VALUE: After Hours (S07 E24): Lowell Capital’s Jim and Abigail Zimmerman on LNF.TO, LYTS, MACF.L, and IWG.L

Transcript

Tobias: I think we’re live. It’s always hard to tell. It’s not like they give you a little flag for it. [chuckles] [Jake laughs] I think we’re live. This is Value: After Hours. I’m Tobias Carlisle. Joined as always by my cohost, Jake Taylor. Our special guests today are Jim and Abigail Zimmerman of Lowell Capital Value Partners based in El Segundo, just down the road from me. Small cap value investment strategy focused on growth companies at value prices. Jim, Abigail, welcome to the show. How are you?

Abigail: Great.

Jim: Doing great. Thanks so much for having us.

Abigail: Yeah, thank you, guys.

Jim: Love the show.

Abigail: Really appreciate it.

Tobias: That’s very kind. Tell us a little bit about your strategy. Growth companies at value prices?

Abigail: Growth companies at value prices. Yeah, so, we run Lowell Capital. We’re a family run investment firm, where we manage our own capital alongside a group of long-term partners who are aligned with our strategy and approach. We primarily focus on small-cap and micro-cap companies that are under followed, cash generative and built to last with, what we call, Fort Knox balance sheets and high returns on capital.

I would say one thing that differentiates us is just how much emphasis we put on cash from operations in the businesses that we look at. So, not EBITDA, but actual cash coming through the door, which we view as the lifeblood of a business.

Why We Focus on Cash from Operations, Not EBITDA

After that filter, we like to evaluate companies as if we’re buying the whole business. And that really shifts our mindset more to an owner mentality, and helps us assess the durability and whether this is something we would want to own for many years. So, that discipline is really core to how we invest. Our goal is ultimately to take intelligent risks, where the odds are clearly in our favor.

We have multiple ways we support that, so we avoid leverage, we’ll hold cash when opportunity is scarce. As you said, we look to buy growth companies at value prices, just so that we can protect the downside and ultimately let a few winners compound for us over time.

Jim: People say, “Well, you act as if you buy the whole business. Stocks, they’re businesses, they’re pieces of businesses.” Berkshire talks about that. Like, how can you sleep at night? Well, if you have no debt. I went through the financial crisis with people with no debt and good cash flow and doctors are like, “What crisis?” [Jake chuckles] So, we’re looking for companies like that. So, we love companies with Fort Knox balance sheets and that have highly resilient cash flows.

Actually, we’ll look backwards of several years and we’ll want something to have amortized a big piece of the enterprise value over the last several years, because we’re smart enough to do the math, like, “Okay, well, if that amount of cash keeps coming in for the next three or four years, they can amortize the entire enterprise value or something good is going to happen.”

How Fort Knox Balance Sheets Help Us Sleep at Night

So, you just sleep at night, because the company’s not going to run out of money, you’re not going to wake up one day, have the stock down 50% because they– That happens a lot. The balance sheet doesn’t get paid attention to, in our opinion, by Wall Street. It will not focus on the balance sheet until there’s a problem, and then it’ll totally focus.

Just like Buffett says, “You take oxygen for granted until there isn’t any, and then it becomes really important.” So, we reverse that. And so, we’re looking at companies that gush cash if we can find them sustainably and that ideally can grow, because they need to grow to really compound your capital. So, we’re trying to come in at modest value multiples with a company that grows and surprises the market. Maybe we saw something before everyone else that they didn’t pay attention to.

Jake: That’s an interesting anecdote from the last Berkshire meeting was– I’d never heard Buffett say this before, but he said that the first thing he looks at when he’s looking at a company is 10-years’ worth of balance sheets, which I think puts him in a very small minority of people who take that kind of balance sheet first approach.

Jim: Absolutely. You’ll see a company that has one of the– Ones we could talk about today, this furniture company can have a ton of debt, and then all of a sudden, over four or five years, all the debt’s gone and then they start buying stock back. So, if we can find a company that buys a ton of stock back and pays all this debt down, that’s highly attractive. People don’t pay attention to that. The thing that lets you do that it’s not even cash from operations. So, if you’re investing in retailers, cash from operations reflects the quality of the management team and their ability to be very disciplined about controlling the working capital.

I mean, you can have a company at two times EBITDA and go bankrupt if they let the working capital go. So, we love that ratio and we use that enterprise value up in cash flow to– It’s a hack to take thousands of companies and cut them down, because very few can meet that criterion.

Jake: I’ve never done a formal study of this, but it’s been anecdotally noticed, I’ve noticed that. In the presentation of the financial statements, sometimes you see balance sheet first. I think more often, you see income statement first. I think the ones that lead with balance sheet actually tend to be less geared, [chuckles] more focused on that. I think there’s a little tell there actually in the financial statements. Have you guys felt like you’ve noticed that?

Jim: I haven’t noticed, but that’s really interesting. I wouldn’t be surprised. People say, “Well, you’ve got excess cash coming in. The activist says buy stock back.” We find that if the company lets cash pile up on its balance sheet, people notice that and they’re like, “Oh, this is a good business.” So, yeah, we look at the balance sheet first, because that’s where all the risk is. If you have a good balance sheet, personally you can lose your job, your company– You can get through anything. Wall Street tends not to pay attention to it, really. So, yeah.

Abigail: Mm-hmm.

Tobias: It’s very Graham. Graham’s been an advocate of looking at the balance sheet forever.

