09/28/2020
Disclosure: I currently own GLGI stock and plan on continuing to own the stock. GLGI is a microcap stock with very little liquidity and high price volatility
Ticker: GLGI
Price: $0.915
Shares Outstanding: 28,361,201
Market Cap: $25.950 million
Cash: $1.1 million
Debt: $22.7 million
Enterprise Value: $52.5 million
Introduction
Greystone Logistics (GLGI) is an innovator by focusing on one of the most common, yet little noticed, items that fuel commerce – pallets. Warehouses and logistics would operate at a much lower level of efficiency without pallets. Pallets allow an enormous amount of products to be stacked on top of one another and moved relatively easily with a forklift or pallet jack across a warehouse, grocery stock, or offloaded from a truck. The standard pallet has weight bearing load of over 4,000 pounds. Domestically, 80% of all commerce is moved on pallets.[1] GLGI is not a typical pallet manufacturer. Instead of making pallets out of wood, the traditional material used to manufacture pallets, it is making pallets out of recycled plastic.
A pallet is almost always made of wood that has been nailed together. Wood is cheap, strong, and easily accessible, making it an ideal material for construct pallets. But wood pallets also present many issues. Wood pallets can splinter, nails can stick out causing a hazard for workers, and is difficult to clean to keep bacteria and viruses from growing. Wood is also heavy (wood pallets weigh up to 48 pounds), and because of the material’s intrinsic nature, pallets lack uniformity and consistency in dimension and quality. This is what makes recycled plastic an innovative solution for these issues.
Plastic is significantly better than wood as a material for manufacturing pallets. It is lighter (plastic pallets are up to 27 pounds lighter than wood), easier to clean, stronger and more durable than wood. Plastic pallets allow for greater uniformity and consistency, and do not present the work hazards wood pallets do. GLGI understands the benefits of this idea and has taken it a step further by manufacturing plastic pallets from recycled plastic.
Business Description
GLGI is the only publicly traded manufacturer of recycled plastic pallets. The company grinds plastic, sourced from various suppliers, into pellets which are then molded into pallets. The company then sells the pallets to its customers. It is a straightforward business but because of the low margins, small market (for the time being), and the inertia commanded by wood pallets, success is far from guaranteed.
Pallet Market
It is estimated that there are about 1.9 billion pallets in circulation in the United Sates, with wood pallets making up approximately 90% of the supply[2]. Wood has been the traditional source of pallet manufacturers because it strikes a good balance of cost and strength. But with increasing health and safety regulations, particularly in the food, beverage, and pharmaceutical industries, future demand growth for wood pallets is minimal, while the demand for plastic pallets is expected to almost double the growth of the overall pallet market over the next five years[3].
Business Fundamentals of GLIG
GLGI started with MillerCoors as its only major customer. Today, GLGI has three major customers, MillerCoors, Walmart, and iGPS (more on iGPS later). Historically, high quality recycled plastic pallets sold for $100/pallet, compared to $25/pallet for wood pallets. GLGI, through efficiencies, improved technology, and cheap source material, can sell high quality plastic pallets for approximately $35/pallet. This lower cost allows for the company’s recycled plastic pallets to compete with wood pallets because of the greater strength and durability, lighter weight, and lower health risks.
Unit Economics
While the overall pallet market presents an attractive opportunity for GLGI, the unit economics of the business are even more attractive. Its costs GLGI $2.5 million to purchase a single pallet manufacturing machine ($2.2 million for the machine and $0.3 million for the molds). Each machine can produce 190,000 – 200,000 pallets per year, resulting in $6 – $7.5 million of annual revenue. Those pallets generate a $1 – 1.25 million of EBITDA per year. Assuming 15% of annual maintenance for the machine, the company’s payback period for the investment is three years and each machine generates 30% FCF pre-tax. Because these machines are extremely reliable and require little human oversight, there is little to no G&A cost increase as GLGI increases its production capacity. This is especially important due to the company’s 15% gross margins, allowing for increasing operating margins.
