investment when business is in a down turn. However, in a up turn, any small inprovement in bottom line can significantly increase earning. I believe OFI currently is in an up businee cycle, and I would like to keep my stake in this stock to see what will happen eventually.