Jim: Yeah. I recently read The Intelligent Investor. I read Chapter 8 and Chapter 20, as Buffett says, the two most important chapters. If you read Graham in there, he’s laser-focused on pay a value price. Do not pay for growth. That’s what we try to do. I don’t know, if we’re as Graham as he is, we’re looking for the growth thing, but I totally agree with that statement.

Tobias: How do you distinguish between a company trading cheaply for temporary reasons and something that’s structurally challenged, which is another way of saying, how do you avoid the value traps?

Jim: Well, I think it’s really that I would say– First of all, we don’t avoid them all the time, but it’s that cash from operations coming in. What are they doing with the cash? Is it piling up? Are they buying stock back? We just look for stuff where the enterprise value can get amortized or at least a large piece of it going forward. With retailers, we’ll look very, very closely at the new stores and what the payback is. And is that you can put cash out, but is the cash from ops climbing? You can do an acquisition, does it–

So, we’re laser focused on the cash from operations, because that’s really the lifeblood of the company. That’s what pays the bills. And then, we call that gross cash flow and then you can figure out how much CapEx you want to deduct from that. But it’s tricky. A lot of our stuff is not growing that fast, and that’s why we get it at a low price. We want to sneak in there and talk to the company and know something about–

We talked a little about Sprouts how– When Jack Sinclair came on board, it was not doing anything. He had this plan to just offer differentiated merchandise and really improve the box of the ROIC. We definitely got that. It made sense to us and it worked out well, and that particular situation’s done well.

Avoiding Value Traps by Tracking Free Cash Flow

Believe me, [chuckles] we’ve been stuck with some value traps, but we try to get out of them. If the cash from ops starts going the wrong way, we’re gone. The company will always have an explanation. We looked at all Buffett’s acquisitions, the companies that Berkshire acquires. They all have very prodigious cash flow operations. Well, not always, but almost always. If the cash flows, isn’t coming in, he wants to know how it’s going to come in over the next year or two to catch him up too. So, it’s almost turning the company and its cash flows into a bond. So, we’re getting a 10% free cash flow yield, we think unlevered, that’s attractive, and if they can actually grow, right, Abi?

Abigail: Yeah, I would agree. I’d say one thing that we’ve utilized to refine our strategy over time is focusing on buying gross businesses at value prices and really focusing on that growth, because you can have a highly cash generative business, but it could not go anywhere if it’s not utilizing its capital allocation effectively. Everyone makes mistakes in this business and we’ve had made mistakes before of getting into highly cash generative businesses and not fully recognizing what the moat was or–

Jim: That it can grow.

Abigail: Yeah. Yeah.

Jim: Yeah.

Abigail: Or, that it can grow or we were in a retailer and that was more of a beneficiary of COVID and didn’t recognize that even though it was very highly cash generative. So, it’s great to be laser focused on cash generation. I would say that that’s our primary filter to refine thousands of companies we look at.

How We Use VIC and MOI Global to Find Simple, Durable Ideas

We’ll read through almost every single VIC write up and then put a stack of paper behind us to make sure, “Okay, we’ve read this one.” 9 out of 10 just don’t work for us. Yeah, I would say ensuring that it’s a company that we feel confident in its ability to grow, and we assess that through detailed calls with management teams. We’ll usually start with just buying a little bit and then if we can build our confidence over time, then we can create that into a bigger position for us.

Tobias: You, guys, carry cash at the fund level too, 30% to 35%, which is a little bit unusual. I’ve certainly felt the pressure to be fully invested. It’s been an easy way to underperform for a long period of time. [Jake chuckles] So, how do you justify the cash?

Why We Keep 20–30% Cash in the Portfolio

Jim: So, I would say average cash position has probably been about 20 over the years we’ve been doing this. That’s gone up and down depending on what is going on. But it forces us to make sure our longs are really strongly performing. There’s something differentiated. You look at a lot of guys, you look at Klarman, you look at Buffett, you look at– They carry a lot of cash. This is playbook that is used– You look at Steven Romick at FPA, these guys have been doing this a long time.

We’re looking for the mispriced long that just work and playing the waiting game. So, so far, the capital we’ve deployed in the longs 5%, 6% per position will perform well enough, so that people don’t have a problem with the cash. We’ve been fully invested before, close to fully invested. But it’s hard to get that right. It’s really reflective of the opportunities that we’re finding.

Tobias: You can be a little bit more choosy with reasonable cash rates these days, much better than a few years ago, it was really getting nothing on the cash at call?

Jim: Definitely. Definitely right.

Jake: And as Munger said, “It’s always nice to have an extra $10 million laying around.”

[laughter]

Jim: Yeah.

Tobias: You mentioned before your investment process is to go through and read all of the VIC write ups, but you put many into the too hard pile, just because they’re too complex. So, what’s a red flag that would make you put something into the too hard pile?

Jim: I would just say there’s a lot of really smart people on that side. We do MOI Global, we do some [unintelligible 00:13:26], we do them all, we get a lot of– And anything that’s complicated where the write up is really well done, it’s really intelligent, it’s very analytical, but there’s too many moving parts, something’s going to go wrong. I think Bob Rubin used to say, “I don’t know if the sun’s even going to come up tomorrow.” So, we’re really simple, simple, simple.

I’ve heard Joel Greenblatt talk about this, just the simpler an idea is the better it is. It doesn’t mean all those other ideas aren’t going to work. So, I would say most write ups, there’s a lot of biotech and real estate and commodity stuff we’re just not going touch. Oil and gas. But a lot of the stuff we look at, people find too boring and they’re like, “Yeah, this is–” But sometimes it’s got a lot of cash flow or something’s changing and it catches people by surprise or it’s too small. So, most people are expecting a lot of things to happen, and they think they can predict that and we just don’t want to pay for that. We want something that’s already working.

