Blyth: Can an average operating performance lead to above-average returns?
Blyth (BTH) calls itself a “home expressions company”. Most people call it a candle company. Neither description is entirely accurate.
Blyth can rightly be called the world’s largest scented candle company, because larger competitors like S.C. Johnson and Sara Lee (SLE) are primarily engaged in other businesses. Like its smaller rival The Yankee Candle Company (YCC), Blyth is primarily a scented candle company. However, unlike the Yankee Candle Company, Blyth has substantial non-candle related operations – hence the “home expressions” designation.
I’m not sure what a home expression is; but I’m pretty sure coffee doesn’t qualify. From that fact alone we can safely say Blyth isn’t really a home expressions company (last year, Blyth acquired Boca Java, an online retailer of coffee, tea, and hot chocolate). Blyth may not be a pure play scented candle company or a pure play “home expressions” company; but, that doesn’t mean it’s merely a hodgepodge of unrelated businesses.
There is a method to Blyth’s madness. From the manufacturer’s perspective, candles, ceramics, frames, vases, coffee, and gourmet food are very different products. But, from the customer’s perspective, they serve a similar purpose. Essentially, Blyth sells personal indulgences to women at affordable prices. That’s a big business in the U.S., Canada, and Europe. It also happens to be a good business.
Since 1998, Blyth has had an average return on assets of 10.33% and an average return on equity of 18.55%. Regular readers of this blog know that I like to use a third profitability metric from time to time. One of the best ways to measure the inherent profitability of a business (independent of its current capitalization structure) is to use the pre-tax return on non-cash assets (PTRONCA). Over the past decade, Blyth has had a PTRONCA of about 19.21%, which is very good – although far from great.
To put that 19.21% PTRONCA into perspective, think of it this way: independent of its capitalization structure, Blyth generated a little over nineteen cents for every dollar invested in the business (before taxes).
Essentially, this means that if Blyth hadn’t utilized any debt whatsoever it would have had a return on equity of roughly 12% (after taxes). Although a 12% return on equity doesn’t sound all that impressive, achieving a 12% ROE without using any debt would actually represent a solid performance for most public companies under most economic conditions.
Of course, over the last decade Blyth actually averaged a much higher return on equity (18.55%). During this period, Blyth utilized a material (but far from egregious) amount of debt. As a result, the company surpassed its own stated goal of achieving a 15% annual return on equity.
Based on Blyth’s past ROA and PTRONCA, it appears to be a good business. If we put aside GAAP accounting for a moment and look at the economic earnings of the business, we’ll see that Blyth has actually performed a bit better than its reported net income figures suggest.
Blyth’s free cash flow margin was excellent in each of the last several years. For the past five years, the company’s FCF margin has ranged from 5% to 12%. Many businesses would be satisfied with a 5% free cash flow margin. So, even when Blyth was at the bottom of this range, it was generating plenty of free cash flow.
Blyth’s free cash flow has been very high relative to its reported net income. Over the past ten years, Blyth had an average reported net income of $70.2 million versus an average free cash flow of $79.5 million.
Unfortunately, this gap would be entirely erased if free cash flow was reduced by the amount Blyth has spent on acquisitions. From a shareholder’s perspective, such a reduction is appropriate. Acquisitions eat up cash in exactly the same way an investment in a new plant does.
However, it’s worth considering the two lines separately, because it’s much easier to match cash outflows with specific acquisitions than it is to match cash outflows with specific investments in an existing business. This is especially true when looking at a company like Blyth, because some of the acquisitions are in different businesses (and different geographic locations).
Blyth has been able to consistently generate quite a bit of free cash flow. Over the past ten years, cash flow from operations (CFFO) has averaged $93.65 million. The latter half of the past decade has been even better as a result of sales growth. During the past five years, Blyth’s CFFO has averaged $142.64 million.
