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QEPC - Recent impressive earnings indicates opportunities or risks?

June 26, 2011 | About:
In the recent first quarter of 2011, QEPC reported more than double increase in the net income. That further enhanced the rapid increase in the share price. During the time horizon from July 2009 to now, its share price skyrocketed from $2.5 to $19.5. Is the business operating efficiently? And would investors be better off to buy in at the current price?

The company was founded in 1979, one of a leading worldwide manufacturers, marketers and distributors of hardwood flooring, flooring installation tools, adhesives and flooring related products targeted for the professional installers as well as the do-it-yourself consumers. It sells its products to home improvement retail centers and specialty distribution outlets in 50 states in the US and throughout the world.

Customers

In the recent filing with SEC in fiscal year of 2009, the company has disclosed its concentration in two customers. Dated from 1982, it began selling products to Home Depot, and in 1993, the Company added Lowe’s as a customer, which is the second largest home improvement retailer in the world and eighth largest retailer in the United States. Home Depot and Lowe’s are two largest customers accounting for 59% and 7% of the Company’s fiscal 2009 sales.

In the fiscal year of 2011, the company get delisted in NASDAQ and begin to trade in the OTC, which limits the information available. In the annual report of 2011, it said that the customer base includes a high concentration of home improvement retailers with one such customer accounting for a total of approximately 63% and 60% of sales in fiscal 2011 and 2010, but it didn’t mention the name of that customer.

Operating figures

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Revenue 110 129 143 174 212 216 218 204 206 238
Operating Income 6 7 7 5 3 -3 10 -4 13 15
Net Income 2 0 3 4 -1 -6 2 -7 9 9
Figures in USD millions

Starting from the top line, the revenue has been increasing gradually, over the last 10 years, revenue went from $110millions to $238millions, growing at the rate of 8.2% per annum. Over the last 10 years, it has two years of negative operating income, which is in 2007 and in 2009. During fiscal 2007, the Company recognized the impairment of $7.5 millions for goodwill and in Mexico, U.K. and U.S. reporting units. And in 2009, another impairment charge of $7.9 million applied to the unit of Domestics, Australia/New Zealand and Europe because of the reduction in net sales due to the global economic downturn.

The negative income in 2006 was due to two items in financial charges, the increased in warrant put liability and the increased in the borrowing interest expense. Now the warrant put liability is no longer in the company’s balance sheet.

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Gross margin 33.8 34.3 34.3 30.9 29.2 27.6 28.9 27.5 31.8 30.9
operating margin 5.53 5.55 5.2 3.09 1.5 -1.5 4.45 -2.2 6.67 6.38
Net margin 1.92 0.01 2.43 2.28 -0.6 -2.6 1.01 -3.6 4.36 4
Figures are in %

We can see the gross margin has been ups and down, fluctuating over years, between the range of 27-34%, the operating margin and the net margin is not very impressive, and subjects to wide fluctuations.

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Asset Turnover 1.74 1.92 1.89 1.99 2.28 2.32 2.52 2.95 2.39 2.71
Financial Leverage 3.17 3.18 2.9 2.95 3.64 3.97 3.29 4.54 3.31 2.50
Return on Equity 10.14 0.04 13.97 13.4 -4.4 -22.7 9.16 -47.7 34.62 26.70
Return on Equity in %

To analyze the Dupont profitability model, we can the return on equity has been in the wide fluctuations as well. The asset turnover is quite stable and it seemed to have the rising trend over the 10 year period. The financial leverage level has been contributing quite a lot to the high return on equity over the last 5 years as the net margin was not very impressive.

Financial Health

For the quarter ended May 2011, the company reported to have $48.8 millions in total liabilities, and $39.7 millions in equity, which indicates the Debt /Equity ratio of 1.23. A little bit high leverage; moreover, the debt figure should be adjusted for other commitments as well as the preferred stocks.

For preferred stocks, there are 03 classes, the Series A is cumulative preferred stock and there are currently 319,160 shares of Series A Preferred Stock issued and outstanding. The holder of each share of Series A Preferred Stock shall be

entitled to receive, before any dividends on the Company’s common stock, cumulative dividends equal to the prime interest rate on the first day of the month in which the dividends are payable, less 1-1/4%, payable in semi-annual installments. Besides, there were 17,500 shares of Series C Preferred Stock issued and outstanding. The holder of each share of Series C Preferred Stock shall be entitled to receive, before any dividends on the Company’s common stock, cumulative dividends at the rate of $.035 per share per annum, payable in annual installments. There is no preferred outstanding stock for series B at the moment. The number of preferred stocks outstanding is not very large at the moment, so it doesn’t affect much on the financial health currently.

For other commitments, QESP will have to make the minimum payments under non-cancellable operating leases. The total operating lease payments are around $6 millions which doesn’t appeared on the balance sheet.

With those adjustments to be made, the Debt/Equity ratio is around 1.4 with the majority of the debt items in trade account payables and accrued liabilities.