So, again, we’re trying to take this approach of converting the investment almost into a bond that’s already cash flowing and working somewhat as opposed to A, B, C, D is going to happen and I figured that out, because it never does– [chuckles]

Jake: [chuckles]

Tobias: Too many things in series.

Jake: Yeah.

Jim: Yeah. It’s just the simpler the better. I think Howard Marks said, “Your returns are driven more by the lack of mistakes than your big winners.” I think we really try to be super defensive. If we can’t figure something out, then we just move on to the next one. [crosstalk]

Jake: I think the purpose of a lot of those write ups is not to necessarily make money. It’s to advertise yourself for a potential job opportunity which you want to then show how smart you are and all that complexity, you need it to– Because if it was just like, “Duh, buy Walmart [chuckles] when it’s at a 10% free cash flow yield in 1990.” You don’t need a big write up for that. You just need an index card.

Jim: Sure. What’s the most important thing to us? Abi checks us all the time. The track record of the author. Do they pick, do they not make mistakes? I think you used to be able to press a button and see that.

Abigail: Mm-hmm.

Jim: And so, we’re really focused if we find something we like, “Okay, is this person generally–” We have a handful of people on there that we keep an eye on. That’s a pretty important thing on there as opposed to just, I’m going to throw an idea up. So, we try to really stay focused. But most of the stuff, a lot of it will work, I’m sure. It’s too complicated for us, so we try to keep it really simple.

Abigail: Yeah. I would say if we can’t explain it in like three to five bullet points, then it’s probably too complicated for us. Again, it doesn’t mean it’s not a great idea or won’t work. It’s just we try to refine our circle of competence and that includes these simple businesses. I’d also say that simplicity doesn’t mean easy. And so, Steve Jobs have said before, “It takes a lot of deep thinking to make something truly simple.”

I’d say that’s very much reflected in our process of doing deep dives on companies we’re interested in. We’ll do regular calls with management. We’ll retype transcripts of conference calls to try to get any kind of nugget or piece of information that someone else may have looked over. We’re trying to figure out something that someone else doesn’t know. And so, if we can find a simple business, and really feel that we truly understand the business and the moat and we can defend it, then that’s really key to our process.

Tobias: When you meet with the management teams, what questions are you asking to help you assess business quality management integrity? What are you looking for?

Abigail: We’ll ask about their cash flow generation, we’ll ask what kind of sustainable free cash flow can they generate over the next couple of years, we’ll ask them about their competitive advantage and what they have as differentiated from their competitors and what product or service do they have that people are going to continue to want years from now. We’re very defensive. As we mentioned, we’re just trying not to make mistakes, as opposed to hitting home runs. And so, every call we’ll ask what could go wrong, or what keeps you up at night or what should we worry about, because we’re always trying to assess the downside.

Jim: Yeah. I think return on capital, how do they think about that? They’re going to deploy capital like what kind of return, how quick are you going to get it back, what’s the payback? Really simple. That’s all a stock is to us. You put money out, you get money back. We look at those types of businesses.

There still is software company called Enghouse that’s run by a guy named Stephen Sadler. It’s very impressive. I was talking to him years ago. He did a fantastic job with that company. He was doing acquisitions, these niche cross sell acquisitions and he was just wanted to know how many years to get my capital back. That’s how we look at stocks. We want the cash back, and so we’re looking at–That’s the point of investing is to get your cash back.

And so, we want management teams that are focused on that cash flow. If they do an acquisition, how quick are they going to pay it down. They really don’t just do stuff without thinking about what’s coming back to the shareholders. So, we’re pretty focused on that. Just what’s special about what you do, how have they built a moat or have they built something that’s sticky with the customers, that type of stuff.

Tobias: Let me give a quick shoutout to the folks who are at home. We’ve got Warren Buffett in Winter Park, Florida. [chuckles] Gothenburg.

Jake: I don’t believe it. [laughs]

Tobias: Sweden. You can’t put a fake name on the internet.

Jake: Okay.

Tobias: Gothenburg, Sweden. Brandon, Mississippi. Madeira. Tallahassee. Valparaiso. What’s up Mac? I was in the other Valparaiso, just last week. Tomball, Texas. Toronto. Jupiter, Florida. Breckenridge. Gavere, Belgium. The Woodlands, Texas. Berkeley. Oregon City. Nashville, Tennessee. Bergenfield, New Jersey. Dead Cat Gully, New South Wales. Me too. Petah Tikvah, Israel. Lausanne, Switzerland. Rochester, New York. Barrow-in-Furness, UK. Chicago, Illinois. Bangalore, India.

Jake: Good spread.

Tobias: Yeah, good spread. Doing all right today. [chuckles] Dead Cat Gully is where I am too right now.

Jake: [laughs]

Tobias: How are you, guys, feeling about the market? This has been a crushing run for smalls. Are you enjoying the opportunity set or are you feeling the underperformance a little bit?

Jake: Are you glad you have extra cash?

Jim: Yeah.

Jake: [chuckles]

Jim: We’re still finding stuff we really like. We’re being cautious about deploying it, but we have a bunch of stuff we think is really interesting. But it’s hard to keep up with the Mag-7. That’s driving a lot of this. We’ll see how long that goes on.

Tobias: And Fartcoin.

Jim: Yeah. All these other things we don’t understand, we just try to stick to– We want to just know what we own. And if we have an investment, make sure we understand it. And that’s worked out well over time.