During that same period, free cash flow averaged $125.18 million before acquisitions but only $60.52 million after acquisitions – which is even less than the company’s average reported net income of $72.16 million during the same period.
What does all this mean? For one, it means Blyth’s free cash flow has grown far more than its net income over the past ten years. This isn’t surprising, considering Blyth invested much more heavily in cap-ex from 1997-2001 than it did from 2002-2006. That’s normally a good sign, but there are a few problems here.
Blyth’s sales growth has slowed considerably during the last five years. Before 2001, the company had been growing sales at 20% or more a year – without a lot of spending on acquisitions. After 2001, sales growth slowed to the mid single digits, despite an increase in the amount of cash being used for acquisitions. Slowing sales growth is clearly a concern. However, it may not be entirely specific to Blyth.
During the early and mid 1990s, the growth in scented candles within the United States was tremendous. By 2000, more than 75% of all candles sold in the U.S. were scented. At that time, Blyth estimated that only 5% of all candles sold in Europe were scented. So, a very large part of the growth in scented candles within the U.S. was simply a one-time migration from non-scented candles to scented candles.
In an August 1999 interview with The Wall Street Transcript, Blyth’s Chairman & CEO, Robert Goergen, illustrated the degree of penetration within the U.S. by citing a study conducted by his company: “Blyth has done research the last two years that indicates that when asked of women 'have you purchased candles in the last six months?' 67% of a random sample will say that yes they have. That percentage ranks with women's purchases in the last six months very close to lipstick and face makeup, which means that candles are a fairly broad and relatively routine part of everyday life.”
Once a product has achieved such penetration, it is inevitable that the rate of sales growth will slow. Sales of candles are limited by the number of women in the United States, because men will not buy scented candles (except perhaps as gifts for women).
So, once more than two-thirds of American women say they’ve recently bought a candle and more than three-fourths of all candles sold in the U.S. are scented, the fact that the growth in sales of scented candles is slowing should be seen as inevitable rather than remarkable.
It’s hard to track total sales of scented candles, because they account for a very small part of a great many different retailers’ sales. Also, while Blyth and Yankee Candle are public companies, many of their competitors are privately held. The rate of sales growth at both Blyth and Yankee Candle has slowed noticeably in the last few years. So, Blyth’s recent experience is clearly not unique.
Morningstar’s website lists Blyth’s stock type as “distressed” – which strikes me as a tad extreme. However, there’s no denying Blyth is now facing some of the toughest challenges it has had to contend with in many years.
Blyth’s Chairman and CEO began his most recent letter to shareholders as follows:
“Fiscal 2006 was a very challenging year for Blyth – in many ways, the most challenging in our nearly 30 year history. Sales growth across North America and Europe was difficult to achieve as consumers, faced with record energy prices, had fewer discretionary dollars than in years past. Moreover, the impact of double-digit cost increases in all of our major purchased commodities and freight had a dramatic impact on our financial performance.”
Later in his 2006 letter to shareholders, Mr. Goergen put the increased commodities cost into perspective:
“Let me offer some context on what the doubling in price of a barrel of oil means to Blyth. The cost of paraffin wax, a byproduct of the petroleum refining process, increased approximately 20% over the past year, as strong demand continued while capacity declined following the impact of hurricanes on Gulf refineries. Approximately 100 basis points of Blyth’s fiscal year 2006 gross margin decline resulted from higher paraffin, freight, and other commodity costs.”
Blyth has three stated long-term corporate goals:
- 5-10% annual sales and earnings growth
- 10-12% operating margins
- 15%+ return on equity
For the year, Blyth experienced a slight decline in sales and a steep decline in earnings. The company’s operating margin was 3.6% (well shy of the 10-12% goal). Blyth’s return on equity also plunged, falling from 17.42% to 4.90%. In other words, the company fell far short of each of its three goals during fiscal year 2005.
