Segment-leading brands don't always guarantee top-flight performance, as Canada's Dorel Industries (OTCPK:DIIBF) demonstrates. The stock hasn't been terrible, but it doesn't really stack up so well against the S&P 500 over the last one, two, and five-year periods, even though Dorel boasts significant market share in the infant/child products, bike, and ready-to-assemble furniture markets.
I wish I could see a brighter future for this company, but I have some doubts. I don't think the issues that are currently hitting the bike business are going to last forever, but this isn't a company that has done all that much from an organic growth, operating margin, or return on invested capital perspective over the past decade. The stock does seem a little undervalued today, but I can't get comfortable with the idea that it's really an outstanding performer.
A Three-Way Play On Consumer Markets
Through multiple acquisitions and internal development, Dorel has established itself as a leading player in multiple consumer markets. Dorel generates more than 40% of its revenue from Juvenile, almost 40% from Recreational/Leisure, and about 20% from Home Furnishings.
Dorel may not be a household name, but brands like Cosco, Baby Art, and Safety 1st are in many houses with children. Dorel is the market leader in categories like car seats, strollers, walkers and monitors, both with its own brands and licensed brands like Disney. Newell Rubbermaid's (NWL) Graco and Dorel basically switch off #1 or #2 positions in many markets - Graco is #2 in car seats, but #1 in high chairs and playards (where Dorel is #2). Mattel's (MAT) Fisher-Price shows up in some markets, like high chairs, swings, potty chairs, as does privately-held Evenflo and Summer Infant (SUMR), which is a credible rival in segments like infant health, monitors, and bedrails.
This business depends upon design, reputation, marketing, and in-store availability. That puts a premium on maintaining good relations with chains like Babies R Us, many of which are trying to boost their own private label offerings at the cost of SKUs for branded manufacturers. It is also a business that, not so surprisingly, has a close tie to the birth rate and that hasn't been all that strong of late in North America or Western Europe.
If I learned nothing else that will stick with me by researching, I learned the acronym MAMIL (for "Middle-Aged Man In Lycra"). Dorel is the largest North American manufacturer of bicycles, and the owner/acquirer of brands like Cannondale, Mongoose, and Schwinn. Schwinn is the largest mass-market brand in North America, while Cannondale is the fourth-largest specialty brand.
Dorel is trying to grow the Cannondale brand and gain on Specialized and Trek by focusing more attention on independent dealers, where the Cannondale brand is under-represented. Dorel is also supplementing this business with acquisitions like the recent deal for Guru's bike-fitting business - a business that provides tools and instruments to develop a customized fit for bicycle buyers in 25 to 30 minutes.
Dorel is also looking to grow its business outside of the U.S. Dorel bought a majority stake in Caloi, the largest bicycle manufacturer in Brazil (with about 40% share). Brazil is the third-largest bicycle-producing country, but when China accounts for 67% of global production, that doesn't seem as impressive (Brazil produces about 4% of global production). Not only does Caloi give Dorel a successful Latin American brand, Dorel can use Caloi's large manufacturing base as a local production hub for its other brands in Brazil (getting around Brazil's 35% import duty).
Last and not least is the Home Furnishings business, a business that includes ready-to-assemble furniture, futons, step stools, and other furniture types. Dorel believes it is the second-largest ready-to-assemble furniture company with about 10% share, and while most sell-side analysts benchmark it against companies like Ashley and La-Z-Boy (LZB), I would think IKEA is the more direct comp. This is not a particularly exciting or high-margin business, but it does generate decent cash flow for Dorel.
Short-Term Problems, Long-Term Concerns
Dorel has been laid low by repeated disappointments driven by the bicycle business. In particular, dealer sell-through has been weak (weather is a frequently-cited reason) and those dealers just aren't ordering as many bikes as a result.
I don't believe these issues will go on forever, but I do have other concerns about the long-term appeal of Dorel as an investment. Operating margin had spent most of the last decade in a narrow band between 5% and 9%, but this year saw results dip below that. What's more, even while Dorel was producing reasonably consistent margins, the return on invested capital was never very good (seldom going above 7%) and organic growth was pretty weak.
I expect Dorel to hold its own against Newell Rubbermaid, Evenflo and Summer Infant, and could perhaps still act as a consolidator. What I don't expect is a big surge in birth rates or a situation that would reverse retailers' push towards private label (which Dorel does manufacture, but at lower margins). Likewise in the bicycle business - I think the deal in Brazil is incrementally appealing and I see the opportunity to gain share with the Cannondale brand, but the overall market growth rate is in the mid single-digits at best.
Even though I'm not explicitly modeling further M&A deals, I'll give Dorel the benefit of the doubt and project a continuation (or slight improvement) of its historical 4% revenue growth rate to about 4.5%. I will likewise assume that more streamlined manufacturing and distribution can lead to incremental margin opportunities such that the company can boost its long-term FCF margin from about 4.5% to 5.5% over the next 10 years. With that, Dorel would be poised to generate FCF growth of more than 9%.
The Bottom Line
Discount that free cash flow back, and I arrive at a fair value of about C$42.50. That's more than 10% better than today's price, but it does assume improved operating performance from today's level. I would also note a few other risk factors to consider - namely, a balance sheet loaded heavily with intangibles and goodwill and an ownership structure that has officers and directors owning more than 72% of the Class A shares, 6% of the Class B shares, and controlling more than 46% of the vote.
If you are interested in Dorel, I'd suggest the Toronto shares (TII-B.TO) instead of the ADR, given the considerable difference in liquidity. Maybe I'm being too hard on a company that is able to wring cash flow out of market-leading positions in multiple consumer product markets year-in and year-out. Likewise, maybe I'm underestimating the impact of the weak bicycle market and letting that overshadow the entire operation. Whatever the case, while Dorel does pay a solid dividend and offers some undervaluation, I just can't work up that much excitement for the historical performance of management vis a vis metrics like ROIC.