Abigail: Yeah. I say we’re so focused on the businesses that we own. Howard Marks said, “You can’t predict but you can prepare.” And to us, we take that to mean we can’t predict what’s going to happen in the economy, or where rates are going to be, or inflation or anything like that, but we can prepare by doing our deep dive on our businesses that we own and we feel that by focusing on the fundamentals of those businesses. If they can perform well over time, that they will despite typical economic cycles or whatever is going on in the macro.

Tobias: Do you, guys, use those services like Value Investing Club, SumZero? Is that your primary source method for finding ideas?

Abigail: I would say so. Valley Investors Club, absolutely. SumZero, we’re also part of MOI Global, and we’ll present there regularly and we’ll also see presentations from other people within that network.

Jim: We’ve got some other fund managers that have similar approach that we’ll compare notes with what they’re doing. We don’t need a lot of ideas. We just need to make sure if we do something it’s pretty much going to be right. So, yeah, we read a lot of stuff, look at a lot of stuff and we pass on it. But we’ll still read it just to see what’s going on with the economy and other parts of it. And so, we have a pretty steady flow of opportunities coming in.

Tobias: Jim, you’ve been doing this for a while. Where do you place this market in the loopy markets that we’ve seen over the last 20 or 30 years.

Jim: Yeah, I think the economy is not bad. It’s still pretty good. That’s good, but there’s a lot of wild cards out there, if some of these tech companies underperform. But it seems like the structure, the economy has changed, service oriented and it seems a lot more resilient than with tariffs and all this stuff. And so far, you know we’ll see. But there’s always stuff that can come out of left field and surprise you.

Obviously, things are quite high now. But as people have said these, “It’s been rare that such big companies have been so fast growing and perform this well,” that’s the wild card. If they stub their toe a little bit, you could see a reaction. So, we’ll see. But the economy itself and the companies we’re looking at, we’re still finding stuff that we think is attractive in the long-term, that’s what has carried the day historically. It’s been good– [crosstalk]

Jake: I saw some–

Jim: Go ahead. Sorry, Jake.

Jake: So sorry. I saw some interesting data recently that was– So, if you took the capital intensity of Microsoft, Google, Meta, Amazon and Oracle, in 2015, 7.6% of sales was allocated to CapEx. In 2020, that number was 11.3%. This year, it’ll be 21.5%. So, this capital light business model is potentially going a little bit in the other direction. I saw that AWS apparently is anticipating 10 points of margin headwind in 2026 from the depreciation that’s already scheduled to flow through their income statement next year.

And so, if you think about like how much incremental revenue are you going to need from these guys in order to get a reasonable ROIC on these huge CapEx numbers, gosh, it’s staggering. I don’t know, like is there going to be an extra $3 trillion to $6 trillion available to the Mag-7 in the next couple years to justify this?

Jim: Probably not. We use AI, and it’s amazing to just ask questions on it. It cuts your time down a bit. How do they get paid for that? I don’t know that that’s going to be so easy, but I’m sure they’re thinking about it.

The other thing with the economy I think is interesting and curious to get your guys’ take. Since 2008, when the economy was really on its back, I always think about, well, how much value in real estate has been created in the United States. I’m not saying it’s all going to stay there, but the equity that consumers have– Maybe their kids don’t have enough money to buy a house, but the parents have the down payment. There’s a tremendous amount of equity. The banks are much, much stronger.

The government, notwithstanding the deficit, is a partner with all these companies, Tesla, Google, the Mag-7. So, if you said to it, borrow some money to grow the assets, was this a good decision around these deficits? A lot of money hasn’t been used well. I know there’s a lot of risk, obviously, and but froth. So, you really got to be careful. But the asset value of the country seems really impressive relative to 2008 when no one had equity in their homes.

And so, I just think about that and I’m like, “Well, maybe it’ll sustain the economy a little longer than perhaps people think.” I don’t know what you, guys, think about that, but that’s my–

Jake: My understanding is the US consumer, US businesses, the banking system are relatively good shape balance sheet wise. Now, I would say there’s still a fair amount of water in a lot of valuations when you’re using that asset total. I don’t know if houses have really found a true equilibrium just because volumes have been so low. If you had to go sell it today a bunch of these houses, is there actually, like, would you get the price that it’s listed at today? I don’t know, I’m a little skeptical. But the government balance sheet is gotten atrocious in the meantime and has been the taking up the slack.

Unfortunately, I think that the productivity multiplier of government spend is a lot lower than when it’s done in the private sector. And so, I think if you just look at GDP numbers and back out the government part of it, it’s probably been a lot of wasted money not going to the most productive things. I don’t know, it’s probably not a good reflection of how we should be maybe organizing ourselves.

Jim: Fair point. Totally. Totally agreed. Yeah.

Tobias: Housing looks to me to be about 30% overvalued. If you look at what the median income can afford versus the median house and where rates are, I think a lot of the housing guys are hanging their hats on rates will drop a little bit from here. That may be right. It looks to me like, if you follow that idea that the two-year is a pretty good predictor of what the Federal Open Market Committee should be setting–

Jake: [crosstalk] the rates at?

Tobias: The rates. Yeah. It looks like, it’s maybe a little bit too high. We’ve been in this inversion now for– That inversion started more than two and a half years. Some days, we’re out of the inversion. Today, we’re back in the inversion. It’s been going on since the start of 2025. It’s very strange. I think some of that stuff is odd. I don’t know how to think about it at all. I’m just waiting to see if it breaks one way or the other. I don’t know if it helps with any of the investment at all. It just a may be a harbinger of a little bit of weakness.

