Tuesday, August 04, 2009

Investment Write-up: CCA Industries

What follows is an investment write-up I recently put together for an investment club I'm a member of. I've made some slight tweaks since the original posting on 8/2/09.

As a disclaimer: 1) I may not ever make another disclaimer again but you should assume the factset of this disclaimer is always true; 2) I own shares in CCA Industries so consider me very biased; 3) Do your own work. If you buy or sell this based on some random write-up you found on the internet, you are taking very real, independent risk. You cannot rely on my work or views to be accurate or current; 4) I may increase, decrease or entirely exit my stake in this business (or any other investment opportunity) at anytime I want without informing anyone; 5) Please recognize this is a highly illiquid microcap, so use a double dollop of caution.


CCA INDUSTRIES INC (CAW) - $3.75 on Aug 2, 2009
7.05 million shares outstanding

The Business:
CCA Industries is a small consumer products company. It makes low-end branded toothpaste, supplements and beauty products. As a low-end brand in product segments that do not tend to face generic pressure, CCA is itself, in essence, the generic offering. A variety of CCA's products can be found in most grocery, drug and supercenter stores. CCA has no sellside analyst coverage. It was previously written up by other members in December 2004 and May 2006, both at much higher prices ($11.24 and $9.59/share, respectively).

The Situation:
I actually was accepted into VIC by writing up CCA almost seven years ago when it traded for $1.80, had $1.50 of net cash and generated annual excess cash greater than the enterprise value. Today CCA is in a similar position.

With 7.05 million shares outstanding, its market cap is approximately $26.4 million. It has $17.4 million of cash and marketable securities and zero debt (that equates to $2.46 of net cash per share). In fact, its net working capital is $26.7 million, or equal to the market cap.*

In essence, the market values the business of CCA at somewhere between $9 million and zero.

There are plenty of good justifications for businesses to be worth zero or, in fact, less. However, CCA is not that sort of business. It has recurring revenue, is profitable and has been for many years, it pays most of its earnings out quarterly in dividends, and has virtually no requirements for incremental capital investment. While everything is not perfect (e.g., there's no need for the company to hold all of its cash on the balance sheet, management is overpaid, etc.), I take the view that owners at prevailing prices are well compensated for CCA's blemishes.

In the first half of 2009, CCA generated EBIT of $1.4 million, which in CCA's case approximates pre-tax free cash flow. After a generic 40% tax rate, that is approximately $0.8 million of FCF or $1.6 million annualized. $1.6 million equates to $0.23/share of annual FCF. Assuming an enterprise value of $9 million, the company trades for 3.2x EV/EBIT and 5.6x EV/FCF. I believe this is a reasonable downside case (though not worst case) for ongoing profitability.

Virtually the entire first half's profit was generated in the Feb. 28th - May 31st quarter (the fiscal second quarter). That is an important statement for two reasons: 1) this past January, the stock got crushed when CCA disclosed that Wal-Mart would no longer carry its Plus+White brands of oral care (a $6 million annualized revenue hit), meaning that the Q2 numbers reflected much of the Wal-Mart damage; and 2) Q2 was a fairly challenging time for consumer oriented businesses in general. Thus, it is quite possible that the second quarter's level of cash flow is the new normalized stream. If that is the case, the company will generate in excess of $0.40/share of annual FCF. While that would be a "nice to have" it certainly is not a "need to have" for today's price to be attractive.

During the second fiscal quarter, CCA generated sales of $14.6 million, down from $17.3 last year. $1.0-1.5 million of the $2.65 million decline can obviously be assessed to the Wal-Mart decision and the balance to general consumer softness. In response, CCA acted aggressively on the cost side by reducing quarterly expenses year over year by $2.5 million, almost fully offsetting the decline in revenue ($0.8 million was COGS, $0.7 million SGA, $0.9 million advertising and marketing).

The Owners and Management:
Insiders - defined by me as Berman and the Edell's - own 21% of the business. Costa Brava (an event driven small and microcap hedge fund) run by Seth Hamot owns another 8% and had a seat on the board which he recently relinquished. David Edell (age 76) and Ira Berman (77) also own 100% of the A-shares which differ in that they are super-voting and thus give those two effective control. As such, they run CCA like a family business. David Edell's two sons - Dunnan and Drew - manage the business day to day. While sons Dunnan and Drew are paid quite well, their compensation seems at least close to fair. However, David Edell (the father) and Ira Berman are both egregiously well paid given the small size of the business. They each make over $1 million per year ($1.3 million each, last year). This extra $2.6 million of compensation should be eyed lustily by some private equity shop somewhere as it is 80% of the FCF I expect the business will earn this year. If run more purely for shareholders and even half of that compensation were recovered each year for owners, it would obviously add enormously to business value (I'd guess $8 million to 20 million of incremental market cap, depending on how much could be taken out).

