I hope the information below provides and objective view of Amcon Distributing and demonstrates why shares are extremely cheap currently. Now on to why I believe shares are extremely cheap:
· Amcon currently trades at a P/E of just 5.5x based on 2010 net income of $8.7 million.
· Earnings in 2011 are almost certain to increase with the company’s recent expansion through the purchase of L.P. Shanks, which did not dilute shareholders.
· Amcon has a solid management lead by CEO, Christopher Atayan.
First, a little background.
Straight from the 10-K:
The company operates the following two business segments:
· Our wholesale distribution segment (“Wholesale Segment”) distributes consumer products in the Central, Rocky Mountain, and Southern regions of the United States.
· Our retail health food segment (“Retail Segment”) operates fourteen health food retail stores located throughout the Midwest and Florida
Our Wholesale Segment serves approximately 4,300 retail outlets including convenience stores, grocery stores, liquor stores, drug stores and tobacco shops. We currently distribute over 14,000 different consumer products, including cigarettes and tobacco products, candy and other confectionery, beverages, groceries, paper products, health and beauty care products, frozen and chilled products and institutional food service products. Our largest customer category is convenience stores. In October 2010, Convenience Store News ranked us as the ninth largest convenience store distributor in the United States based on annual sales.
Our Wholesale Segment operates five distribution centers located in Illinois, Missouri, Nebraska, North Dakota and South Dakota. These distribution centers, combined with cross-dock facilities, comprise approximately 487,000 square feet of floor space. Our principal suppliers include Philip Morris USA (PM), RJ Reynolds Tobacco, Proctor & Gamble (PG), Hershey (HSY), Mars, Quaker and Nabisco. We also market private label lines of snuff, water, candy products, batteries, film and other products. We do not maintain any long-term purchase contracts with these suppliers.
The retail health food stores comprising our retail segment, which are operated as Chamberlin’s Market & Café and Akin’s Natural Foods Market, carry over 30,000 different national and regionally branded and private label products. These products include high-quality natural, organic, and specialty foods consisting of produce, baked goods, frozen foods, nutritional supplements, personal care items, and general merchandise. Chamberlin’s, which was first established in 1935, operates six stores in and around Orlando, Florida. Akin’s, which was also established in 1935, has a total of eight locations in Oklahoma, Nebraska, Missouri, and Kansas.
It is important to note that 72% of the company’s wholesale sales come from tobacco products. The wholesale segment accounts for 97% of sales and 82% of operating income. Consistent with all distribution businesses, margins are small, but well-run companies can consistently earn adequate returns on capital employed.
Brief History of Company and Management
Christopher Atayan has served on the board since 2004 and became CEO of Amcon in October of 2006. At that time, the company was bleeding cash due to a failing beverage unit. The unit contained two companies, Trinity Springs and Hawaiian Natural Water Company. In the fiscal year ending Sept. 30, 2005, Amcon lost $11 million due mainly to a $13 million impairment charge (before tax) on the beverage unit. The company would have lost roughly $1 million even without the impairment due to operating losses in the beverage unit and excessive debt. In fiscal year 2006, the company lost another $1.5 million. The stock bottomed at $9 around June 30, 2006. Hawaiian Natural was sold in October of 2006. The operating assets of Trinity Springs were sold in 2009. From 2007 – to present the company has generated positive and ever-increasing amounts of cash flow.
In the fiveyears from September of 2005 through September of 2010 the company reduced debt from $60 million to $25 million ($7 million/year) and increased book value from essentially $0 to roughly $33 million. This has been extremely beneficial for shareholders. While the gains from the disposition of the beverage businesses have already been made, Amcon remains significantly undervalued based on its cash generating ability.
Amcon Distributing Operating Statistics:
|(#'s in 000's except per share)||2007||2008||2009*||2010|
|Operating Profit (EBIT)||$11,453||$11,659||$15,384||$15,526|
|Free Cash Flow||$8,149||$4,309||$16,211||$8,465|
|Net Income / Diluted Share||$5.16||$6.26||$16.61||$11.99|
|Return on Invested Capital||7.7%||9.2%||14.6%||15.0%|
Trinity Springs was accounted for in discontinued operations between 2007 and when it was sold in 2009. Results are not included in sales or operating profit, but net income does reflect Trinity Springs operations.