Since 2022, there has been a lot of weakness, certainly in the small and micro world, and mid-cap has been mediocre, bumping along sideways. All of the earnings gains have been in large-cap stocks. Smalls are down and mid-caps are sideways. So, I don’t know if that means that’s all now in the past and we’re going to move into a glorious part of the business cycle where small and mid-caps rip, or if there’s some weakness that hasn’t yet been recognized by the market yet. I have no idea.

Jake: Or, is it all the adverse selection that’s just left over in the public markets after private equity took all the gems out? [chuckles] I don’t know.

Tobias: Do you see private equity being active though in small– I don’t see private equity doing much ever.

Jim: Yeah. Very little. A lot of our companies– We have a couple we could talk about. They are very cash generative. They should be good opportunities for private equity, but we just don’t see that private equity has really been that active in it. I don’t know if it’s the higher interest rates or that their portfolios are pretty full and they’re trying to– Yeah, we haven’t really seen them as active as we would have thought.

Abigail: Mm-hmm.

Jake: Well, they are pretty stuffed to the gills at the moment with assets. Some of these are getting long-lived enough where the fund life is going to start dictating that you’re supposed to be returning capital to your LPs, and it’s a question mark as to how that’s going to happen.

Tobias: Well, they can’t flick it public, because they seem to be getting better multiples privately than they can [Jake laughs] get publicly. I don’t know if that means that the public markets are right or the private markets are right, but it doesn’t seem like there’s an easy exit onto the public.

Jake: Somebody’s offsite, huh?

Jim: Yeah. I just think that the private equity portfolios are– The valuations there are, that’s going to be tricky, I think. Public stocks are quoted every day, and so our portfolio is liquid. We’re finding some good companies out there they’re not maybe growing super-fast, but they’re generating really good cash flow and they look like good values to us even with this economy, with the high interest rates that may come down or they may not. But that’s what we’re focused on, just stuff that’s got a pretty solid franchise.

Tobias: I don’t know that it’s entirely private equity just mismarking the books either, because I think that they’re actually doing transactions at those very elevated levels. It’s just that for whatever reason it’s not reflected in the public markets. I think they do a lot of trading between themselves or they trade one private equity firm to another private equity firm, which is probably, that’s a fair mark. But when they trade one of their own funds to a follow-on fund, I’m not entirely sure that that’s a fair mark. One of those funds is not getting a good deal.

Jim: And the leverage is pretty high on a lot of things.

Tobias: Yeah.

Jim: I don’t know if I’d be comfortable with the multiples there. We’re looking for stuff that has no debt and just maybe less risk, so that could be coming– [crosstalk]

Tobias: What’s risk? Risk hasn’t been important for [Jakke chuckles] 17 years now. [chuckles]

Jake: Yeah.

Jim: So, we have a couple companies we could talk about.

Tobias: Yeah, please.

Jake: Should we get the veggies out of the way first?

Tobias: Oh, yes. Sorry.

Jim: Oh, yeah.

[crosstalk]

Abigail: We’ve been looking forward for that.

Tobias: [laughs]

Jake: Just in case, because I’m sure once we get into individual names, we’ll go down rabbit holes. All right. So, as we’ve detailed on the travel episode that Toby and I did about Japan and China from earlier this year, I think we both were quite impressed with what we saw in China and the pace of innovation, the appetite and the ability to build things and like just generally get things done there was quite impressive.

I came away thinking that, boy, the rest of the world maybe has no chance to really compete with this Chinese manufacturing juggernaut. And related to that, I was down in San Diego a few weeks ago and I met with the founder of this pretty successful children’s clothing brand. He’s been in the garment industry for 30 plus years. So, he’s spent a lot of time in China for sourcing. He only confirmed that he thought China was really far ahead of the rest of the world. He told me like he didn’t think the US could be competitive in clothing for at least two generations. And that’s if we started today, if there was any appetite to start today, which I don’t know if there even is.

So, my views on China’s manufacturing dominance, I feel like are getting pretty firmly cemented in place, which I actually don’t like. So, I borrowed a page from Darwin, and I went looking to find facts that would kill my newly cherished beliefs before they worm their way in so deeply that I was losing open mindedness about the subject.

So, I asked myself, how does Mother Nature tackle manufacturing? which leads us today’s topic of ribosomes. And inside of you right now, there are trillions of ribosomes humming along invisibly in every cell of your body. They’re these unsung molecular machines that are responsible for translating your genetic code into the proteins that make you you. So, your skin, your organs, your enzymes, your hormones, all lovingly handcrafted by these tiny little micro machines that build stuff for you.

So, their central function is to take that genetic information which is carried by mRNA into proteins, and they create this structural and functional roles within your body. And so, they’re not organelles that are enclosed by membranes like the nucleus or the mitochondria, for instance. They float around freely in the cytoplasm or they’re attached to the endoplasmic reticulum.

I apologize if you’re getting Bio 101 flashbacks here, but there’s each one– Let’s explore a little bit more of what they look like. They’re about 20 to 30 nanometers in diameter. And so, for perspective on that, that’s roughly 1,10,000 the size of a typical human cell. And a human hair, for instance, is 80-100,000 nanometers wide. So, tens of thousands of these ribosomes could fit across the width of a single human hair.

How do they work? They bind to a strand of MRNA which has been transcribed from DNA in the nucleus. It scans and it’s looking for this thing called a starting codon. That’s basically these three nucleotide bases which are signaling like, “Hey, start here.” They’re basically looking for this chemical on switch to start building. When they find that, then they start reading sequence by sequence along these codons. Each codon has a matching transcription RNA that has a corresponding amino acid. So, these amino acids are linked together by these peptide bonds, and they form a polypeptide chain.

