Dorel Industries (TSX:DII.B, DII.A, PinkSheets)

May 5, 2011


Price: $30.75


Diluted Shares Out: 33 million (Class A: 4.2 million + Class B: 28.4 million)


Market Cap: $1021 million


Net Cash: ($346) million


EV: $1,367 million (estimated)


Dorel Industries SELECTED FINANCIALS 2001 - 2010




Company Description:


Dorel Industries Inc. (DII.B, Financial)(DII.A, Financial) is a world-class juvenile products and bicycle company. Established in 1962, Dorel creates style and excitement in equal measure to safety, quality and value. The company’s lifestyle leadership position is pronounced in both its juvenile and bicycle categories with an array of trend-setting products. Dorel’s powerfully branded products include Safety 1st, Quinny, Cosco, Maxi-Cosi and Bébé Confort in juvenile, as well as Cannondale, Schwinn, GT, Mongoose, Ironhorse and SUGOI in Recreational/Leisure. Dorel’s home furnishings segment markets a wide assortment of furniture products, both domestically produced and imported. Dorel has 4,700 employees, facilities in nineteen countries, and sales worldwide.


Operating Segments


Juvenile (45% of sales)


The juvenile segment manufactures and imports products such as infant car seats, strollers, high chairs, toddler beds, playpens, swings, furniture items and infant health and safety aids. Globally, within its principal categories, Dorel’s combined juvenile operations make it the largest juvenile products company in the world. The segment operates in North America, Europe, Australia and Brazil and exports product to almost 100 countries around the world. In 2010, the juvenile segment accounted for 45% of Dorel’s revenues.


Dorel Juvenile Group ("DJG”) U.S.A.’s operations are headquartered in Columbus, Ind. The principal brand names in North America are Cosco, Safety 1st , Maxi Cosi and Quinny. In addition, several brand names are used under license, the most significant being the well-recognized Disney and Eddie Bauer brands.


Competition: There are several juvenile products companies servicing the North American market with Dorel being among the three largest, along with Graco (a part of the Newell Group of companies) and Evenflo Company Inc.


Dorel Europe is headquartered in Paris, France, with major product design facilities located in Cholet, France and Helmond, Holland. In Europe, products are principally marketed under the brand names Bébé Confort, Maxi-Cosi, Quinny, Baby Relax, Safety 1st, HOPPOP and BABY ART. In Europe, Dorel sells juvenile products primarily across the mid-level to high-end price points. With its well recognized brand names and superior designs and product quality, the majority of European sales are made to large European juvenile product chains along with independent boutiques and specialty stores.


Competition: Dorel is one of the largest juvenile products companies in Europe, competing with others such as Britax, Peg Perego, Chicco, Jane and Graco, as well as several smaller companies.


In Australia, Dorel is the majority shareholder in IGC Dorel (IGC) which manufactures and distributes its products under several local brands, the most prominent of which are Bertini and Mother’s Choice. IGC has also introduced Dorel’s North American and European brands in Australia and New Zealand, broadening their sales range. Sales are made to both large retailers and specialty stores.


Dorel is also the majority shareholder in Dorel Brazil. Significant operations began in 2010 as Dorel Brazil began to manufacture car seats locally and import other juvenile products. Dorel Asia sells juvenile furniture to various major retailers. Over and above its branded sales, many of Dorel’s juvenile divisions also sell products to customers which are marketed under various house brand names.


Recreational/Leisure (33% of sales)


The Recreational/Leisure segment’s businesses participate in a marketplace that totals approximately $55 billion in retail sales annually. This includes bicycles, bicycling and running footwear and apparel, jogging strollers and bicycles trailers, as well as related parts and accessories.


The breakdown of bicycle industry sales around the world is approximately 50% in the Asia-Pacific region, 22% in Europe, 12% in North America, with the balance in the rest of the world. Bicycles are sold in the mass merchant channel, at independent bicycle dealers (“IBDs”) as well as in the sporting goods chains. In 2010, the Recreational/Leisure segment accounted for 33% of Dorel’s revenues.


