(Editors' Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.)
Acme United (ACU) is admittedly a boring business - the company manufactures and distributes knives, office supplies, and first aid products to school, home, office, and sporting goods markets. Despite selling seemingly commoditized products with zero barriers to entry, the company has achieved an EPS CAGR of 18% since 2002 while posting average return on equity of 15%.
I am pitching ACU as a buy, as it is my belief that the stock should be selling at least 20% higher based on strong 2013 YTD results, robust guidance, and a recent asset acquisition that immediately added over $3 in per share book value (~22% of current share price, amazingly the stock has not yet reacted). I believe this is a simple mispricing brought about by virtually zero analyst coverage, ACU's small float of just 3.3 million shares, compounded by significant insider ownership of nearly 30% which makes the stock difficult to acquire. This should work itself out as 2014 unfolds and the company begins to realize cost savings associated with manufacturing/warehousing consolidation which by my estimates could be as high as $0.13 in fully taxed per share earnings, a material catalyst to the company's current high single digit EPS growth rate.
I believe the stock also has strong appeal to value/dividend investors looking for a steady business run by an intellectually capable management team. The stock itself is fairly cheap on a book and earnings basis and is surprisingly down over 2% since ACU's 3Q13 earnings release, a strong quarter in which the company reported 9% and 13% revenue and EPS growth respectively on a year-over-year basis. Additionally the stock has risen only 2-3% since the end of August, when management announced the asset acquisition I previously alluded to despite the fact that it adds over $3 in per share book value with the stroke of a pen and could result in substantial cost savings beginning in 2014.
Acme supplies cutting, measuring, and first aid equipment with operations in the United States (83% of revenue), Europe (8%), and Canada (9%). ACU has five brands including Westcott, Clauss, Camillus, PhysiciansCare, and Pac-Kit. It acquired the patents/intellectual property of Camillus Cutlery in 2009 (one of the oldest knife companies in the United States) and launched a new family of proprietary-designed knives with high performance titanium carbonitride coatings. These have been a strong growth driver for ACU as of late, and the company maintains a robust R&D program spending half a million annually to add incremental value to its products.
The company has shown solid fundamentals over the past several years: in 2009, sales bottomed out at $59.1 million while earnings sunk to $0.87 per share. Acme has grown steadily since and continues to add new products and brands to its portfolio, primarily via acquisition (acquired C-Thru Ruler Company in June 2012). As the company purchases new products/brands, significant chunks of the purchase price are allocated to "customer relationships" to reflect newly won distribution access, representing a typical growth avenue for Acme.
Below is a summary of ACU's revenues, margins, earnings, and cash flow since 2009:
I believe ACU could trade 20% higher in light of the company's recent asset acquisition. On August 30th, management announced they had acquired a 340,000 square foot manufacturing, distribution, and warehousing facility in North Carolina for $2.8 million out of liquidation. This prints to roughly $8.20 per square foot while local rental rates are much higher and the replacement cost of the building is $13.5 million (the difference between the two is equivalent to $3.22 per share, or 22% of ACU's stock price). A simple check on free sites such as LoopNet confirms that industrial real estate in North Carolina is selling for much more than this - my checks show a range of $25 - $100 per square foot which would imply a floor valuation of $8.5 million. ACU owns two other facilities in North Carolina, both of which will be consolidated with the new one by March 2014. One of the facilities is already listed for sale at $900,000.
