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Omega Protein: Can You Swallow the Volatility?

June 04, 2014 | About:

Omega Protein Corporation (OME) came to my attention through a Peter Lynch screen done at GuruFocus on May 29, 2014. Lynch looked for a major gap between a company’s earnings line (based on 15X earnings) and the stock price, which OME exhibits. The screen also shows an EBITDA 10-year growth rate of 26%, and a P/E ratio of 8.7, other important criteria for this guru.

All of that points to a candidate fitting the Peter Lynch criteria. But further investigation shows some other issues that could knock this stock out of contention as a Lynch candidate, or at least give investors a bumpy ride.

Omega Protein Corporation logo

History
Based on information at Wikipedia, unless otherwise noted:

  • 1878: John and Thomas Haynie open a fish processing operation in Reedville, Virginia.
  • 1913: The current company (under a different name) is founded (according to the Omega Protein website; it subsequently undergoes several name changes).
  • 1997: The company goes public, under the name of Zapata Protein.
  • 2002: Renamed Omega Protein.
  • 2010: The Board adopts a Shareholder Rights Plan, in part because the share price has been affected by the BP oil spill in the Gulf of Mexico (company news release).
  • 2010: acquires Cyvex Nutrition, Inc., a dietary supplement supplier.
  • 2011: acquires InCon Processing, L.L.C., a processor that uses molecular distillation technology.
  • 2013: acquires Wisconsin Specialty Protein, L.L.C. (fiscal 2013 10-K) http://files.shareholder.com/downloads/AMDA-HWM23/3209321092x0xS1437749-14-3713/1053650/filing.pdf.
  • 2014: Shareholder Rights Plan is terminated (company news release).

Takeaways: This is a company with now more than a century of history, growing and apparently adapting successfully to changing markets; the Shareholder Rights plan has been closed (six years ahead of its original expiry date).

The Business Model

  • A nutritional ingredients company.
  • Vertically integrated producer of omega-3 fish oil and specialty fish meal products.
  • Develops, produces and delivers nutritional ingredients throughout the world.
  • Serves three primary industries — human nutrition, animal nutrition, and plant nutrition.
  • Describes itself as “one of the world’s leading producers of fish oil and the largest manufacturer of fish meal in the United States.”
  • Five manufacturing facilities and 40 fishing vessels
  • Headquartered in Houston, Texas.
  • Animal nutrition responsible for 87% of revenue; customers include Cargill, IAMS and Nestle Purina.
  • Human nutrition responsible for 13% of revenue; customers include Whole Foods Market, Shaklee and Sprouts.

Takeaways: This is a niche company with a well-defined focus on nutrition. It has vertical integration with the pros and cons that delivers. Animal nutrition is the company’s main business line.

Business Strategy

Source: Investor Presentation, May 2014

OME strategy
Takeaways: The company has a plan to increase shareholder value, and a "map" for how to deliver.

OME by the Numbers

Omega Protein statistics

Takeaways: This is a micro-cap company with revenues that will likely put it into small cap territory within the next year or two. It pays no dividends or share buybacks. It carries P/E below the double-digits and a price near the high end of its 52-week range.

Ownership

  • Gurus: Only three of the gurus followed by GuruFocus have holdings in Omega Protein Corp.; in the quarter ended March 31, Richard Snow (Trades, Portfolio) owned 103,000 shares, increasing his holdings by more than 90%; Robert Bruce (Trades, Portfolio) held 600,000 with no change in the quarter; and Jim Simons (Trades, Portfolio) reduced his holdings by about 5%, to 190,000.
  • Institutional investors: 83%.
  • Insiders: 4%.
  • Short interests: 2.8%.

Takaways: It has a high level of institutional holdings, probably too high for Lynch’s liking, and short interests are low for a company of this size and volatility.

Financial Strength

Following the process Peter Lynch describes for annual reports in "One Up On Wall Street," we use GuruFocus' 10-Year Financials to capture the following data:

  • Current assets & marketable securities - 2013: $34.1 million
  • Current assets & marketable securities - 2004: $32.8 million
  • Long-term debt - 2013: $21.1 million
  • Long-term debt - 2004: $15.9 million
  • Net cash position - 2013: $13.0 million
  • Net cash position - $2004: 8.1 million
  • Shares outstanding - 2013: 20.6 million
  • Shares outstanding - 2004: 26.4

Takeaways: On each of the issues Lynch considered important, OME has made progress. The 2013 net cash position is 60% better than the position in 2004, and shares outstanding have been reduced by 22% over the same 10 years.

Management

President and CEO: Bret Scholtes, age 44, president and chief executive officer since Jan. 1, 2012; an executive at Omega Protein since 2010; previously an executive at GE Energy Financial Services. (10-K report).

Chairman: Gary R. Goodwin, age 66, Director since 2006; Chairman since February 2013, formerly Principal and Vice President of a privately held crude oil marketing company (10-K report);

ISS Governance QuickScore: 10 (scores are described this way at the ISS QuickScore website, “Scores indicate decile rank relative to index or region. A decile score of 1 indicates lower governance risk, while a 10 indicates higher governance risk.”