During the current fiscal year, Blyth’s results have only worsened. On August 31, 2006, the company reported a second quarter operating loss of $27.7 million compared to a $16.9 million operating profit in the year ago period. All of last quarter’s operating loss (and most of the difference between this year’s results and last year’s) was attributable to a non-cash goodwill impairment charge of $36.8 million.
Last year’s second quarter was also helped by a $5.5 million reserve reversal. Excluding these items, second quarter operating profit was $9.0 million in the second quarter of this year versus $11.4 million in the second quarter of last year.
Blyth also took a $68.6 million loss on the discontinued operations of its European wholesale business. In all, Blyth reported a net loss of $89.4 million during the second quarter of this year versus net income of $4.2 million during the year ago period.
Net sales for the last six months were essentially flat. Sales for the first half of the fiscal year fell by 0.40%, dropping from $545.1 million a year ago to $542.9 million this year.
The Good News
The company is in much better shape than these recent earnings reports suggest. Blyth’s Restructuring efforts have obscured its relatively normal operating results. Excluding the restructuring, Blyth’s performance has still been far weaker recently than it had been from 1997-2001.
However, the company will not continue to report losses for years to come. Even over the last twelve months, Blyth has generated nearly $100 million in cash from operations and over $80 million in free cash flow. So, the net loss is actually somewhat deceptive when considering the company on a continuing basis. These losses will not continue.
The Bad News
Blyth does face real challenges – and not just the short-term challenges presented by higher commodity costs.
Blyth also faces the prospect of declining direct selling revenue within the U.S. Over the last year, the number of independent sales consultants in the company’s U.S. PartyLite business fell by more than 7%. There were approximately 24,000 independent consultants this year versus 26,000 a year ago.
This decline in the number of active independent sales consultants caused a 5% decline in sales for the company’s U.S. direct selling operations. While the number of consultants in Canada was flat and the number of consultants in Europe was actually up this year, no one would be surprised by a continuing trend towards fewer active independent consultants and thus lower sales within the direct selling business as a whole and the U.S. segment in particular.
Blyth has long been involved in the direct selling business. The company acquired PartyLite in 1990. That was four years before Blyth’s 1994 IPO; so, PartyLite has been a part of Blyth for the entirety of that company’s history as a public company.
Direct Selling accounts for approximately 44.7% of Blyth’s total revenues. The company’s PartyLite subsidiary has more than 45,000 active independent consultants selling in the U.S., Germany, Canada, the U.K, Austria, France, Switzerland, Finland, Australia, and Mexico. Approximately 24,000 of these 45,000 consultants sell within the United States. These consultants sell scented candles and other accessories via the party plan method of in-home selling.
In addition to its PartyLite subsidiary, Blyth now owns two other party plan marketers: Two Sisters Gourmet and Purple Tree. Two Sisters Gourmet is a gourmet food company. Purple Tree is a crafts oriented business. At present, these businesses incur multi-million dollar operating losses as Blyth invests to grow them into larger, more profitable businesses.
Regardless of their current operating performance, these businesses do seem to be a good fit with Blyth’s existing PartyLite business and appropriate new ventures for the company to pursue. Of course, only time will tell if any of these ventures develops into the kind of larger, more profitable direct selling business Blyth is hoping for.
Blyth’s current price-to-earnings, EV/EBIT, and other such ratios are meaningless, because of the company’s recent losses.
During the last ten years, Blyth has had an average EBIT of $113.47 million. During the last five years, Blyth’s EBIT has averaged $113.77 million – essentially the same as the company’s ten year average EBIT.
Blyth’s current enterprise value-to-EBIT ratio is very high, because the company only reported $32.03 million in earnings before interest and taxes during fiscal 2006.
Blyth’s EV/EBIT ratio would be much more reasonable if computed using the average EBIT from past years. Depending on exactly how you calculate both the company’s current enterprise value and its average EBIT from past years the ratio will vary slightly. Regardless, this “normalized” EV/EBIT ratio would be around 8.7.
