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Paradise Inc: Cost Containment Has Been Fruitful

December 06, 2012 | About:
This is one in a series of articles where I will be covering most of the "30 Obscure, Profitable Stocks" listed by Geoff Gannon on his blog on Nov. 29, 2012. Many thanks to Geoff Gannon for the wonderful list of interesting stock ideas.

Paradise Inc (PARF) conducts its operations through two business segments: the Candied Fruit segment and the Molded Plastics segment. The Candied Fruit segment is engaged in the production of candied fruit, a basic fruitcake ingredient, sold to manufacturing bakers, institutional users, and retailers for use in home baking. The Molded Plastics segment is engaged in the production of plastic containers for its products and other molded plastics for sale to unaffiliated customers.

Valuation

PARF is currently trading at a trailing twelve months P/E of 5.98 and a trailing 12 months EV/EBITDA of 3.84. In terms of asset-based valuations, it is currently valued at 0.48x P/B and 0.64x P/NCAV. PARF achieved a 8.3% ROE for the past twelve months and a five year average ROE of 4.4%.

Financial And Business Risks

PARF has a relatively strong financial position with a gross debt-to-equity ratio of 12%. It repaid almost all of its long-term debt in June 2009.

Wal-Mart Stores, Inc. is PARF's largest customer accounting for 15% of its 2011 sales and has exclusive use of a Paradise-owned controlled brand. The trend of consolidation in the supermarket industry is expected to increase concentration of candied fruit buying activity and the bargaining power of customers.

PARF needs to process candied fruit and peels for 10 months during the year and acquire the fruits used as raw materials during their seasonal growing periods. This allows PARF to meet delivery requirements during the months of September, October and November, when demand for fruit cake materials is at its seasonal peak. The result is that PARF need to hold large inventories, which require financing to meet relatively large short-term working capital needs — that accounts for the short-term debt on PARF's books. Inventory days for PARF average from four to six months.

PARF needs to invest in maintenance capital expenditures to comply with certain environmental regulations. Over the years, it has made capital investments of over $1 million, including the building of screening and pretreatment facilities for water effluent and the redesign and rebuilding of one processing department in order to improve the control of the quality of air emissions. For the past five year, capex has averaged about 1% of PARF's sales.

Business Quality and Capital Allocation

PARF believes that its brands account for a large majority of all candied fruit sold in supermarkets and other grocery outlets in the U.S and estimates that it sold approximately 80% of all candied fruits and peels consumed in the U.S. during 2011.

In the plastics molding segment, sales to unaffiliated customers continue to increase, as PARF shifted its focus from the sale of high volume, low profit generics to higher technology value added custom applications. Also, PARF is expanding its base of business to include such diverse industries as medical supplies, food processing and aerospace, to offset the loss of business related to the housing market showdown.

PARF improved its 2011 net margin to 4.9%, compared with net margins of 1.7% and 2.9% in 2009 and 2010 respectively. This is the result of successful containment of its production labor costs through actions such the elimination of 15 full time positions, reduction of executive and salary wages by 15% and 10%, respectively, and the rescission of a 4% merit increase awarded to hourly workers. This has helped to offset increases in the cost of raw fruit commodities within the fruit segment and the increasing cost of resins within the Plastics segment.

PARF has been profitable for the past decade with gross margins consistently above 25%. EPS growth has accelerated in recent years, with three-year EPS CAGR of 17.8% and five-year EPS CAGR of 26.5%. PARF has paid dividends in every single year since 2006, and currently sports a dividend yield of 1.05% with a dividend payout ratio of 12%.

Conclusion

The market has not rewarded PARF for its improvement in ROE, indicating that it does not believe that the increase in net margin through cost control initiatives are sustainable.



Disclosure


The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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