Whether the business can sufficiently generate enough cash to meet with the liabilities, we will examine the trend in the free cash flow and the working capital

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Free Cash Flow 2 -2 7 4 0 4 4 -1 15 7
Working Capital 10 12 14 11 8 5 9 6 20 28


Over the past 10 years, the the FCF as well as Working capital is subject to large fluctuation as well, Working capital tended to decrease over time until 2009 and went back up for the last 02 years. The reason for the high FCF in the last 02 years because of high net income (due to lower cost of good sold) and increase in the trade payables and accrued liabilities.

It seems quite hard to have some predictability on the profitability and free cash flow the firms might generate in the future.

Management

Lewis Gould, Chairman of the Board, CEO

He has served in this position since 1979. Mr. Lewis Gould, formerly President, will remain as QEPC’s Chairman of the Board and Chief Executive Officer.

Leonard Gould, President

He has served as Senior Vice President, Retail Accounts of QEPC since 1998. He has held management positions in QEPC since 1995. On May 2008, He was appointed to be President of the company. In his new role Leonard Gould will be responsible for retail sales and all operational aspects of QPEC. Mr. Leonard Gould is the son of Mr. Lewis Gould and Ms. Susan Gould, the Secretary of the company.

James Brower, Executive Vice President and COO

He has served as Executive Vice-President and Chief Operating Officer since October 2005. Before that, he got substaintial experience in different operation fields with Dorel Juvenile Group, Applica Consumer Products, Inc and Remington Consumer Products, LLC.

Richard A. Brooke, Senior Vice President,Chief Financial Officer,Treasurer

He has served as Senior Vice President since January 2006. On August 2008, He got appointed as the Company's Chief Financial Officer, Senior Vice President and Treasurer. Before that, he was independent management consultant providing strategic and financial planning, restructuring and technology solution services from 1989 to 2006. Prior to 1989, Mr. Brooke was the chief financial officer of Sahlen & Associates, Inc., chief financial officer of Biogen, Inc., and a Partner with Deloitte Haskins & Sells.

Jamie L. Clingan, Senior Vice President

She has served as the Senior Vice President, International Marketing since July 2006. She has held management positions with QEPC since 2002. Prior to 2002, Ms. Clingan served as Marketing Manager with MAPEI Corporation, a supplier of adhesives and chemicals to the construction industry.

Besides, there are Lawrence P. Levine, the General Counsel and Susan J. Gould, the wife of the chairman, to be the secretary.

The largest shareholder is the chairman and CEO of the company, holding around 40% of the total outstanding shares, and his wife of 1.4% of the company.

By looking at the share holding structure and the key executives, it gives me the feeling of the family company where the father, the son and the wife involves deeply in the operation of the company.

Comparables

QEPC CBE DHR SWK Industry
Gross margin 31.57% 33.47% 51.52% 37.09% 34.23%
Operating margin 7.54% 14.07% 17.37% 10.63% 5.68%
Net margin 4.75% 9.39% 14.18% 4.87%
P/E 5.70 14.52 18.20 25.11 15.82
All figures are TTM

When looking at this table, by far the best company in the industry is DHR, enjoying the highest gross margin at whopping 51% and net margin, nearly double the closest competitor. QEPC is very on average in terms of gross and net margin, the operating margin is the lowest of the four.

Valuation

Comparing the relative P/E ratio with the industry and the closest competitors, QEPC seems to be cheapest. However, the low P/E is regarded as good stock normally, but not with the cyclical. Besides, the earnings and the cash flow of the company over the past 10 years seems to be very volatile, it’s hard to have some confidence on the future profitability.

With the cyclical, we need to pay extreme attention to the health of the balance sheet. For QEPC it’s not in the warning sign, but it doesn’t give the common stock holder enough confidence to sleep well at night.

Roughly, the average earning of the company over the last 10 years is at $1.7 millions. Assuming that is the average earnings for the future period to infinity, with the discount rate of 10%, the company would be value at $17 millions only.

The liquidation value or net working capital of the company stands roughly around $22million. As for both liquidation value and going concern value, the maximum price I would pay for the business is around $39millions.

Conclusion

The company earnings and cash flow are volatile, and the financial strength is not very outstanding. Besides, the stock price keeps increasing in the price at the breathtaking pace. At the market valuation of $65millions, I consider it is the overvalued. In the short-term, investors might still be able to see the market price increase, but the probability of price increase over the long run is low.

If QEPC proves to produce good consistent earnings and cash flow over some more periods in the future, then it can enhance its balance sheet and the value investors would have more confidence to get involved.

It is solely the subjective viewpoint of the author. It is not the recommendation to buy, hold or sell certain stocks. Anyone should do his/her own researchs for his/her own actions.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 4.1/5 (35 votes)

Comments

Blueblaze
Blueblaze premium member - 3 years ago
Great analysis.....thank you!
ken_hoang
Ken_hoang - 3 years ago
thanks. hope you find it useful.

Please leave your comment:


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