Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.
Castle Brands (ROX) has provided extraordinary returns ever since I first highlighted the company in this article, which revolved around Phillip Frost's open market stock purchases. In less than two months, the company's stock has appreciated by more than 110%. Because of my position in Castle Brands, and the company's swift stock price appreciation, I believe a more thorough analysis of the company is appropriate.
Castle Brands, Inc. offers a premium selection of different alcoholic beverages. Their most notable beverages include Gosling's Rum, Gosling's Dark 'n Stormy ready-to-drink cocktail, and Gosling's Ginger Beer (non-alcoholic). The company also sells premium whiskey, vodka, tequila, wine, and a variety of liqueurs. The company is headquartered in New York City, was formed in 1998, and filed for its IPO in 2006 at $9.00 a share. Since then, the stock has been battered year after year. The chart below paints a crystal clear image of the catastrophe.(click to enlarge)
And for good reason, this company has failed to achieve profitability since their inception! However, the company's robust growth, strategic acquisitions, and solid management have Castle Brands inching towards profitability, ever so slightly, and they should achieve profitability very soon. While it's too late to get into the company at the same prices as insiders like Phillip Frost, it is not too late to get in before the turnaround actually materializes.
A Look Back
At the end of Castle Brand's 2005 fiscal year, before their IPO, the company recorded sales of 170,060 cases of all beverages combined, which represented revenue of approximately $12.6 million. This was a 161% increase in revenues compared to their 2004 fiscal year. By 2005, the company had invested more than $60 million in capital to develop their operating platform, acquire and grow premium spirits, and establish sales and distribution throughout the U.S. and abroad.
Shortly after going public, investors realized that although the company was growing at an alarmingly fast rate, the company had messy management and miniscule revenues to justify a more than $30 million market cap. Realizing that the company wouldn't reach profitability for a long time coming, with consistent negative earnings and an accumulated loss of $40 million, the stock sold off hard. In less than three years, the stock went from $9.00 to $0.20. Once the dust settled, Castle Brands restructured their operations abroad, changed around management, and brought in a new President and CEO.
The Current State Of Castle Brands
Fast-forward to the present, and you'll find that Castle Brands is a much larger company than before, and quite stable. For the fiscal year ending in March of 2013, Castle Brands revenue stood at $41.4 million, an increase of 16.8% when compared to 2012, and more than 350% when compared to revenues in 2005. The company sold 372,059 cases of alcohol in 2013, which represented an increase of 12% when compared to 2012, and more than 120% when compared to cases sold in 2005. Gosling's Rum and Jefferson's Whiskey has consistently been the driver behind growth. Gosling's Rum accounts for 41% of cases sold. This solid, steady growth is derived both organically and through the strategic acquisitions of premium brands.
While the company has grown tremendously over the past few years, they have also taken on more debt. A lot more debt. Currently, the company's accumulated deficit and total liabilities stand at $130 million and $20 million, respectively.
What's encouraging is that the company expects administrative and operational expenses to decline due to large economies of scale being reached. As Castle Brand's sales continue to grow, their operational and administrative expenses are either remaining constant or decreasing. Castle Brand's gross profit margin increased by 14.3% in 2013, and their adjusted EBITDA improved by almost 70% year-over-year, with a loss of $741,000, compared to $2.4 million in 2012.
Steps Towards Profitability
The company's overall objective is to continue building a distinctive portfolio of global premium and super premium spirits brands as they move towards profitability. Management plans to do this by increasing revenues from their more profitable brands, improving value chains and managing cost structure, and by selectively adding new premium brands to their portfolio.
Castle Brands seems to be following these initiatives. The company's most profitable brand, Gosling's Rum, continues to grow and increase revenues year after year. The company is shifting their focus from selling less profitable premium wine, in order to focus on their faster growing and more profitable spirits brands, and to reduce operational costs. The company is reducing core operational costs through supply chain efficiency and reaching larger economies of scale. Lastly, through strategic acquisitions, Castle Brands is able to significantly boost shareholder value.