So, basically, it’s like building one little block at a time, like a machine reading a tape. And then, it gets to the end of that and called a stop codon and then it will then basically, “Okay, this one’s done. Break it off,” and now you have a protein. That’s how you get created. Your body’s making 10 million proteins a second. So, just marvel at that for a second. Imagine anything being produced 10 million per second. It’s just an amazing feat.

So, let’s see if we can stitch some of this together and try to land the plane. Our entire industrial age of smokestacks and mega factories, container ships gliding across the oceans, was built on this concept of centralization and control, uniformity of process, increasing scale that drives down costs. China is I think the ultimate manifestation of this production at scale right now. When we’ve erected these enormous infrastructures that are optimized for throughput, and you make it in Shenzhen and then you ship it to Long beach and then you put it on a train and that’s how it gets to you if you’re in the US

But Mother nature has taken a completely different route for her manufacturing of ribosomes. If they’re these tiny, distributed independent factories all over the entire structure and there’s millions of little actors that are interpreting code and making what’s needed, where it’s needed, when it’s needed, and they respond to the cellular environment, the energy levels, stressors, nutrient availability, they’re adjusting their output dynamically at all times. It’s very decentralized and it’s very fault tolerant. Like, one piece breaking doesn’t destroy the whole chain.

That works okay. The 20th century ran on centralization with these massive factories and top-down planning, global supply chains. And that works when things were slow, customization was rare, the customer just wanted a black Model T or that’s what they told they could have. But events like the earthquake in Japan, COVID, restrictions on microchips and technology, all these things make supply chains potentially fragile. It turns out that centralization, while is efficient, is also quite brittle to change.

So, the counterargument to this Chinese dominance is a concept that we might call like ribosomal microfactories. You take a digital blueprint, it gets interpreted by a robotic arms and 3D printers and CNC machines, and they’re all working autonomously and locally and in parallel like biology– A single failure in Cleveland is not going to derail the part that you need in Seattle. These local nodes can adapt to the stresses and localize preferences much easier.

So, whether it’s climate disruptions or geopolitical tensions, shifting demand curves, everybody wanting their own unique, whatever, the world has a lot of fault lines in it. It’s likely we need systems that can bend a little bit more without breaking. I think that same kind of ribosomal approach could apply to energy as well with these small self-contained nuclear reactors that are powering every local neighborhood, or food supplies that are grown much closer to the end user, instead of shipping fruit from South America to the US in the wintertime. Or, 3D printing houses.

I think there’s all kinds of places where this trend of hyperlocalization might play out. And who knows? Maybe the future still belongs to China with these massive factories. But I at least wanted to explore some other paths that the world might unfold before I got too committed to any one worldview.

Tobias: How does he do it, folks? I saw somebody pitching an idea that– I think this is going
ahead. There’s a city that they’re going to build in Solana in California, which is near Silicon Valley, but they’re going to try to recreate that Shenzhen.

Jake: Oh, really?

Tobias: I saw a Twitter thread where he was making all the arguments for why this was a good location. All these things are going to be able to co-locate together, and close to AI and all of the stuff in Silicon Valley but also close to shipping and rail and so on.

Jim: Hard to figure it all out. [crosstalk]

Tobias: Yeah.

Jake: [chuckles] Just find a 10% free cash flow yield [Jim laughs] and stop messing around with all these hypotheticals. [chuckles]

Jim: Yeah. Keep an eye on everything really. I mean, it’s just everything affects everything else.

Tobias: Jim and Abigail, do you want to walk through one of your–

Jim: Sure.

Tobias: I’ve got a few, but you tell me which one you-

Jim: Yeah, we can-

Tobias: -want to start with.

Jim: Which one? Yeah, why don’t you start with it?

Abigail: Sure. Yeah, we can just walk through–

Jim: And these are all the same playbook which is enterprise value, cash generation hopefully sustainable, hopefully grow, some kind of barrier, great balance sheet, that’s our playbook. So, Abi can walk through one or two. We’ve got a couple of them here we can talk about really quick.

Leon’s Furniture: A Hidden Compounder with Real Estate Upside

Abigail: So, one of it we really like is Leon’s Furniture. They trade on the Toronto Exchange. The ticker is LNF.TO. They’re Canada’s largest furniture retailer. They’ve been around for over 100 years. I think they have a 115-year history. They operate over 300 stores under their banners, which are Leon’s, The Brick and Appliance Canada. So, about 50% of their sales are furniture, 30% are appliances and the rest are mattresses and electronics.

We see this as a highly resilient business model, as they have a strong market share of 15% to 20%. They’ve also developed very strong customer relationships, and deep brand recognition after being around for so many years and building upon customer trust across the portfolio of banners, including Leon’s and The Brick. So, we think this is a much more diversified business than people recognize.

Jim: Basically, if you go into your house, they’re selling everything in your house.

Abigail: Right.

Jim: Mattresses, appliances, furniture, electronics. They’ve been doing this a long time and they are very well known in Canada. We think it makes the business more resilient and sticky than it. Otherwise, it would be– I owned The Brick a long time ago. This was bought by Leon’s. I think they borrowed $500 million, $600 million to buy it in 2013. They paid all that off. While they were doing that, they got to a net cash position, they bought back 20% of the shares at the same time.

This company just generates tremendous cash flows. It has no leverage. The family is a large stakeholder in it. The CapEx is modest. And then, the cherry on the cake– It trades at about five times EBITDA, and has we think a double-digit free cash flow yield and we think sustainable. Again, it’s not exciting. People look at furniture, but it’s more than a furniture retailer. We think it’s pretty integrated. They have a really strong competitive position versus the smaller players in Canada. Again, they’re selling everything in your house.

