DryClean/EnviroStar: Customers and Suppliers Reduce Risk

DryClean USA (DCU), soon to be known as EnviroStar (EVI), is a distributor of laundry equipment. This is a tiny company, with a market cap of just $7 million. But for value investors who simply focus on buying businesses that trade at discounts to their intrinsic values (instead of trying to apply small-cap or illiquidity discounts), some of this company's numbers are appealing.

The company's market cap is not much higher than its net cash position of $6 million. Often, a stock with a high cash to market cap ratio is one that is a perennial money-loser. But not in this case. Operating income over the last 7 years stands above the company's current market cap. Demand for heavy-duty equipment has of course waned through this recession, but there are two important attributes of this company that reduce its risk: its customers and its suppliers.

The company is not reliant on any one customer, as it distributes its products to over 1700 customers in various industries (hotel/motel, dry cleaners, hospitals etc). A diversified customer base reduces a company's risk, as its revenues/earnings are not reliant on a potential single point of failure.

Furthermore, the company is not burdened with the fixed costs associated with manufacturing this equipment. Instead, the company outsources the manufacturing to various suppliers. By acting solely as a distributor, the company has a more flexible cost structure, allowing it to react quickly to a lower demand environment. As a result, the company should be able to restore margins to previous levels with ease, relative to fixed-cost manufacturers.

The biggest risk to this company may be the way its controlling (and managing) shareholders appear to view public stockholders: as opponents rather than partners. Last December, the controlling shareholders tried to take advantage of a misbehaving market by making a bid for the remainder of the company. The bid, which valued the entire company at $6 million, likely so undervalued the company's assets that it was withdrawn just six days later. Consummation of the deal required a fairness opinion that the price offered was fair for the public stockholders, an opinion no financial advisor could likely offer with a straight face.

Despite this issue, the managing shareholders have done a great job with the company itself. Returns on equity have been commendable over the last few years, despite the fact that the company keeps a fairly sizable cash buffer around. As a result, Mr. Market appears to offer an excellent entry point at these price levels.

Disclosure: Author has a long position in shares of DCU

Comments

[user396040]

I have drunk the Kool Aid and bought some of this stock. It is clearly very undervalued on fundamental financial analysis terms. I always worry about a micro-cap like this because the numbers are so small that things can be disasterously affected by excessive executive compensation, a bad lawsuit, or an SEC investigation that leads to an expensive requirement that financial statements be redone. Still, on balance, I think that the risk/reward on this one is pretty good.

2009 Nov 25 06:16 PM

[Ankit Gupta]

Have you noticed that 154 of their 227 US locations are in Florida? Does that concern you at all?

Florida's markets have been hit pretty hard and so do you have any concerns about those locations not doing so well?

2009 Nov 26 01:35 PM

[Oscar Sahlberg]

Management of this company is a horror to deal with. They simply refuse to talk to anybody by making up reasons like "SEC has banned us from talking to anyone" which is not true (I have confirmed this with the SEC) and if true I would be running away fast from a company that's been banned from communicating with their investors. On paper things may look good but I am not going and this stock may make money but I simply refuse to put my hard earned cash into managements that are antagonistic to their shareholders/managers that I do not believe in or wish to be associated with. Why risk it?

2009 Nov 26 01:54 PM

[Saj Karsan]

Hi Ankit,

The investment horizon of my fund is of a long-term nature. As such, short-term cyclical issues are not a major concern. Instead, they create an opportunity, as prices come down for temporary problems, allowing the long-term investor to take advantage.


On Nov 26 01:35 PM Ankit Gupta wrote:

> Have you noticed that 154 of their 227 US locations are in Florida?
> Does that concern you at all?
>
> Florida's markets have been hit pretty hard and so do you have any
> concerns about those locations not doing so well?

2009 Nov 29 06:08 PM

[John DiStanislao]

This was nice work and very well written.

DCU scores at the top with most value measures such as , EV/Sales. GP/Sales, Cash to debt, share count reduction, insider ownership, ignored, reversion to the mean, consistent high ROIC, FCF and high earnings yield, and leader in their industry with a diversified customer base… You get the point. I first stating buying the stock at .75 and continue to buy at these levels.

2009 Nov 30 11:48 PM