Though Castle Brand's last strategic partnership occurred back in 2011 with the Distillerie Franciacorta, management is constantly keeping an eye out for strategic mergers and distribution partnerships. The company's small size allows them to offer flexible and creative structures for small, premium, family owned spirits brands that are interested in partnering with a beverage company that has an established global distribution network. Castle Brands has an extensive network of industry contacts and at the same time is extremely small and accommodating, which makes them a more attractive company to partner with than a larger sized beverage company.
Castle Brands holds a diversified portfolio of premium spirits, and when focusing in on each brand separately, the story behind Castle Brand and their comeback becomes more and more bullish. The first premium spirit that is truly the foundation of Castle Brands is Knappogue Castle Whiskey 1951, which founder Mark Andrews inherited from his father. The 36-year-old aged whiskey is the oldest and rarest Irish whiskey in the world. 60 bottles were released in 2008 to celebrate the company's 10 year anniversary. Currently, the average price of a 750 ml bottle, excluding tax, is $1,285.
Knappogue Whiskey may be the foundation of Castle Brand's Inc., but Gosling's Rum is the true driver behind the company. Castle Brands owns 60% of Gosling-Castle Partners, and has the exclusive rights to distribute the product globally. Castle Brand's has increased sales from 35,000 to more than 150,000 cases since the tie up occurred back in 2005. The company's latest product launch was in 2012 with their Darn n' Stormy ready to drink cocktail, a mixture of Gosling's Rum and ginger beer. The drink added $600,000 in revenue for its first year, and management expects to sell more than 140,000 cases this year. Gosling's is well positioned for continued, substantial growth, and the recent launch of the Dark n' Stormy will only add to this.
Jefferson's Bourbon has become a success in the "small batch" segment of bourbon. There are multiple line extensions of Jefferson's, including Jefferson's Reserve, Jefferson's Rye, and Jefferson's Presidential Select. Jefferson's is highly profitable and is the company's second fastest growing brand, behind Goslings. The brand is 100% owned by Castle Brands and was acquired in 2006. Sales increased from 40,000 cases in 2012 to 53,000 cases in 2013.
Boru Vodka is a high quality liquor that is comparable with other premium vodkas. The drink is produced in Ireland, and has won numerous awards in the industry, including top awards for best liquid and best packaging. The company competes in a rapidly growing vodka market that sells more than 12 million cases every year. Boru is a small player in this market, with case sales sitting at approximately 70,000 for 2013, and their main competitors are Smirnoff, Skyy, and Svedka. While the brand faces intense competition, total margins continue to increase thanks to management's focus on targeting Boru Vodka's most profitable markets and through efficient inventory management. The brand was acquired in 2003 and Castle owns 100% of it.
In 2004, Castle Brands gained exclusive U.S. distribution rights for Pallini Limoncello and its related products. U.S. sales increased from 5,000 cases to more than 35,000 cases since the tie up. Pallini Limoncello is the top selling premium limoncello brand in the U.S., is the largest liqueur category in Italy, and is rapidly growing in the U.S. Castle Brands expects this brand to continue strong sales growth.
Castle Brands distributes two different brands of Irish Whiskey, Knappogue and Clontarf. Knappogue is an aged, single malt whiskey (minimum of 12 years), while Clontarf is a blended Irish Whiskey. They are both premium in the sense that they are triple-distilled and aged in bourbon barrels. Knappogue is more aged, and therefore, a bit more expensive. Irish whiskey is the fastest growing segment of the whiskey market, there are significant barriers to entry, and the continued growth of Jameson's only benefits these brands, because a portion of consumers want premium alternatives to the mainstream choice. Castle owns 100% of both brands, and management anticipates substantial growth over the next ten years for this segment.