Financing and Capital Structure
GLGI has financed its growth mainly through debt and capital leases. At fiscal yearend 2020, the company had $28.5 million of debt and capital leases outstanding, resulting in a debt/EBITDA ratio of 2.3x and an interest coverage ratio of 5.1x. I am assuming GLGI is able to self-fund all future growth which would bring the company’s leverage ratio down over time.
GLGI also has 50,000 preferred shares outstanding that pay an annual dividend rate of prime rate plus 3.25%. Annual dividend payments are capped at $500,000. The preferred dividend as a percentage of net income has declined from over 50% in 2015 to 8% in 2020. These 50,000 shares can convert to 3,333,333 common shares (~12% of current shares outstanding) at the preferred shareholder’s discretion.
iGPS
Starting in the 90s, the pallet industry business model began to change. Previously, it was the job of the pallet purchaser to maintain and manage their pallet inventory. Then the large pallet manufacturers began to offer pallet management services. Instead of a retailer or manufacturer buying pallets, they would rent them from a pallet pooling company. The pallet pooling company will rent, resupply, recover, and recycle their customer’s pallet for them. Today, CHEAP (subsidiary of the world largest pallet manufacturer Brambles), PECO, and iGPS are the largest pallet pooling companies.
iGPS differentiates itself by offering only recycled plastic pallets. GLGI is the sole provider of recycled plastic pallets to iGPS. Costco, Walmart, Publix, Kroger, SC Johnson, and Dannon are all customers of iGPS. It was recently announced that over the next two years, merchants and manufactures that sell their products through Costco must use recycled pallets when shipping their product to a Costco warehouse[4],[5]. Costco is doing this because, 1) the company understands that plastic pallets are a more efficient way of shipping products, 2) it reduces work hazards, 3) the pallets easier to clean, and 4) recycled plastic pallets are more environmentally friendly and sustainable than wood pallets. Costco is the second largest retailer in the world. I believe other retailers will start making the same requirements from their suppliers once Costco is able to show the cost savings and gained efficiencies of using recycled plastic pallets. The growing importance of environmental sustainability will also push other large retailers and manufacturers to use recycled plastic pallets.
Competition
There are several small plastic pallets manufacturers and a few very large plastic pallet manufacturers that are subsidiaries of larger companies (e.g. ORBIS, Loscam, Cabka Group). GLGI’s future success is going to depend a lot on the relationship with iGPS and its ability to grow. That growth includes persuading manufacturers and retailers to switch from wood pallets to recycled plastic pallets.
Management
Warren Kruger has been at the helm of GLGI since 2006 and owns over 30% of the outstanding shares. He has done a tremendous job of growing the company from having one major customer, MillerCoors, to being the sole provider of recycled plastic pallets to one of the largest pallet pooling companies. When I spoke to him, he said what drew him to the company was the incredible market opportunity of the world shifting from wood to plastic pallets.
During our conversation, Warren talked about how difficult 2020 has been. At the beginning of the year he had hoped to continue the growth the company had experienced over the last couple of years, but COVID changed all that. He is now focused on improving margins, maintaining employees, and improving GLGI’s suite of pallets. Warren hopes the company can resume growth in 2021.
Valuation
GLGI’s stock price has almost doubled this year, but it still presents a very attractive investment opportunity. Assuming 8% annual revenue growth by adding two pallet manufacturing machines per year, (7% in FY2020 and an average growth rate of 29% over the last 5 years), and modest improvement in margins, I calculate a DCF value of ~$4.70/share for GLGI. The company currently trades at an EV/EBITDA, P/E, and FCF Yield of 4.3x, 6.0x, and 9.1% respectively. GLGI’s publicly traded comps trade at an average EV/EBITDA multiple of 9.8x, P/E of 17x, and a FCF Yield of 8%.
[1] G. Raballan and E. Aldaz-Carroll, “How do different standards increase trade costs? The case of pallets” (World Bank Policy Research Working Paper #3519, 2005)
[2] https://www.freedoniagroup.com/brochure/33xx/3314smwe.pdf
[3] https://www.eppm.com/blogs/guest-blogs/plastic-pallet-market-growth-leads-to-increased-manufacturing/
[4] https://prostack.com/2020/07/24/costco-supply-chain-updates/
[5] https://igps.net/resources/costco-pallet-requirements/