Volcom: Small Cap with Excellent Upside

| About: Volcom, Inc. (VLCM)
Volcom (NDQ:VLCM) August 14, 2009: $13.07

52-week range: $6.39 (Nov. 21, 2008) - $22.06 (Aug. 14, 2008)

Volcom is a specialty clothing and accessories designer and marketer to snowboarding, skateboarding and surfing enthusiasts. The company was founded in 1991 by two partners who loved the sports. The business grew and came public on June 29, 2005 at $19.00 /share.

Since their IPO, Volcom shares have been as high as $51 (in 2007) and as low as $6.39 (at the November trough of 2008). Officers and directors still hold about 22.7% of the outstanding which closed Friday at $13.07 /share.

This is a very conservatively managed company. As of June 30th they held $96.2 million in cash and short-term securities against just $100,000 in total debt. That $3.95 /share in cash represents about 48.2% of Volcom’s book value. There is no defined benefit plan, no preferred stock and the number of outstanding shares has remained virtually constant over the four years since their IPO.

Normalized earnings power is quite good. Here are their per share numbers as reported by Value Line:

Note: I first wrote about Volcom here on December 3, 2008 when the shares were $9.23 and the earnings estimate for 2009 was $1.43. Since then the recession has dropped expectations to $0.71 - $0.75 yet the shares have climbed by 41.6% from last December’s crazy low quote.

Cash earnings are substantially better than the GAAP numbers. In this year’s first half Volcom took a $0.38 /share (non-cash) amortization of intangibles charge. In the like period of 2008 is was $0.60 /share.

The recession will end eventually and both sales and earnings should head back to more normal levels over time. Estimates for 2010 run from $0.80 - $0.90 right now assuming no quick economic recovery. Back out the $4 or so of cash/share and add back the amortization charges to see just how cheap Volcom really is.

Value Line sees 3 - 5 year EPS of $1.65 and a target price of $26.40 based on a normalized 16 multiple. A 12 – 18 month goal of $18 - $22 does not seem out of reach based on all historical parameters.

The chart above shows that VLCM has actually traded between $18.20 - $51.00 during each of the four calendar years 2005- 2008. They hit a high of $15 as recently as June 2 this year.

For timid souls or those investors seeking a short-term play on Volcom, here is a combination play I actually put on for myself Friday…

If Volcom stays above $12.50 through January 15, 2010:

  • The $12.50 calls will be exercised.
  • You will sell your shares for $12,500.
  • The $12.50 puts will expire worthless.
  • You will have no further option obligations.
  • You will hold no shares and $12,500 in cash.

That’s a best-case scenario net profit of $3,030 / $9,470 = 31.9% achieved in about 5 months on shares that:

  • Went up.
  • Stayed unchanged.
  • Declined by no more than 3.6% (to $12.50).

What’s the risk?

If Volcom ends below $12.50 on January 15, 2010:

  • The $12.50 calls will expire worthless.
  • The $12.50 puts will be exercised.
  • You will be forced to buy an additional 1000 shares.
  • You will need to lay out another $12,500 in cash.
  • You will end up with 2000 VLCM shares.

What’s the break-even point on the whole trade?

On the original 1000 shares it’s the $12.97 purchase price less the $2.05 /share call premium = $10.92 /share.

On the ‘put’ shares it’s the $12.50 strike price less the $1.45 /share put premium = $11.05 /share.

Your overall break-even would be $10.99 /share.

Volcom could drop by up to (-15.3%) without causing a loss on this trade.


Volcom is a profitable, financially sound, small-cap with excellent upside and little company specific risk. The main concern would come if the US economy slides further rather than turning around.

The buy/write combination offers a remarkable 31.9% total cash-on-cash return (if writing the puts against marginable equity) for a five month holding period if these shares go up, stay level, or even if they decline slightly.

If you want to allow for greater upside by accepting a higher break-even point you can consider selling $15 strike-price options.

Disclosure: Author is long VLCM shares and short VLCM options.