Brand differentiation is an important part of the bicycle industry with different brands being found in the different distribution channels. High-end bicycles and brands would be found in IBD’s and some sporting goods chains, whereas the other brands can be purchased at mass market retailers. Consumer purchasing patterns are generally influenced by economic conditions, weather and seasonality.


Principal competitors include Huffy, Dynacraft, Trek, Giant, Specialized, Scott and Raleigh. In Europe, the market is much more fragmented as there is additional competition from much smaller companies that are popular in different regions.


The IBD retail channel is serviced by the Cycling Sports Group (“CSG”) which focuses exclusively on this category principally with the premium-oriented Cannondale, SUGOI and GT brands. Pacific Cycle has an exclusive focus on mass merchant and sporting goods chain customers. The mass merchant product line is sold mainly under the Schwinn and Mongoose brands which are used on bicycles, parts and accessories.


However, in Europe and elsewhere around the world, certain brands are sold across these distribution channels and as an example, in the UK, Mongoose is a very successful IBD brand. Sales of sports apparel and related products are made by the Apparel Footwear Group (“AFG”) through the IBDs, various sporting good chains and specialty running stores. AFG’s principal brand is SUGOI and its major competitors are Nike, Pearl Izumi, Adidas, among others, as well as some of the bicycle brands.


Home Furnishings (22% of sales)


Dorel’s Home Furnishings segment participates in the $80 billion North American furniture industry. Dorel ranks in the top ten of North American furniture manufacturers and marketers and has a strong foothold in both North American manufacturing and importation of furniture, with a significant portion of its supply coming from its own manufacturing facilities and the balance


through sourcing efforts in Asia. Dorel is also the number two manufacturer of Ready-to-Assemble (“RTA”) furniture in North America. Products are distributed from our North American manufacturing locations as well as from several distribution facilities. In 2010, this segment accounted for 22% of Dorel’s revenues.


Dorel’s Home Furnishings segment consists of five operating divisions. They are Ameriwood Industries (Ameriwood), Altra Furniture (Altra), Cosco Home & Office (Cosco), Dorel Home Products (DHP) and Dorel Asia. Ameriwood specializes in domestically manufactured RTA furniture. Altra Furniture designs and imports furniture mainly within the home entertainment and home office categories. Cosco’s majority sales are of metal folding furniture, step stools and specialty ladders. DHP manufactures futons and baby mattresses and imports futons, bunk beds and other accent furniture. Dorel Asia specializes in sourcing upholstery and a full range of finished goods from Asia for distribution throughout North America.


Q4 Highlights:



• Total revenue decreased 1.1% to US$539.5 million from US$545.3 million. Net income rose 4.2% to US$25.2 million, or US$0.76 per diluted share, from US$24.2 million, or US$0.73 per diluted.


• Juvenile revenue decreased 5.0% to US$236.2 million. Excluding the FX impact, the organic sales decline was under 2% due principally to a slowdown in U.S. retail, which also explains the decreased earnings. Earnings from operations decreased 30.5% to US$14.6 million. Sales in the segment’s other markets increased.


• Q4 Recreational/Leisure revenues increased 17.2% to US$205.9 million. Earnings from operations rose 18% to US$10.6 M. Sales increased in the mass market category by almost 20%, supported by the successful Schwinn brand marketing campaign. Sales to IBD customers also grew by approximately 20%.


• Home Furnishings’ revenues decreased 19.6% to US$97.4 million, affected by a slowdown in retail at the majority of its customers. Replenishment orders were reduced and inventories at mass market customers were cut. Earnings from operations declined 53.8% to US$5.6 million as fixed


overhead absorption was reduced by lower sales and production levels and input costs were higher.