But the interesting thing is, really, we like it even without that it’s maybe trading at 10 times, 11-times earnings. So, a very modest valuation and it is growing. But they own probably a billion to a billion five of real estate, which is almost the enterprise value of the company. They talked about spinning that off into a REIT. Loblaw did that.

Abigail: Canada Tire.

Jim: And Canadian Tire did that. So, even without that, we like the situation. It’s a play on Canada growing over the next 5 or 10 years. The housing market in Canada obviously has issues. They all do, but it’s a very resilient business that again has gushed tremendous cash over the last several years. It did fine through COVID and has a really strong position relative to its competitors throughout Canada. Where it’s got its locations deployed across Canada, it’s very hard to compete with. So, that’s something we like. We think if you hold onto it for a long time, it could compound away and you could do quite nicely. [crosstalk]

Tobias: Why do you think it’s trading cheaply here? What’s the reason for that?

Jim: It’s not super liquid, honestly. The family owns a lot of it. They’ve only recently in the last year or so gotten more aggressive about hiring an outside CEO and trying to get some credit for all the real estate they own. Because you think about this company, they paid off all their debt. While they did all this, they have 50 properties to 60 properties they own outright that they bought over the years. There’s tremendous value there. We find a lot of companies in Canada. People don’t pay attention to them. People think Canada is just all natural resources–

Jake: Mining.

Jim: Yeah. So, we find a lot of really good companies up there.

Jake: Can I ask a question? Do you find yourself often coming across companies that are more family owned? Oftentimes, there’s a less aggressive balance sheet when it’s your own money and you know you want to transfer it to the next generation. Whereas, professionally managed CEO, if the average time in the seats four and a half years, of course, you’re going to lever up and like, “That’s going to be the next guy’s problem. I need to get the stuff stock price up while I’m here.”

Tobias: Got to get those options to pay off.

Jake: You got to get those options in the money.

Jim: No, I think that’s really true. A lot of our companies are family owned. Not all of them, but–

Abigail: Hammond Power was originally family owned. I think the family is still involved.

Jim: Yeah. Yeah. That was one where we– It was a Canadian company. It was the largest manufacturer of dry transformers in the world-

Abigail: Yeah.

Jim: Nobody was paying attention to it. We bought into it. They had no debt and really good cash flow. The CEO was so excited when we called and I started asking questions, Bill Hammond, he pulled over to the side of the road and talked to us.

Abigail: Yeah.

Jim: So, we love those types of situations. And then, people discovered it, it did really well. So, that’s one. Another one Abi can talk about is LSI Industries. It’s a little more liquid. Do you want to give a quick overview, Abi? That’s in the US.

LSI Industries: Lighting Up Returns with Capital Discipline

Abigail: Yes. LSI. The ticker is LYTS. We presented this at MOI Global a few years ago and still really like it. Our thesis is the same. They’re a manufacturer of lighting systems and digital signage for commercial and industrial customers. They operate in two segments. They have their lighting segment, which is indoor and outdoor LED fixtures, and then they have their graphics segment, which is custom signage and digital displays, like the digital menus you see when you’re going through a drive-thru. They also do the lighting in convenience stores and gas stations, things like that.

They also are highly selective about the verticals that they’re in, and they serve high-value verticals like QSR (quick service restaurants), retail, petroleum. As I said, grocery, all the lighting when you go into a grocery store where produce is, that’s all lit up. They’ll do things like that. But similar characteristics in this one that we really like across all of our investments, highly cash generative business model. They have limited working capital and CapEx needs. They also have a high return on invested capital business model that’s supported by their asset light operating structure and disciplined capital allocation by management.

Jim: They very much focus on make-to-order.

Abigail: Mm-hmm.

Jim: So, they’re trying to be a solution provider for the convenience store player and the grocery store player. They’ll do little things that we would look at and say, “Well, who cares?” Well, if you’re putting in thousands of lighting locations, the ease of putting it in. So, Arby’s or whoever will give them an order for thousands of stores.

What’s happening is the convenience store area is really an attractive area and they’re competing with each other as to how attractive the lighting is inside and outside of the store, the displays. These guys are providing a solution. They’ll do everything, not just sell products. And it creates a sticky relationship with those customers where they go back. The cycle of refurbishment is getting shorter and shorter as these guys are competing with each other to get somebody to drive into their convenience store or the grocery store. Now, the– [crosstalk]

Jake: It does feel like my LED bulbs burn out a lot faster than the–

[laughter]

Tobias: They do.

Jake: It’s quite annoying.

Jim: You know, that’s the management. We like the CEO-

Abigail: Yeah.

Jim: Jim Clark. He likes to talk about under-promise, over-deliver. That’s the kind of guy we like. He had a set of projections out a few years ago, and he hit them two years ahead of time and now he’s got another set that fast-forwards to get them to $100 million of EBITDA in two or three years from now. They’re running about $50 million, $60 million today. Just very niche. They’re the largest pickleball lighting company in the country.

Jake: Gold mine.

[laughter]

Abigail: Yeah.

Jim: The company doesn’t have a lot of leverage. He’s done some acquisitions, and they paid back really quickly and paid the debt off really fast. So, we love that. We think he’ll keep doing that. It’s a display lighting company, but it’s not selling products. It’s selling the whole solution package, is the idea.

We think this is pretty attractive. If it can hit its $100 million EBITDA in a couple of years, because so much of the cash flow, the EBITDA drops to free cash flow, which is something we always look for cash from ops. We think it could trade easily at 10 times. The stock could go into the low 30s from 17 today, but we’ll see. So far, he’s executed very well. That’s another one we like.

