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CCA industries ($CAW) follow up

July 30, 2012 | About:

One stock that I wrote about a few months ago that I’ve been actively following is CCA Industries (CAW).

It’s rare to say this in such a short time frame (it’s only been seven months!), but quite a bit has changed since that write up.

Mainly, the company has an absolute hit on their hands in their new nail products. Check out the third line on this chart.


That’s a huge increase in nail care!!! An absolute hit! And the 10-Q also mentions that the company is continuing to increase distribution of the new hit products, which should lead to further rapid increases in sales.

And the increase in sales has lead to a (welcome) return to profitability.

I’m not going to do the math here, as I did much of it in the last write up on CCA, but the company is basically undervalued on any metric you look at it. As a matter of fact, I’ll even give you two new-ish metrics to value the company.

Before I do, I want to remind you that this is a brand company. Brand companies have very little need for invested capital and great ROIC. More importantly, brand companies represent very, very attractive acquisition targets. It truly is a case of 1+1=3. The math is pretty simple: buy a company, take out all of their SG&A costs (which fall straight through to the bottom line), cross sell your products through their distribution and their products through your distribution.

So, that said, here are the two new sources ways to value the company.

  • Carl Icahn, in his bid for Clorox, argued for an EV / EBIT multiple over 16x in an acquisition (you have to do some work to back into it, but basically buy the company for $15.5B while it earns $950m per year). While this may strike you as a high multiple, it’ s probably reasonable given the excellent economics, pricing power, and huge synergies.
  • CCA’s own CEO has stated that he looks to buy companies at 1.5x sales + cash. Coincidentally, in the failed merger in 2007 (see end of last post on CCA for more), the company was valued at ~1.5x sales + cash.
Feel free to do the math for either of those- but I’ll give you a quick summary: you’ll come up with a share price more than double today’s share price (note: for Icahn’s valuation, I removed some but not all of the excess compensation, as there’s simply zero chance a new owner would pay their mgmt what CCA pays themselves. Thus, a “free” synergy”. You could arrive at the same valuation without removing excess SG&A costs but by normalizing EBIT from the past five years. If you remove all of the excess compensation, you’ll get an even higher target!).

So why am I not investing in CCA? It really does have all the makings of a great value investment: activist shareholder grabbing board seats (Biglari), mean reversion to historical earnings power potential, a new hit product, great economics, a huge dividend (not that dividends matter, but the company has strong cash flows… you’d rather them pay most of it out than reinvest in a business that doesn’t need reinvestment!), and a potential catalyst from either a takeover or simple earnings increase once the founders consultant contracts expire in 2015.

And I’m truly tempted to make a purchase. Here is a truly goofy side story to show you how tempted I am to buy the stock: as part of my “due diligence”, I ordered their toothpaste from amazon and tried it (couldn’t really feel a difference between it and “normal” brands).

But I can’t help but worry that mgmt will simply steal too much of the value here. Remember- they’ve already cut the dividend once. It’s very instructive that they choose to cut the dividend instead of reduce their own lavish pay. With the controlling shareholder’s son now running the business (and enjoying a modesly lavish contract himself!), you have to wonder if any activist is going to be able to cause change here- what’s to stop the son from taking over the dad’s shares once he dies and continuing to rob the company.

Now, it is true that I’ve invested in plenty of “controlled” companies with crappy corporate governance and lavish paypackages (RDI, in particular, has way too many related party contracts and gives their CEO some hefty perks). But I think the difference here is this is actually a really good business with lots of cash flow- it’s simply too easy for the execs to steal. In RDI’s case, much of the value is at the property level w/o much cash flow… which, ironically, makes it harder to steal.

But in CAW’s case, mgmt just seems to willing to line their own pocket, and I really don’t know how that changes. If you can get comfortable with that, or you truly believe that the consulting agreements end in 2015, then this could be a multi-bagger in the making. If you can’t……..

Disclosure- Long RDI

Rating: 2.4/5 (5 votes)


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