So in addition to adding a net $3.22 in per share value to the company's stock, ACU will be consolidating its warehousing/distributing footprint and generating cost savings beginning in 2014. The company has not disclosed estimated savings yet; however, in 4Q13 ACU will recognize duplicate facility costs as they prepare the newly purchased facility for operations and continue to shut the remaining two down. Management has alluded to $160,000 as their expectation for 4Q duplicate costs, or $640,000 on an annual basis which computes to about $0.13 per share fully taxed (30% tax rate). If this is a reasonable expectation for go-forward cost savings, it could add over 10% to ACU's earnings growth rate. Earnings will grow roughly 7% in FY13 per management's guidance and 2014 is lining up to be a strong year according to the company. This essentially goes from a high single digits earnings growth story to mid double digits, likely in the 15% range beginning in the 2014 fiscal year - add another niche brand acquisition to the mix and ACU could see another year similar to 2012 when EPS grew 37%. This would be a story that could reasonably support a 15x earnings multiple. If you give the company credit for only the expected cost savings and nothing in the form of growing revenue/distribution access, then FY14 EPS would likely clock in at around $1.33 per share ($0.13 per share expected cost savings added to FY13 expected EPS per management's guidance). At a 15x earnings multiple, the implied stock price would be nearly $20 (34% upside). If you give the company credit for 5% sales growth (extremely reasonable for reasons I will discuss below), earnings could come in closer to $1.40-$1.45 per share, implying ~45% upside against today's share price.
Another way to attack this is simply to look at book value: the company has sold for an average price/book multiple of 1.9x since 2002, yet prices at a 26% discount to this today despite gaining niche profitable brands, distribution access, a growing dividend, and the recent facility purchase on the cheap which will improve return on equity as the company is placing an asset worth $13.5 million on its balance sheet for less than 1/3 of the cost. The replacement cost of the new facility is $13.5 million yet will be marked on ACU's balance sheet for just $2.8 million (closer to $4 million after improvements are finished), implying "hidden" book value of $9.5 million or almost $2.90 per share. Applying a 1.4x multiple to this gets me an incremental $4 in per share upside (~25% to today's price), and again, the stock has hardly reacted since this announcement was made and all the while, cost savings will be hitting the P&L making the story even better.
ACU has multiple potential revenue catalysts: (1) European business is strong at +26% year-over-year in the most recent quarter, and consensus is that Europe is emerging from a deep recession with inflecting auto sales and GDP expectations, and (2) Canadian operations have been miserable (down 18% in 3Q) but are likely bottoming out as they reached a low of 8% of consolidated revenues in 3Q and the declines will necessarily decelerate and become less bad due to easy comparisons. Management notes this business has been cash generative and they remain faithful to it (generated $130K in EBIT during 3Q at a 7% margin). Additionally management has replaced the head of the Canadian business suggesting some of the problem may have been internal/execution related. Regarding Europe, ACU is fairly bullish and believes they are gaining share and distribution space - the Camillus knives in particular have been star performers and the company recently began selling these in Scandinavia while also gaining a "major" distribution agreement in Germany.
Looking at the full year 2013, ACU expects $1.20 - $1.22 in per share earnings on $90 million in revenue. For 2014, management sees "solid growth" on both new and existing business. Revenue and earnings multiples on 2013E numbers are 0.7x and 12.2x, fairly cheap in light of everything I've discussed.
One other thing I like about the stock - management owns a lot of it. Combined executive/board ownership is just shy of 30% and accordingly management treats the business as if they own it. I like the focus on profitable growth (i.e. purchasing a huge distribution facility on the cheap and using it to consolidate/save money), while maintaining a modest R&D program to add value to seemingly commoditized products.
Additionally the company has consistently raised its dividend, which was paid out at $0.08 per share each year in 2004 and has since risen to $0.32 per share. ACU also has a repurchase program authorized. It was initiated at 200,000 shares (~6.5% of the shares out at the time) and currently has just over 140,000 shares remaining under authorization. The business should continue to throw off cash now that ACU has ample manufacturing capacity coupled with a favorably financed debt facility at low single digit interest rates.
ACU is boring, cheap, and unknown, but has made moves in recent months which should juice earnings growth and return on equity - as such, I believe the stock has 20% upside based on steady increases in distribution access, niche products supplanted by a modest R&D budget that allows the company to keep its products competitive, a meaningful earnings catalyst in the form of cost savings in lieu of the recent facility acquisition, and most importantly, the fact that the recent facility acquisition added meaningful value to the company's balance sheet. A growing dividend and potentially larger share repurchase program serve as additional catalysts as 2014 unfolds on top of continued core business improvement and another year of healthy earnings growth.