As I look at the table above, I notice a few things:
· P/E of 5.5x, which equates to an earnings yield of 18.1% and improving return on invested capital
· Revenue and net income increased despite some pretty turbulent times, which included very high fuel prices and an economic collapse.
· Enterprise value (EV) / EBIT of only 4.1x (Based on debt at 3/31/11)
The wholesale distribution industry is a mature and stable, but competitive business. Most of the large companies competing in this industry have been in business for many decades, some for more than 100 years. The industry does not seem susceptible to rapid technological change or rapid change in general. Despite these positives, companies concentrated in tobacco sale (like Amcon) are exposed to a market in decline. Tobacco industry sales have declined 3 – 4% annually on average, which means we can expect Amcon’s sales to decline 2 – 3% annually due to tobacco, all else equal.
I would encourage you to click on the link below for additional insight into the competitive landscape. The link takes you to an interview with Eby-Brown Company CEO, John Scardina. Eby-Brown is a privately held regional player in the industry. The interview is 18 months old, but I believe the issues discussed in the interview are still the primary threats confronting the industry today.
L.P. Shanks Acquisition
On May 30, 2011, Amcon announced the acquisition of wholesale distribution company L.P. Shanks (Shanks). The purchase expands Amcon’s footprint into Tennessee, Kentucky and Georgia. Shanks generates annual revenue of $200 million, which will increase Amcon’s wholesale revenues by 20%. Amcon paid $16 million, which was financed by debt. I have not seen anything that shows the operating earnings that Shanks generated; hopefully the third quarter 10-Q will shed some light.
Amcon generates operating margins of 1.4% on its wholesale business. If we assume Shanks generates 1.0%, the company’s operating earnings (EBIT) would be estimated as $2.0 million. This would increase Amcon’s annual operating earnings by 12.9% to about $17.5 million on an annualized basis. Using these conservative assumptions, EV/EBIT increases to 4.5x after the transaction. The good news… the company has increased cash flow without diluting shareholders and will be able to payoff the $16 million in less than two years with free cash flow!
Management – Christopher Atayan, CEO
I have been impressed with Atayan both through his actions and through reading his annual shareholder letters. I would encourage people to read the letters for themselves here:
On the downside, Atayan was on the Board when the company purchased Trinity Springs in 2005. He actually invested in preferred stock of Amcon to fund the purchase. As it turned out, that purchase did not turn out very well for shareholders.
On a positive note, Atayan has divested two money-losing business and increased cash flow at the company’s remaining, profitable businesses. He has substantially reduced debt since he became CEO. I expect him to continue focusing on reducing debt now that the company has used leverage to purchase L.P. Shanks. I believe this is a good use of capital for shareholders. Atayan owns 35.7% of the company, so his interests are certainly aligned with shareholders.
This analysis focuses mainly on the wholesale distribution segment as it accounts for 82% of operating income.
Finding like-sized publicly traded companies to compare against is difficult. There are very few businesses of similar size that are publicly traded. Most of the businesses available for comparison are much larger than Amcon.
I think the best comparable is Core-Mark Holdings. Core-Mark is much larger than Amcon ($400 million market cap), but it is also heavily concentrated in servicing convenience stores. Tobacco sales total 70% of revenue at Core-Mark, which is close to the 72% for Amcon. This similarity is more important than size, since tobacco sales will likely decline over time. Core-Mark trades at a multiple of EV/EBIT of 7.2x, which is 60% of Amcon’s after the purchase of L.P. Shanks (further described below). Given its size and liquidity, Core-Mark probably deserves a premium over Amcon, but not 60% in my view.
I would give Amcon an EV/EBIT multiple of 6-7x, which equates to an enterprise value of $105 - 123 million. This provides a premium of 31%-54% over the current market enterprise value of $80 million.
