With the surprisingly sky-high dividend yield that the company is offering its investors, should investors consider it an opportunity?
CPI (CPY) was formed in 1982, and has been a long-standing leader in the professional portrait photography of young children, individuals and families. As of fiscal year 2010, it has 3084 studios throughout the US, Canada, Mexico and Puerto Rico, mainly under lease and license agreements with Walmart Stores (WMT), Sears, Roebuck (SHLD) and Toys “R” Us. The company has an advantage of being the sole operator of portrait studios in Walmart stores since 2007, and for Sears since 1986. It also just entered a license agreement with Toy “R” Us since April 2010, to expire in the beginning of 2016. For the revenue segment, Walmart accounted for 52% of total revenue in 2010, Sears was 43% and Toy “R” Us was 5%. CPY's business is quite seasonal; large volume normally occurs in the fourth fiscal quarter, between Thanksgiving and Christmas. The fourth quarter made around 33% of total net sales and the majority of revenue for the year.
In terms of the balance sheet, CPY ran into negative equity in the most recent quarter reporting, as of November 2011. It was largely because of two factors: the negative treasury stock at around $46 million and the $20 million deduction in the retained earnings, due to the loss incurred during the year. Following the 10-Q in November 2011: “On August 24, 2011, the Company's Board of Directors authorized an extension of its share repurchase program and an increase in total shares from 1.0 million to 1.5 million shares. During the 40 weeks ended November 12, 2011, the Company repurchased 52,937 shares of its common stock at an average price of $20.54 per share.”
In addition, it was quite heavily indebted. Total liabilities topped $158 million, whereas the current portion of the long-term debt was $73.5 million. Even with the continuation of dividend payments historically, just last month, the company entered a credit agreement comprising three main points. First was the suspension of a leverage ratio test for the quarter ended Nov. 12, 2011. Second was the reduction of revolving commitment under the Credit Agreement from $105 million to $90 million. And third was the suspension of dividend and other restricted payments, including share repurchases, until the company presents evidence it can meet the debt covenants.
If the leverage ratio test for the quarter ended November 12, 2011 had not been suspended, the Company would not have been in compliance with this covenant. The current Credit Agreement requires a leverage ratio not to exceed 2.50 to 1.00. As of November 12, 2011, the Company's calculated leverage ratio was 3.10 to 1.00. The Company is currently evaluating long-term financing alternatives, which may include further amendment to the Credit Agreement. Until such time as financing alternatives and/or amendments are formalized, the balance currently outstanding under the revolving credit facility totaling $73.5 million as of November 12, 2011 has been classified as current in the consolidated balance sheet.
So if the company cannot meet its debt covenants, it would be restricted from paying out dividends to shareholders.
Over the years, CPY has been known for consistently positive cash generation. Over a 10-year period, CPY has generated around $30-$40 million per year of operating cash flow. And with the current price, the market values the company at only $12.75 million, and the TTM CFO was around $ 11 million, so the P/CF valuation is only 1.2 times, and the P/E is at 6x — quite a cheap valuation.
Regarding insider trading, for the whole year of 2010 and beginning of 2011, when the shares were trading at $13-$23, the insiders kept selling. But in October 2011, Dale Heins, the CFO and Treasurer, bought nearly $17.5k worth of stock for $5.7-$5.8 per share.
One of our gurus, Arnold Van Den Berg, has consistently bought and sold CPY’s shares over the last 12 years and now has become the largest shareholder, owning more than 16% of the total company. He commented on CPY in the recent interview with GuruFocus: “As one of the originators of the national portrait studio business, CPI Corporation (CPY) has a long heritage with the lowest cost structure in the industry. CPI Corporation generates substantial free cash, which it has deployed in a variety of ways: debt repayments, acquisitions, share repurchases and dividends. While I have no special insight as to whether a Buffett-type investor would make a play for CPI Corporation, it would not surprise me as the nature of CPI’s business could lend itself to that type of outcome.”
In short, CPY seems to be quite a nice play at the recent price, with the seasonal business concentrated in the fourth quarter. The only thing that makes me worried is the high leverage that the company has on its balance sheet. Only when the company can generate enough cash and stay at an ample leverage ratio can it keep paying dividends for existing shareholders. Nevertheless, currently CPY might be worth looking into as an opportunity for any careful value investor.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.
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