Central European Distribution Corp.: An Opportunity in Spirits

Oct.28.09 | About: Central European (CEDC)
Central European Distribution Corporation (NASDAQ:CEDC) distributes, imports and exports alcoholic beverages primarily in Poland, Hungary and the Russian Federation. It produces and sells vodka and also distributes approximately 700 brands of alcoholic beverages (spirits, wine, and beer) as well as non-alcoholic beverages. It serves retail outlets, petrol stations, duty free stores, supermarkets and hypermarkets plus bars, nightclubs, hotels and restaurants.
As of December 31, 2008, CEDC operated 19 distribution centers and 124 satellite branches located throughout Poland. It imports well-known brands, including Corona, Budvar, Guinness, Carlo Rossi, Sutter Home, E&J Gallo and Concha y Toro wines, Metaxa, Remy Martin, Guinness, Grant’s, Jagermeister, Jim Beam, Sierra Tequila, Teacher’s Whisky, Campari, Cinzano, Skyy and Old Smuggler.
Shares are listed on the NASDAQ under the symbol CEDC and trade as at $31.00. Earnings had risen dramatically from 2000 through 2008 with EPS growing from a (split-adjusted) $0.07 to $2.93 over that 8-year period. The company now expects 2009 earnings to come in between $2.35 and $2.50 /share due to unfavorable exchange rates. Management indicates $3.00 - $3.15 as their best projection for 2010.
CEDC shares had been market darlings from 2003 through mid-2008 on the strength of their rapid growth. Peak prices of $61.10 and $77.50 were touched in 2007 and 2008. In the craziness of early 2009 they bottomed at an incredible $6.00 before rebounding strongly as the market recovered.
Here are CEDC’s per share numbers as reported by Value Line:
Year
Sales
C/F
EPS
B/V
Avg. P/E
2000
8.96
0.14
0.07
1.13
18.8x
2001
11.92
0.28
0.17
1.39
9.9x
2002
14.68
0.49
0.44
2.16
9.0x
2003
17.71
0.71
0.64
3.43
15.9x
2004
23.45
1.02
0.87
4.86
18.0x
2005
21.06
0.70
0.70
10.54
35.7x
2006
24.56
1.67
1.53
13.55
16.7x
2007
29.51
2.16
1.91
20.22
20.3x
2008
33.31
2.95
2.93
19.13
17.7x
2009*
26.60
2.90
2.42
21.72
11.1x
Click to enlarge
* 2009 data includes Zacks estimates
Based on the 2009 – 2010 expectations CEDC now trades for about 12.8x this year’s and 10x next year’s earnings. Those are pretty low for CEDC by historical standards. Buyers in 2001 – 2002, the last time P/Es were lower than today; saw their split-adjusted shares surge from $1 – 2 to $30 over the next few years.
If earnings rebound to next year’s lower end estimate of $3, even a 13 multiple would bring CEDC shares back to $39 or plus 25.8% from Wednesday’s quote. Is that a reasonable target price? CEDC shares actually traded as high as $31 in 2006 on EPS of $1.53. They hit peaks of $61+ and $77+ in 2007 – 2008 and have been as high as $36.41 already this year.
Here’s what I think is an even better play than just outright purchase of the shares.
Cash Outlay
Cash Inflow
Buy 1000 CEDC @ $31.00 /share
$31,000
Sell 10 June $30 calls @ $6.10 /share
$6,100
Sell 10 June $30 puts @ $5.10 /share
$5,100
Net Cash Out-of-Pocket
$19,800
Click to enlarge
If CEDC shares merely stay above $30 through the June 18, 2010 expiration:
  • The $30 calls will be exercised.
  • You will sell your shares for $30,000.
  • The $30 puts will expire worthless.
  • You will have no further option obligations.
  • You will end up with no shares and $30,000 in cash.
This best-case scenario will result if the shares:
  • Go up.
  • Stay unchanged.
  • Decline by up to $1.00 /share (-3.2%).
You would show a cash-on-cash net profit of $10,200/$19,800 = 51.5% in less than eight months even if the shares do nothing.
What’s the downside?
If CEDC shares finish above $30 on the June 18, 2010 expiration:
  • The $30 calls will expire worthless.
  • The $30 puts will be exercised.
  • You will be forced to buy another 1000 CEDC shares.
  • You will need to lay out an additional $30,000 in cash.
  • You will have no further option obligations.
  • You will end up with 2000 CEDC shares.
What’s the break-even point on the whole trade?
On the original 1,000 shares, it’s their $31.00 purchase price less the $6.10/share call premium = $24.90 /share.
On the ‘put’ shares it’s the $30 strike price less the $5.10 /share put premium = $24.90 /share.
Your break-even is $24.90 /share, or $6.10 below the price at the trade’s initiation.
CEDC shares could fall by up to 19.6% without causing a loss on this trade.
Summary: Central European Distribution looks like a good choice for a 20 – 30% move up over the next 12 months or so. The valuation is low by historical standards and the fundamentals appear strong. Buying shares and writing in-the-money calls and out-of-the-money puts mitigates much of the risk yet would still permit a cash-on-cash return of over 50% between now and June 18, 2010.
Disclosure: Author is long CEDC shares and short CEDC options.