We believe that the trust units of Chesswood Income Fund present a compelling value opportunity as well as offering the potential for growth.
Chesswood Income Fund owns 3 businesses: Pawnee (an equipment lease financing company operating in the US), Acura Sherway (an automobile dealership in Toronto), and Lease-win (an automobile lease financing company) which is being wound-down. We very much like the business of Pawnee, where most of the trust’s profits come from. The business of Acura Sherway, while not in the most attractive industry, has an excellent location adjacent to sprawling Sherway Gardens shopping mall in Toronto. Acura Sherway has shown remarkable resilience to the economic downturn, especially for an automobile dealership, although it does not throw off very much in terms of profits. On a consolidated basis the fund as a whole has operated profitably throughout the credit crisis, after adjusting for goodwill impairments.
We believe the real value driver going forward will be Pawnee, with added optionality from the business that is Acura Sherway.
Pawnee offers commercial equipment lease financing to “B” credit businesses and start-ups for up to but not exceeding $30,000 per lease. We like this “niche” business because if risk is managed properly the margins are much better than a typical leasing company. We feel that management has done an excellent job of managing risk as proven over the trying credit-crunch period.
The company has a rigorous credit testing process and generally only funds a lease when they feel they are getting an above average risk/reward ratio; they actually fund less than 10% of lease applications received by dollar volume.
As a matter of protection, Pawnee diversifies to an incredible extent. No individual leasing contract makes up more than 0.01% of the lease portfolio. Leases are also diversified across 85 different industries and 65 different equipment categories. All leases require a personal guarantee from the business owner. And they eat their own cooking too; Pawnee keeps all of their leases on-balance sheet, rather than generating fees through the origination and sale process.
Obviously revenue from leases must exceed charge-off rates in order for the investment to be successful; so how about little bit of math. Since 2000 charge-offs as a % of net investment in leases has averaged 8.5%, while lease income as a % of net investment has averaged 30%. Assuming credit standards have not changed (leases funded as a % of applications received have not), this would imply a normalized charge-off rate of $6.8M, and revenue of $24.4M on $81.2M net investment in leases.
Assuming no recovery in revenue streams, and adjusting to normalize provision for credit losses, earning power of at least $7M can be conservatively expected within the next few years. Using this number, EPS of $0.76 is not to be unexpected, after assuming conversion of outstanding dilutive securities. The trust units are currently trading at only 5.3 times this number, and at 75% of book value.
It is important to bear in mind that Pawnee’s lease portfolio grew at a rate of ~17% between 2000 and 2006, and averaged 12% between 2000 and 2008. If the pre-credit crisis expansion rate is any indication then we feel that the patient unit-holder may be pleasantly surprised with a purchase at today’s price of $4.02.
Although we would rather own a pure-play on Pawnee, Acura Sherway should not be a drag on investment performance through a holding in Chesswood Income Fund. We do, however, feel that a transaction to split Pawnee and Acura Sherway would be beneficial to unitholders.
NOTE: If you are Canadian as we are, keep in mind by holding this position you are incurring foreign exchange risk, even though the equity is listed on the Canadian market. Management owns ~28% of CHW.UN on a diluted basis.
NOTE: Author has a long position in CHW.UN. This is not a recommendation or an offer to buy or sell securities. Do your own research.