Castle Brand's is teetering on the edge of profitability. In 2012, the company forecasted that they would see positive adjusted EBITDA if they reached revenues of $41.4 million. They reached those levels this past year yet did not see positive EBITDA, but if you look a little bit closer, there is a silver lining. In March of 2013, Castle Brands decided to reduce their sales and marketing efforts on their wine brands, which never provided a material contribution to their bottom line. The company recognized a loss of $1.7 million, consisting of good will, intangible assets, and obsolete inventory related to their wine business. If it weren't for the wine write off, Castle Brands would have seen a positive adjusted EBITDA of $973,911. With strong, rapid growth, I strongly expect to see Castle Brands record a profit of more than a million dollars for their 2014 fiscal year, ending in March of 2014. For a company that has yet to turn a profit in more than 14 years of operation, this is a big deal.
An even more bullish note I took away from Castle Brand's most recent 10-K filing revolves around their financing under the Keltic Facility. Recently amended in March of 2013, Castle Brands has secured a revolving loan agreement between Keltic Financial for $8 million. This loan commenced in 2011, beginning with $5 million, and has subsequently increased in 2012 and 2013. Keltic Financial focuses on lending money to small and mid cap businesses that are poised for substantial growth. The company lends anywhere from $1 million to $10 million to these businesses.
Castle Brand's has borrowed $6.5 million of the available $8 million, leaving $1.5 million left for the company to utilize for operational needs. According to their 10-K filing, management strongly believes that their current cash position, working capital, and remaining funds from the Keltic Facility will enable them to fund their losses until they achieve profitability, ensure continued supply of their brands, and support new brand initiatives and marketing programs until at least March of 2014. Castle Brands will see profitability before March of 2014, and should start to slowly lean off from being financially propped up as their balance sheet starts to slowly turn green.
It seems that there is a tight knit management group revolving around billionaire Dr. Phillip Frost. The President and CEO of Castle Brands, Richard Lampen, is also the President and CEO of Ladenburg Thalmann Financial Services, and is the Executive Vice President of the Vector Group. Chairman and founder of Castle Brands, Mark Andrews, was a former director of IVAX Corp (from its founding) until its eventual sale to Teva Pharmaceuticals. Frost has/had a significant position in the above companies. Andrews also founded a natural resources company in the 1980's that went public and was eventually sold to the Louis Dreyfus Natural Gas Corp. John Glover, COO of Castle Brands, holds an MBA from Dartmouth College, served as marketing director for Smirnoff, and served in various roles in marketing and commercial management with International Distillers and Vintners before it merged with Diageo. Kelley Spillane, Senior Vice President of sales, has more than 25 years of experience in spirits sales, and held senior sales roles during the rise of Absolut and Grand Marnier.
Besides management's impressive backgrounds, they are also extremely confident about the company. Insider buying has occurred throughout 2012 and 2013, and altogether, officers and directors of Castle Brands own approximately 50% of the company's shares. Phillip Frost was the last director to buy the stock, for a mere $0.27 and $0.35 back in March and July of 2013, respectively.
The stock price recently broke out of its 7 year downtrend and is now on the rise. Eventual profitability, most definitely coming by March of 2014, will help boost this stock above the $1.00 range and break through the $0.99 resistance that was touched last month.
Castle Brands is a micro cap stock, the company has yet to turn a profit after 14 years of operations, and they have an accumulated deficit of more than $130 million. There is a lot of risk associated with this stock, especially with liquidity and dilution concerns. But with profitability right around the corner, experienced management, and substantial sales growth, these risks should subside as time passes. The company has a strong portfolio of premium brands, and has strong potential for developing a break-out brand success and attract new premium brands.
The stock price recently broke out of its 7 year downtrend and is now on the rise. Eventual profitability, most definitely coming by March of 2014, will help boost this stock above the $1.00 range and break through the $0.99 resistance that was touched last month. Long-term investors who have a stomach for risk should consider starting a position in Castle Brands.