Today, I already wrote about GTSI (GTSI). That was a bonus article caused by the buyout being announced.
This is the regularly scheduled net-net article for May. It’s about Lakeland Industries (NASDAQ:LAKE).
The Ben Graham Net-Net Newsletter’s May 1, 2011, issue picked Lakeland. Then, on May 9, 2011, the Ben Graham Net-Net Newsletter’s model portfolio bought 70 shares of Lakeland at $8.70 a share. There was also a $7 commission. So the total cost per share was $8.80.
As I write this, Lakeland’s stock price is $10.39. So that’s a gain of $1.59. Or 18%. Over the same time period, the S&P 500 is up about 1%.
Reasons for Buying
Here is what I wrote about Lakeland back in May 2011:
Lakeland Industries... is an unusual net-net. Unlike the vast majority of net-nets, Lakeland is profitable. And it’s been profitable for most of its history. Lakeland was founded in 1986. It’s been profitable every year since 1994. Lakeland hasn’t just been more consistently profitable than other net-nets. It’s also been a faster grower. Since turning a profit in 1994, Lakeland has grown sales by 7.4% a year without posting a single loss.
Over the last 10 years, Lakeland’s pre-tax return on invested tangible assets was 10.18%. That should translate into a 6% to 7% after-tax return on assets. Not great. But hardly terrible either. A lot of companies that earn 12% or 14% on their equity do so by leveraging their assets up 2 to 1. Like a lot of net-nets, Lakeland doesn’t do that. And the market punishes Lakeland for its lack of leverage.
But low leverage doesn’t justify Lakeland’s rock bottom price. Lakeland has $11.43 a share in tangible book value. Based on its past returns on capital, Lakeland’s normal earning power should be 75 cents a share—without leverage. That puts the stock’s normalized P/E under 12. Not bad for a company that’s been profitable and growing for more than 15 years.
Lakeland isn’t just an asset play. It’s an earnings play. With a lot of emerging market sales growth ahead. Lakeland already gets 41% of its sales from outside the U.S. And that percentage is growing fast. Eventually, Mr. Market will change the way he sees Lakeland and start valuing the company based on its growing earnings instead of its current assets.
It’s not as if the stock has been dead money. Lakeland’s shares trounced the S&P 500 over the last 10 and 15 years. The stock has returned 9.5% a year over the last 15 years.
Lakeland isn’t really a below-average business. It’s just getting below average love from Mr. Market…
And here is what I listed as Lakleand’s pros and cons:
· $11.42 a share in tangible book value. $8.76 in net current assets.
· Earning power around 75 cents a share. Normalized P/E under 12.
· No losses in the last 17 years.
· 41% of sales are international. Growing fast in Brazil.
· “Foreign sales tend to have much higher margins than the U.S.”
· Stock outperformed S&P 500 over last 10 and 15 years. Returned 9.5% a year since 1996.
· Owns two-thirds of space it uses in the business. 443,150 owned square feet in U.S., Canada, China, Brazil and India.
· 92% of employees are international. Expenses have come down as the company has moved more operations outside the U.S.
· Most net-nets have a history of substantial losses. Lakeland hasn’t lost money since 1994.
· All the year-over-year numbers are improving. Business is rebounding from the depths of the Great Recession.
· Lakeland stayed profitable even in the very bad economy we’ve seen over the last two years.
· Low capital expenditures.
· A lot of sales come from disposable protective clothing. Plenty of frequent repurchases.
· Lakeland’s products are a cheap but critical part of expensive clean-ups, high-tech factories, worker safety, etc.
· Worker safety is a growing concern in emerging markets because of international trade standards.
· “DuPont, Lakeland and Kimberly Clark are the dominant disposable industrial protective apparel manufacturers.”
· Despite lack of a long-term agreement, hasn’t had any problems getting DuPont Tyvek since Lakeland was founded in 1986.
· International sales are growing.
· Growth company. “Have expanded substantially in recent years... large increase in employees and business... in short time.”
· Global. “...business model is far superior to what... had been... during the prior two decades when… focused domestically.”
· Excess capacity. Current facilities can handle 30% sales growth without any additional capital spending.
· Recently bought back stock equal to 4% of total shares outstanding.
· CEO knows stock is cheap. “Shareholders may... look forward to... our capital markets initiatives.” Code for buybacks.
· Takeover defenses include a staggered board and a poison pill.
· Inventory is 53% of tangible book. “We believe that by sustaining high levels of inventory we gain a competitive advantage.”
· Never paid cash dividends. Has no intention to start.
· 60% of employees are unionized.
· DuPont is both a competitor and a critical supplier.
· DuPont’s Tyvek makes up 22% of Lakeland’s total cost of goods sold. Tyvek is proprietary. DuPont is a competitor.
· Narrow margins.
· U.S. sales are shrinking.