Tobias: I had a few that I thought were interesting. One was International Workplace Group.

Jim: Yeah, exactly. We’ve been longtime customers of Regus ourselves. We think it’s a fantastic product service. We work done right as they say.

Tobias: We work for adults.

Jim: Yeah.

Jake: Yeah. [laughs]

Jim: Yeah. Mark Dixon, the CEO, owns 25% of the company. They have, I think, 4,000 locations. The next player has maybe 500. So, they’re global. They’ve been paying debt and generating cash. They did very well through COVID. We think it’s trading five times or six times adjusted EBITDA and we– [crosstalk]

Jake: Community adjusted EBITDA?

Jim: What’s that?

[laughter]

Jim: But we’re tracking the cash flow as well, which is important. We think that can grow at around 10% a year through 2030, but they’ve gone to this capital-light approach, because people are doing flex work. It’s so attractive, because people are commuting as we are right now by electronics and technology, not in the office. So, yeah, people are going back to the office a little more, but trying to get people to go in five days a week– When you have little kids, it’s going to be a tough sell. I think that structure will– And so, this is really just leveraging real estate assets.

So, IWG has shifted to this capital-light approach where they put up no capital and they get the landlord to pay for tenant improvements and fit out the location. All their relationships with PwC, Chase Bank or whoever, and they can drive and fill the center and run the center much better than individual real estate. So, what’s happening is they’re signing up all these real estate locations all over the world. Its very capital-light, and they get paid a fee for doing that.

As that capital-light piece becomes a bigger and bigger part of the business, the multiple of the stock could appreciate quite significantly. The CEO, Mark Dixon, is very frustrated with the share price, and they’ve done a lot of stuff to– I think Abi, they switched to the US GAAP reporting this year and USD reporting.

Abigail: Right. Right. So, that’s driving investor attention and it’s quite easier to understand. So, we think that’s a positive as well.

Tobias: The other one I thought was very interesting was McFarland Group, which is the UK packaging company. Just tell us thesis there?

Jim: I mean McFarland Group, yeah, UK packaging company. Basically, very long track record of successful acquisitions, kind of a roll up but done very well if you look back over many years. Really, they’re in a very strong position in the UK market. They’re expanding into Europe. They’ve got a very strong balance sheet, great cash generation.

The economy there is pretty tough, so their recent results, they reported a disappointing latest quarter but we think long-term. I wouldn’t bet against that management team when you look at the CEO and what he’s built so far and how he’s done it. And so, again, that’s something where we think if you hang on to it over a number of years, you’re going to do pretty darn well. And great cash generation, great balance sheet and very sharp pencil on doing acquisitions, that’s–

Abigail: Yeah. It’s interesting, for sure. They’re also a solutions integrator, because it’s a one-stop-shop for customers for all their packaging needs. Again, not very exciting, but it’s something their customers need. And so, they have these innovation labs where customers can come in and you can look on their website, but they have these areas in the innovation labs of them coming up with these bespoke niche packaging needs for the customer. They also have this significant fix program where they walk the customers through six different areas of how they could cut costs with their packaging, make it more efficient and demonstrating to the customers the necessity to have a great packaging solution.

Tobias: I noticed you, guys, invest across a number of geographic locations. We did mention Australia, but you do have some Australian holding at least, US, Canada, UK, Australia. What do you think about the opportunities in those various different markets and how do you handle the interest rate, and currency and everything else that goes with different accounting regimes?

Jake: A little rough on [Tobias laughs] bringing dollars back here.

Why We Invest in Canada, UK, and Australia Despite Currency Risk

Jim: Usually, we’re only going to invest internationally if it’s something so compelling. The opportunity is much larger than what we think could happen with the currency though you never know, for sure. The Australian company we own, Duratec, has been really successful. That’s done quite well, and it fit our playbook.

We talked to the company several times, and it was a very simple company that there’s many, many defense outlets throughout Australia. They do the maintenance. No large projects, but just maintenance on the facilities in those locations, and that’s their– So, it’s a very low risk business model without large capital commitments. They had a great balance sheet with large net cash position and the multiple is really modest.

They continue to execute that as they– So, that was really just the opportunity outweighed by far the concerns about. But it’s definitely a higher bar internationally. Canada is probably the place where we do the most stuff, but we see stuff in the UK. Usually, if we get the business features right, it overwhelms the currency and interest rate issues. But not always.

Tobias: Folks, we’re coming up on time. If somebody wants to get in contact with you or follow along with what you’re doing, what’s the best way about going about doing that?

Abigail: Yeah. So, we’d love to connect. We always enjoy connecting with like-minded investors, who understand our strategy and approach and always happy to talk about ideas or just opportunities we’re seeing. I say the best way is through email. My email is abigail@lowellcap.com. L-O-W-E-L-L. Jim’s email is jez@lowellcap.com. And we would welcome the opportunity to have another conversation.

Jim: Absolutely.

Tobias: Jim and Abigail, thanks so much for spending time with us today.

Jim: Thanks so much for having us. We love– [crosstalk]

Jake: Thanks for coming on.

Abigail: Thank you, guys.

Tobias: Pleasure.

Abigail: We enjoyed a lot.

Jim: We enjoyed it.

Tobias: JT, always a ball. Folks, we’ll be back next week same bat time, same bat channel.

VALUE: After Hours (S07 E24): Lowell Capital’s Jim and Abigail Zimmerman on LNF.TO, LYTS, MACF.L, and IWG.L

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