Even though I mentioned private equity, I do not expect a takeout. In late 2006/early 2007 Dubilier & Co. actually agreed to take CCA private for around $12/share (A shares were to receive $14.50 and B shares $12.00). The deal ultimately fell through when Dubilier exercised a financing contingency (and, in your author's humble opinion, they probably recognized they were paying a full price!). Given both David Edell and Ira Berman are getting on in their years, I guess it would not shock me if they tried again to sell the company.

Ira's simple metric for acquiring other businesses/product lines has been: cash + 1.5x sales = a full price to pay. Applying the same methodology to CCA would be $17.4 million of net cash + ($56 million sales x 1.5) = $101 million. Given 7.05 million shares outstanding, that would equal $14.33 per share (almost exactly what he was to receive for his super-voting A shares...). So, I'm a bit skeptical we see a deal...but you never know. In any case, even if you disagree vehemently with Berman's valuation technique, there is a lot of room between $3.75 and $14.33.

The Valuation:
With a rock solid balance sheet and a proven responsiveness to top line weakness, I believe CCA is well positioned to survive the current storm and generate an attractive total return as the market comes to realize that the Company is generating plenty of cash. In the meantime, the patient owner will collect a $0.28 annual dividend which equates to a 7.5% dividend yield at today's price.

Most people like price targets. I am not one of those people.

My simple minded view is that I'm basically paying hard asset liquidation value, receiving a reasonable dividend and getting the franchise for free. The franchise earns somewhere between $0.20 and $0.50/year in FCF over a cycle. Using even a fairly onerous discount rate, in combination with the balance sheet I feel confident you will come out with a value that substantially exceeds today's market price. Happily, even if that estimation of value is massively optimistic, today's share price is well supported by the balance sheet.

The Risks:
- Microcap that has been flattened many times and has every reason to stay hated;
- Tremendously overpaid, aging controlling shareholders that may not care about us;
- Management gets regular, substantial raises despite a shrinking (or non-growing) business;
- Loss of the Plus+White Wal-Mart business may be the tip of the iceberg. Perhaps other big accounts decide to retrench and focus only on core brands;
- We are in the midst of the worst (only?) consumer driven recession in my lifetime.

The Catalysts:
Value is its own catalyst - CCA Industries is a business that generates ample free cash flow and has a rock solid balance sheet, allowing you to own the business of CCA for next to nothing. Getting paid 7.5% to wait could be worse too. If the company reports its August quarter akin to its May quarter, it will make the company screen remarkably cheap.

* Note: for both the cash and working capital calculations, I've included Marketable Securities even though they are not categorized as "Current Assets". These are generally liquid and well marked (other than one auction rate security issued by the New Jersey State Higher Education Assistance Authority carried at $400,000 that has a face of $500,000). This is also important because that $2.2 million (or 8.5% of the market cap) is generally excluded from value screens as part of the business's cash.


After posting, another member asked me further about the ridiculous level of management compensation. Here is an edited version of my response:

In the past, they responded to criticism about their compensation and the risks associated with an excessively capitalized balance sheet (i.e., the temptation to do value destroying acquisitions or product launches) by instituting the dividend in the early part of 2003.

While meaningful, this is modest consolation today.

Their belief is that this is their business and the high comp reflects 25 years of value they've built.

I fundamentally disagree. My view is when you go public, you crystallize the "value" in the traded share price and at that point you give up the right to pay special profit distributions to yourselves (which is basically what these are; they clearly are not "compensation" since the two older gentlemen don't work day to day that much; rather the "comp" is really a preferential profit distribution at the expense of their fellow owners).

I find it upsetting, but predictable.

I also recognize that it most likely is a meaningful contributor to our opportunity to buy at today's prices and to our long-term upside. That said, they may continue to milk the company in this quasi-ethical manner indefinitely and that will be a drag on the business as they siphon profits away from their fellow shareholders.

Let me know what you think. I occasionally have investment ideas and would be happy to share them periodically (maybe one or two a year) if folks find it useful.