That’s a fairly low EV/EBIT ratio, but not an absurdly low one. To put it in perspective, invert the ratio to get the EBIT/EV yield (essentially a pre-tax earnings yield comparable to the yield on a taxable bond). An EV/EBIT ratio of 8.7 translates into an EBIT/EV yield of 11.49%. Obviously, that’s a good yield – especially in the current low yield investment environment. However, there are better yields out there.
To be fair, the average EBIT numbers I gave may be unduly conservative as normalized numbers, because they include Blyth’s abysmal EBIT of $32.03 million in 2006.
A better normalized figure would probably be Blyth’s average EBIT from 1999 – 2005. Those seven years may be the most representative, because they neither penalize Blyth for its extraordinarily poor 2006 performance nor for its far lower total sales prior to 1999 (remember, Blyth had once been quite the growth story).
During the seven year period beginning in fiscal year 1999 and continuing through fiscal year 2005, Blyth’s average EBIT was $134.40 million. If this average were used as Blyth’s normalized EBIT, Blyth’s EV/EBIT ratio would come in a bit lower at 7.34. That translates into an EBIT/EV yield of approximately 13.63%.
Buying a Company vs. Buying a Stock
As a business, Blyth is clearly underpriced. If I were drawing up a list of businesses selling for less than they’re worth, Blyth would be near the top.
If you could buy the entire business by merely paying the current enterprise value, you’d have yourself a very nice deal. But, you can’t. You can only buy small pieces of the business via the stock market.
No one could buy the entire business at the price at which each piece is selling in the open market. So, in that respect, you’re actually getting a better bargain than you would if you had to acquire the entire business.
Unfortunately, there’s a downside. Buying the entire business is an attractive opportunity, because the acquirer could use the company’s cash flow as he saw fit. Buying a small piece of Blyth in the stock market doesn’t offer this kind of control over the allocation of capital. That’s potentially a very big problem, because cash can be squandered.
Has Blyth squandered cash in the past? Not really. While it has acquired other companies (and so far has little to show for some of those acquisitions), it has generally made these deals at reasonable if not rock bottom prices. There are many other public companies guilty of paying far more for far less.
On the other hand, from the perspective of a 100% owner, Blyth’s free cash flow has not been successfully reinvested in the business during the last several years. The returns produced by additional capital (in the form of acquisitions financed with free cash flow) have been meager at best – at least in terms of creating additional free cash flow.
Over the last five years, Blyth spent $323 million on acquisitions, $230 million on share repurchases, $86 million on dividends, and $66 million on capital expenditures.
Right now, the best use of cash would certainly be to buy back stock. At these prices, investing in Blyth makes a lot more sense than investing in another business via an acquisition. Hopefully, Blyth’s management recognizes that fact and will act accordingly.
But, should you invest in Blyth? As always, that’s ultimately a personal decision. A lot of people don’t want to invest in companies in the midst of such upheaval. That’s fine.
However, failing to see the value in Blyth, simply because of its most recent reported results is not fine. In fact, it’s a very common and very costly mistake.
You will always overweight the last datum in a series. It’s nearly impossible not to. Just as it’s nearly impossible not to believe the current economic cycle will be different from all the rest.
If Blyth’s most recent results occurred five years ago, you would see them for what they are – an aberration. But, because they are the company’s most recent results (and the very last bit of information you have to go on) you’ll likely see them as the beginning of a new and terrible trend.
Human history favors the interpretation that years of past data are more informative than a single year of “current” data. Unfortunately, human history also favors the interpretation that this fact will only be obvious in hindsight.
Future operating results will determine whether Blyth is a good buy today. I don’t know what those operating results will be. However, I do know they don’t have to be particularly good to justify buying the stock at its current price.
Considering how great Blyth’s cash generating ability is relative to its current enterprise value, an average operating performance from Blyth will lead to above-average returns for the company’s shares.