Takeaways: Assuming no missteps or personal issues on Scholtes' part, continuity at the CEO level looks solid. QuickScore comes from an organization that advises institutional investors on corporate governance matters; despite the low score, Omega Protein enjoys significant institutional ownership at 83%.

Valuation

Omega Protein Corp was found using a Peter Lynch screen at GuruFocus, and as this chart shows, a large gap exists between the current price and the earnings line:

1401742441943.png

  • Current price: $14.61 (at closing, June 3, 2014)
  • Earnings line: $25.50
  • P/E (ttm): 8.7

Using the criteria Lynch lists for Fast Growers in "One Up on Wall Street," we’ll assess OME:

  • Product a major part of the company’s growth? Yes, animal nutrition.
  • Growth rate of earnings in recent years: EBITDA 10 year rate = Yes. At 26% this would fit within what Lynch calls “...the 20% to 25% range....”
  • Duplicated its success in more than one market: Yes, with human nutrition.
  • The company has room to grow: Yes.
  • Stock selling at a P/E at or near the growth rate: No, the P/E of 8.7 sits significantly below the growth rate of 26%.
  • Expansion is speeding up? Yes and no: The fish oil segment is constrained by catch limits; however, the company has expanded through several acquisitions in recent years.
  • Few institutions own the stock: No, this stock is heavily owned by institutions.

Takeaways: While the gap between earnings and price shows promise from a Lynch perspective, it does have a couple of negatives: the volatility of its earnings history and high ownership by institutional investors. From another perspective, the stock appears on the radar of only three gurus followed by GuruFocus and, according to Yahoo Finance, only three analysts follow the stock; in Lynch’s book, low analyst coverage makes a stock more suitable.

Risks

Omega Protein Corporation faces a number of internal and external risks, as outlined in the 10-K report:

  • The company’s fish oil segment depends on a single, natural resource (menhaden fishery).
  • Adverse weather, including hurricanes, may affect fishery operations.
  • Fishery concentrated in the Gulf of Mexico, and susceptible to oil spills (OME was affected by the recent BP oil spill).
  • Potential, and unknown, environmental liabilities in connection with closure of its Cameron, La., plant.
  • Prices subject to worldwide supply and demand factors.

For the full list of risks, see the 10-K report for 2013.

Takeaways: Like any company in the natural resources and the food business, it faces a number of inherent risks, and likely will continue as a volatile holding.

Outlook

A number of broad trends suggest Omega Protein is in the right place at the right time:

  • Growing emphasis on wellness and preventative health measures, ensuring markets for human nutrition products.
  • Pets are being treated like children in more and more households, supporting growth in animal nutrition products.
  • We see a rapidly growing middle class in India, China, and elsewhere, with an appetite for protein; as CEO Bret Scholtes noted in the Q1 2014 Results - Earnings Call Transcript, “Long-term, we reiterate our view for positive pricing trends based on several variables, including a stable non-expanding global supply, growing population and increased standard of living.”

Looking at the Price and Earnings chart again, we note that while the current and recent management teams seem to have had the ability to grow earnings rapidly, they have not been able to do it consistently:

1401831314541.png

Of course, some of that volatility was not of their making--the 2010 Gulf oil spill, for example, But, such risks are an inherent part of a business that depends heavily on the fishing industry.

Also notable: looking at the chart above, for roughly 2011-2012, we see the price line did not rise as dramatically as the earnings line. Will that happen with the current gap between the two lines?

Takeaways: OME has a number of positives, including favorable macro trends, and a management team capable of growing the earnings. At the same time, though, price and earnings may each go their own way.

Conclusions

First, strict adherents of Peter Lynch’s investing philosophy would reject this stock; the institutional ownership is simply too high.

Second, this company is currently undervalued, based on the path of the earnings line, and by a significant amount.

Third, Omega Protein Corporation has the potential and ability to grow its revenue and earnings, but investors--like ocean-going fishers--should be prepared for rough seas on the way to their harvest.

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995, and in 2010 added options, mainly covered calls and collars with long stocks. He’s currently exploring two potential routes to an income portfolio: First, to combine dividend challengers, contenders, and champions with covered calls, and second, to combine more volatile stocks with collars.

As a writer and publisher, Abbott explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the Unseen Revolution. In Big Macs & Our Pensions: Who Gets McDonald's Profits?, the first of a series of booklets on this subject, he looks at the ownership of McDonald’s and what that means for middle class retirement income.

In an eclectic career, Robert Abbott was a radio news writer and announcer, a newsletter writer and publisher, a farmer, a telephone operator, and a construction worker. When not working, he has been a busy volunteer, which includes more than a decade of leadership roles at the Airdrie Festival of Lights, one of North America’s leading holiday light displays. He lives in Airdrie, Alberta, Canada.

Visit Robert Abbott's Website


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