Crown Crafts Inc. (NASDAQ:CRWS) is a tiny microcap that appears to be trading at a very attractive valuation based on a variety of metrics. At today’s price of just under $4 per share, I think there is significant upside (over 100%).
What do they do?
Crown Crafts sources products for babies, including furniture (like cribs) and blankets. In general, they buy products from manufactures in India, China, and Taiwan, and then sell them to major retailers, including Wal-Mart (NYSE:WMT), Target (NYSE:TGT), and Toys-R-Us. They sell products to these retailers either for the retailers' own private label brand, under a licensing agreement (they have agreements with Disney (NYSE:DIS), Sesame Street, Looney Tunes, and several other major brands), or under one of their own labels (Nojo, Kimberly Grant, and several others). Because they can source from India, China, and Taiwan, they can take advantage of whichever country is able to produce their product for the least amount of money and quickly shift where they source their products from. However, they recently opened an office in China and appear headed towards sourcing mainly from China.
Do they have a moat?
Yes, a small one. Their brands and license agreements provide them with some brand power and pricing power. In addition, from what I can find, they are the major/one of the major players in most of their industries. It would be difficult for a start up to come into the industry, build the relationships with all of the foreign suppliers and major retailers, and build up the brand equity Crown Crafts has. In addition, the industry is somewhat regulated by strict consumer products laws that requires relatively strict testing of products to ensure all products are safe for children.
The major risk is revenue concentration. Wal-Mart (47%), Target (10%), and Toys-R-Us (21%) make up over ¾ of sales. The loss of any one of these customers, especially Wal-Mart, would be devastating. Indeed, Target decreased their sales from 11.23 million in 2008 to 8.74 million in 2009. Further decreases could significantly affect the company. However, due to their licensing agreements and brand power, I don’t think any of these retailers will drop Crown Crafts. Also, I personally believe that the fact that they source for all of these major retailers provides them a slight competitive advantage that will keep them from being dropped. Sourcing for all these retailers can give the economies of scale and allow them to sell to each individual retailer cheaper than the retailer could buy from an individual company that didn’t sell to the other competitors.
The other truly critical risk is their licenses. If they were to lose any, particularly Disney (33% of sales), it could significantly impact the company. Their Disney license does expire at the end of this year; however, I think it is most likely that they manage to retain the license at the end of the year due to their existing relationship and leadership position. Still, this represents a very significant risk.
Another major risk is commodity prices. The company uses “significant” quantities of cotton and cotton-polyester. An increase in oil or cotton could cause a decrease in gross margin, though I don’t see this as a significant risk.
The company is also pretty acquisitive. They have done two acquisitions in the past two years. This could be dangerous, as they generally use debt to finance the acquisitions, and the wrong acquisition or overpaying for an acquisition could seriously harm the company. So far, however, they have been pretty good with acquisitions, paying reasonable multiples for companies that expand their product offerings.
Finally, the company does employ some amounts of leverage. They have a VERY favorable line of credit with CIT (prime – 1%). Earlier in the year, they built up their cash balance and drew down the line in case CIT’s bankruptcy would result in the line being removed. However, they recently extended the line until July 2013. Their current net debt to equity is about 0.2, and when adding in operating leases, their net debt to equity goes up to about 0.4, and would take less than two years worth of my estimation of normalized FCF to pay off.
The company is trading at a significant discount to normalized earnings. However, to see this, you must look slightly beyond the traditional valuation metrics displayed on finance sites. During fiscal year 2009, the company wrote off all of their goodwill because their stock price was consistently trading below book value due to the financial crisis. This resulted in an almost $23 million dollar write off of all the company’s goodwill. However, even throughout the financial crisis, the company’s results (excluding the writeoff) have been relatively stable and profitable. In 2008, the company earned 0.44 cents per share. Excluding the write down, the company earned about the same amount in 2009, and is on pace to earn about the same amount in 2010. This puts the companies P/E at less than 9 times. However, the company is also performing significant amounts of amortization. The amortization amounts to (by my estimates) 0.18 cents per share. Adding this back in gives a P/E between 6 and 7.
Another interesting valuation for this company is P/S. Normally, I don’t like to use this metric. However, because the company seems to make acquisitions at just over 1 times sales, I thought it was interesting to look at the company based on this metric. The company is trading for less than half sales. Personally, given the company’s relationships with major retailers, I think this metric slightly undervalues the company.
Personally, I have a price target of around $11 on the stock. The company’s business is recession resistant, and they have significant growth opportunities through continued acquisitions where they can increase company sales through their current relationships. At $11, they’d trade for a market average P/E, which I think would balance out the positives (recession proof business, strong growth opportunities) with the negatives (customer concentration and license dependence).
The company recently resumed paying dividends after a ten year hiatus. The dividend yield is just over 2%. As the company's P/E turns positive (after the goodwill write off is no longer in the metrics), the dividend could begin attracting investors. Additionally, the company announced a $2 million share repurchase program (over 10% of current market cap) last July. They haven’t really utilized it so far, but if they did begin to at today’s attractive prices, it could significantly increase EPS and intrinsic value.
Also, Wynnefield partners small cap value has a large position in the stock (about 17%). In 2008, they started to go active and were placated by a seat on the board. On April 30, they sent a letter expressing interest in another seat on the board. Their original proxy contest focused on improving shareholder governance and searching for a buyer for the company. With an increasing level of activism, they could find a buyer (at a healthy premium) for the company, or focus on increasing shareholder repurchases, both of which should lead to a very satisfactory ROI for an investor today.
Disclosure: Long CRWS