Of course every reader should make their own determination on what multiple of Amcon's earnings is appropriate. I think 6-7x is reasonable given the stable industry dynamics (with some well documented headwinds) coupled with the fact that 18% of earnings are generated by the health food segment. I would apply a slightly higher multiple to the health food segment compared to the wholesale distribution segment
I believe negotiated sales provide the best basis for comparison, especially given the lack of like-sized publicly traded competitors to compare to. Basing a comparison based on multiple competitors instead of just one is definitely preferred.
The table below shows recent negotiated sales within the industry:
|(#'s in 000's)||Annual||Price /|
|Company Purchased||Date||Sales||Sales Price||Annual Sales|
In the table above, L.P. Shanks and Discount Distributors were purchased by Amcon. The other two companies were purchased by Core-Mark. The table is focused on an analysis of price/annual sales. While a comparison based on earnings would be ideal, I could not find adequate information to complete that analysis.
The table demonstrates that prices tend to increase as the purchased company gets larger. I think a range of 8-10% of sales is appropriately conservative for Amcon given the average of 8.7% and the tendency for larger companies to command a higher multiple (at over $1 billion in sales, Amcon is larger than any of the companies above). I estimate Amcon’s annual run rate sales of $1,150 million for the wholesale business after the L.P. Shanks acquisition.
Based on the multiple of sales range and annual revenue, the value range is $92–115 million.
Deduct estimated debt and preferred stock after the L.P. Shanks acquisition of $41M, and we are left with a value range of $51–74 million. This is 31%–90% above the current market price and you are left with a debt free retail health food business that generates operating earnings of $3.8 million annually.
Debt: After the purchase of L.P. Shanks, The company maintains net debt of roughly $37 million. This seems large for a company of this size at first, but annual free cash flow of $10 million will knock that down quickly. Interest coverage will remain well over 5x including the L.P. Shanks debt. The majority of debt is on the company’s working capital line secured by receivables and inventory. The company’s line commitment is $70 million (subject to the level of working capital assets), which gives the additional credit availability if needed.
Industry Headwinds: The continued decline in tobacco sales is real. As is the regulatory uncertainty surrounding tobacco. The good news is that management understands this. They are focused on increasing sales outside of tobacco products. Despite these headwinds, I believe that well-managed companies in the industry will continue to earn decent returns on capital (10–15%) over time.
Capital allocation: The risk of management doing something stupid with the company’s capital is always there. I am encouraged that the two acquisitions recently completed by the company have been in the wholesale distribution business instead of some unrelated business, i.e., beverages. Secondly, management’s demonstrated focus on reducing debt is favorable to shareholders.
Why Is Amcon So cheap?
This is always an important question to ask yourself when you think a company is undervalued. Here are a few possibilities:
· The company is small and operates in a boring industry
· Folks who invested in the company for the turnaround have made their money. This is now a cash flow story.
· Industry headwinds related to possible future tobacco legislation and capital expenditures required to upgrade technology.
· The market has no confidence that the company will invest its excess cash flow well. While the company has made poor capital allocation decisions in the past (See Trinity Springs in 2005), even average capital allocation decisions should results in sizable upside for the share price. With his 36% ownership, at least we know the CEO’s interests are aligned with shareholders.
There is no clear catalyst here except for the continued reduction of debt through cash flow. The CEO has a history in investment banking and private equity (He is Senior Managing Partner of Slusser Associates), but he has not talked publicly about selling either of the business units. If those options were to be considered, I think it would result in substantial upside for shareholders.
Amcon provides a compelling risk reward scenario. The chance of a permanent loss of capital (Remember Graham’s Rule No. 1) is minimal given the low P/E (5.5x) and EV/EBIT (4.5x). Amcon trades at multiples well below those seen applied to purchases within the industry. Unless there is a sizable increase in the rate of decline for tobacco sales or management allocates capital really poorly, a purchase of Amcon here should work out very well here. I think these risks described above are more than adequately accounted for in the current price. In my view, Amcon trades at least 40% below its true value, which implies a stock price of $93. If the CEO were to ever look at selling the distribution business, the payoff could be much larger.