2010 Highlights


For fiscal 2010, Dorel recorded revenues of $2.313 million an increase of 8.1% from 2009. Sales improved by 3.5% in the Juvenile segment, 13.7% in Recreational/Leisure and 9.5% in Home Furnishings. If the impact of business acquisitions and year over year foreign exchange rate variations are excluded, organic sales growth in 2010 was just above 7%. Net income for the full year amounted to $127.9 million or $3.85 per share fully diluted, compared to 2009 net income of $107.2 million or $3.21 per diluted share.


As a result of recalls in the crib industry and new legislation banning drop-side cribs, Dorel has elected to cease the importation of cribs until the impact of these new regulations has been fully assessed. Though less than 2% of segment sales over the past two years, the negative impact of the crib business on earnings in 2010 was approximately $5 million.


Balance Sheet


“Versus the December 30, 2009 year-end balance sheet, the majority of the total asset increase was due to higher inventory levels. There are several reasons for the increase. While the impact of order reductions in the U.S. was significant at approximately $30 million, several other components account for the total increase. Firstly, last year’s inventory levels were too low to adequately service the Company’s customers, and as such, approximately 35% to 40% of the increase was intentional to align inventories with business needs. The bulk of the remaining increase was due to inventory for 2011 sales being brought in earlier than in the prior year.”


Cash + ST Investments = $16 million


Receivables = $370 million (normal level)


Inventory = $510 million (2008 and 2010 had this elevated level. Usual $300-$400 million)


Gross PPE = $350 million


ST Debt = $31 million


LT Debt = $320 million


Accounts Payable = $277 million


With LT Debt/Equity at 27% and interest covered 10x, company is in good financial health.




Profitability: Dorel is a steady business earning reasonable returns on capital. While double digit would be preferred, stability also is valuable. ROC has dropped in recent years.




Management


Martin Schwartz has been CEO since 1993, and is also Chairman of the Board. Due to Dorel's dual-class share structure, the Schwartz family controls 70% of voting shares despite owning only 10% of the company's share capital.


Risks:


· 30% of sales are to one customer (likely Walmart) (WMT, Financial).


· Juvenile products usually have focus on security aspects from various groups. There is higher than usual potential for litigations and product recalls.


· Sales in US for Juvenile Products and Home Furnishings continue to be weak for an extended period of time.


· Inventory of $500 million on the balance sheet may have to be moved at discounted prices if economic conditions deteriorate.


Valuation


At the current price of $30.75 and TTM EPS of $3.85, DII appears cheaply valued trading at a TTM P/E of 8. DII also trades at about 9 times the average earnings from 2008 to 2010. DII is trading cheaply on other measures such as EV/ EBIT, EV/Sales and EV/EBITDA.




DII has seen higher multiples in the past for all of these measures as can be seen from the table below.




FCF in 2010 was much lower due to the inventory issues mentioned earlier. In fact, FCF has jumped around a lot from 2008 to 2010 mainly due to inventory issues. However, if you consider the average FCF for the five year period from 2006 to 2010, it is about $100 million. Using this average number, we arrive at a P/FCF multiple of 10x. I expect FCF in 2011 to return to $100 million + levels.


Acquisition History


Dorel has a long history of making successful acquisitions. These details can be found on the website http://www.dorel.com/corporate_history.htm. As a result of these, Dorel carries a goodwill of $554 million on its balance sheet.


Summary:


Dorel Industries has an excellent portfolio of consumer brand products many of which have leadership positions in their product space. Dorel has been consistently profitable while growing the top line by 12% CAGR over the last ten years. Dorel has a good balance sheet with low leverage. The current concern is the high level of inventory which is 20%-25% higher than usual. Dorel shares currently yield 2% which is well covered by cash from operations. Valuation of Dorel @8x earnings (8.8x 3 year average) or @10 times 5-year average FCF is quite attractive.


Disclaimer: Currently no position. My position may change at any time. This is not intended to be used as investment advice or a recommendation to buy /sell shares of any securities discussed in this article. Please do your own research or contact your financial advisor.