Aceto Corporation (ACET), at a recent price of 6.02, is a good quality small cap that lately has experienced some issues, manifesting as a sudden decrease in revenue followed by the departure of a long term CEO. Predictably, the stock tanked.
A strong balance sheet, together with experience and expertise in their industry, provides a limited downside while the investor waits to see if the new CEO can restore value.
Recent developments suggest management has successfully identified areas of opportunity in a generally difficult business environment; and further, that they are starting to see results. The potential payout in recovery is good: Aceto should reach 9.00 per share within two years, for an annualized return of 23%.
From the 10-K:
We are a global leader in the sourcing, quality assurance, regulatory support, marketing and distribution of chemically derived pharmaceuticals, biopharmaceuticals, specialty chemicals and crop protection products. ...Our business is organized along product lines into three principal segments: Health Sciences, Chemicals & Colorants and Crop Protection.
I see a distributor that identifies chemicals (including generics) that can be sourced in low cost areas, secures regulatory approvals, and then brings them to market.
Past performance had been stellar, a protracted history of 10% growth in revenue, EPS, and tangible book value. Here is a link to a somewhat dated presentation, from August 2008, before the trouble started. The track record was impressive for many years.
Rvenue declined from a high to 107 million in the 3rd quarter of the 2009 Fiscal year (FYE 5/30) to 71 million for the recently completed 2nd quarter 2010 (see conference call transcript here). The earnings press release explains:
The decreased sales affected us across almost all of our global operations, in part due to the fact our customers are more closely managing their inventory to coincide with their own reduced demand.
Long-time CEO Leonard Schwartz left the company late in 2009 and was replaced by 37 year veteran Vincent Miata, who came up through the sales department. Charges were taken in the most recent quarter, primarily due to the departure of the CEO, but also including an inventory write-down.
The current environment features a lot of competition and price pressure from governments, who often are the payers on generic pharmaceuticals. Chinese companies that have been the source of cheap production are starting to open sales offices in the US in an effort to eliminate the middleman; ie, Aceto.
Key Customers and Suppliers
Per the 10-K, there were no customers or suppliers who accounted for more than 10% of business during fiscal 2009. This is good news, as it reduces the odds of further large declines in revenue.
How to Fix
The latest shareholder meeting featured a presentation of the future of the Agricultural Products segment. Given the troubles in pharmaceuticals, management has turned toward this area, in which the company has a long history. Included in the presentation was Glyphosate, that would be generic Roundup, a big product for Monsanto (MON) while it was under patent protection. Aceto has secured EPA approval and sourced the chemical from China, and plans to develop a market for it here in the US. This should be regarded as a sign that management is redirecting their efforts into new areas that may help rebuild revenues.
To the extent that problems were indeed inventory corrections, the situation should be self-correcting.
Current assets are much larger than current liabilities, and there is no long term debt. Treating anything over a current ratio of 2 as excess operating capital, it comes to 2.62 per share as of the most recent quarter.
For cases of this type, where management has the human and financial resources to resolve the issues, I prefer to envision the hoped for result rather than attempt to project quarter by quarter how this is going to play out. A respectable outcome from where it lies would be a leg up to reflect the sale of the Glyphosate now in inventory, followed by 6% annual growth at historical average margins. That works out to .44 EPS X 15 P/E = 6.60 + 2.62 excess current assets = 9.23, round to 9.00.
Assuming two years to reach this target, there is the potential for 23% annualized, as mentioned at the beginning of the article.
Downside is limited by a .20 dividend, yielding 3.32%.
Reflections on Risk/Reward
Investors got spoiled in the months following the March 2009 bottom; many companies with no long-term problems were available at fire sale prices. Four baggers were a dime a dozen.
There are still plenty of value candidates out there, but it's back to where bargain prices are symptoms of problems. It is necessary for the investor to form an impression of whether management is aware of the problem, has a plan, and has the resources to execute. If the impression is positive, take a position and monitor developments.
Progress on Glyphosate
The last conference call featured the following:
In our Crop Protection business, we've begun to see the balance sheet effect of entering the Glyphosate market for the current growing seed. If you look at our financials, you will see that our cash position has declined while both our inventory levels and accounts payable have increased in large part due to purchases of Glyphosate.
I think, we've said this publicly that because of the cash outlays on this thing, and because of the commodity nature of this product, if you would look at segmental analysis and look at our typical gross margins on crop protection, they will definitely be a reduction in gross margins because of the commodities nature of this product. We still believe though of course we are going to see higher top-line and even with the gross margin reduction, as the standalone product, if I would get that specific it will be a profitable business for us.
My take: this is not a home run but it clearly demonstrates that Crop Protection is an area of opportunity and that management is performing effectively in extending the company's reach into the field. Roundup was a huge winner for Monsanto (MON), and they have lost a lot of business since it went generic. Aceto is working to capture a part of that.
Inventory buildup is a two edged sword – in this case I saw 15 million of additional inventory compared to the previous quarter and I regard it as a tell for increased sales going forward. Aceto just took an inventory write-down and they will not be adding inventory unless they expect to increase sales.
I got this idea from a value screen by Scott's Investments, seconded by Alan Brochstein, who I should mention was on the last conference call, doing his homework. I took a 1/3 size position and planned to monitor. I only recently got back to the case, prompted by reading about Monsanto's lost business on Roundup. I think this situation is going to catalyze itself by increased revenues. Earnings should improve, for the simple fact that the CEO's departure saves .20 per share going forward.
With the positive indications from the last conference call, and my amended estimates going forward, I plan to double my existing position, bringing it up to 2/3 of planned size. I will complete the position on dips (if any) or on positive developments on the next earnings report.