· Often fails to produce free cash flow. Profit goes into supporting 7% or more growth in working capital — especially inventory.
What’s Happened Since
Lakeland’s stock is up 18%. The company’s net current asset value is $8.53 a share. So, the stock price is now higher than NCAV. That means Lakeland is no longer a net-net. And it wouldn’t be eligible for purchase by the Ben Graham: Net-Net Newsletter’s model portfolio today.
There was one negative event. On July 15, 2011, Lakeland announced:
“...DuPont will only fulfill orders for the purchase from DuPont of finished garments containing Tyvek® and Tychem® that can be fulfilled prior to September 10, 2011.”
And there was one interesting potentially positive event. A company in a related field – Ansell – bought 10% of Lakeland’s shares. Ansell is also in the safety garment business. But Ansell sells a much wider assortment of products than Lakeland does. For example, they sell surgery and exam gloves for doctors. They also sell condoms.
Some of those are much better businesses than Lakeland is in. And it shows.
Returns on assets, equity, etc. are much higher at Ansell. Most recently, unleveraged return on equity was around 20%.
Most recently, Lakleand’s return on equity has been right around break-even. And their unleveraged return on equity hasn’t been over 10% a year in the last decade or so.
They claim they can get ROE up to 12% at some point.
What does Ansell see in Lakeland? Are they interested in buying the whole company?
I don’t know. Lakeland put out a press release after Ansell filed their 13D:
Christopher J. Ryan, Lakeland’s President and Chief Executive Officer, said: “The purchases by Ansell, as reported this past Friday, were undertaken by Ansell through no solicitation or understanding with Lakeland. We believe such purchases reflect the undervaluation of the price of Lakeland’s stock. At the current time, Lakeland’s book value per common share is $14.34, and its tangible book value per share is $11.47. Based upon Friday’s closing price of the common stock of $8.98, the aggregate common stock valuation of $46.9 million is less than one-half of Lakeland’s trailing twelve (12) month’s revenues of $101.2 million. This discount of greater than 50% exists, even after the Ansell announcement and the increase in the stock price from the $7.88 closing price on Thursday. In addition, given the foundation we have built for strong worldwide growth, which management expects will be reflected in improved financial performance both near and long term, we believe that our common stock market price does not reflect Lakeland’s intrinsic value.”
Who knows why they put out that press release?
Obviously, Ansell did not simply buy Lakeland stock because they thought it was cheap. Ansell is not in the investment business. It is a company competing in some of the same product categories as Lakeland. Ansell had reasons beyond “the undervaluation of the price of Lakeland’s stock.” Although that undervaluation could have been part of the reason.
Ansell is a lot bigger than Lakeland. Ansell has a market cap of $1.8 billion. Lakeland has a market cap of $54 million. Even if Ansell bought all of Lakeland – the purchase would be no more than 3% of their current market cap. It would not be a big deal.
You’ve also probably noticed that Lakeland’s management is a bit promotional. When the DuPont deal was canceled, the actual statement from Lakeland barely mentioned that the DuPont agreement had in fact been canceled. Instead, it made it sound like Lakeland was announcing that the DuPont agreement’s cancellation would not cause a big sales decline.
That’s fine. But usually the first line of the press release can just say that, yes, the agreement is being canceled. And then somewhere a few paragraphs down you can make your point about “earnings should not be significantly impacted.”
This combined with Lakeland’s press release about Ansell’s investment does make you wonder about management. Why do they need to keep making press releases that are so optimistic?
They are very chatty – and very eager to spin stories – for a small company.
That doesn’t disqualify Lakeland as an investment. But it’s something to keep in mind.
Will We Sell or Hold?
Even though Lakeland is no longer a net-net, I see no reason to sell the stock so quickly.
The company had an operating profit of $1.4 million last year. Net income was negative. EBITDA was $3.4 million. Meanwhile, enterprise value is about $64 million. So, at an EV/EBITDA of 19 times Lakeland certainly doesn’t look cheap.
But the company has $11.98 a share in tangible book value. And unlike GTSI, Lakeland has managed to generate an operating profit just about every year.
In fact, in its latest press release, Lakeland heralds its “20th consecutive year of profitability from continuing operations.” That claim is only true because the language is so precise (“operating” and “continuing” being the key words) but it does reflect a very long history of profitability for a net-net.
Plus, another company in the same industry seems to think Lakeland is cheap. While that’s probably not a good enough – on its own – reason to buy the stock. It’s another reason not to sell the stock.
I’d prefer to hold the average net-net in the Ben Graham: Net-Net Newsletter’s model portfolio for longer than one year. Something like two years to five years sounds like the right holding period.
I don’t see a very good reason to sell Lakeland at this point. So I won’t. It stays in the portfolio for another year.
We’ll revisit Lakeland in May 2013.
Check out the Ben Graham: Net-Net Newsletter