By Jae Jun
Lifetime Brands (NASDAQ:LCUT) had a tremendous 2010, gaining just over 100%. The company sells food preparation, tabletop and home decor products and owns household brands such as KitchenAid, Cuisinart and Farberware.
Despite the 100% run up, LCUT could still be in value territory.
Gross margins is just above 40% with operating margin at 6.7%. Normalized net margin is around 4-5%, which is very respectable for the industry.
All About Inventory
To backtrack, the reason LCUT was so cheap was a problem with inventory. If you go back to 2005 and 2006, inventory grew at 56% and 69% respectively year over year. This was a big blow as sales growth could not exceed this inventory bloat for the same years. Over the years that inventory has been steadily reduced and was $99.9m at the end of 2010 compared with the peak of $155m in 2006. This equates to inventory totaling 36% of total assets. The peak in 2006 was at 45%.
As you can see, the company has done an excellent job bringing inventory down to the historical normalized level. You can easily figure this out by looking at the historical numbers from 2001 to 2004.
During this period, inventory came out to be between 34% - 38% of total assets, which is in line with the current 36%.
By being able to reduce inventory steadily for the past 3 years, LCUT has since been working toward positive cash flow and the result has been most noticeable the past 2 years as LCUT has been able to generate positive FCF.
If you like to use Warren Buffett's definition of FCF, which he calls owner earnings, the trend is actually much more positive. Where 2009 FCF is $61.6m followed by a 2010 FCF of $27.2m, the owner earnings for 2009 and 2010 come out to $14.5m and $29m respectively. This shows that in terms of the "real" owner earnings, LCUT has improved considerably as opposed to the drop you see in regular FCF.
In terms of valuation, LCUT is trading at a P/FCF of just 5.5, which is equivalent to a FCF yield of 18%. Tremendous compared with the bond market nowadays.
If I were to perform a reverse DCF, the current price of $13.32 is equivalent to assuming that LCUT would only be capable of generating $20m in FCF at a 12% discount rate with 0% growth assumption. Quite pessimistic if you ask me.
If the market increases the P/FCF from the current 5.5 to a more acceptable 8, the value comes out around $19. If you apply a more normalized DCF, the value comes out to $20ish.
Apply a margin of safety of 30% and the buying price is close.
Every Company Has Risks
Keep in mind however that LCUT is still a retail business. That is, a lot of the assets are made up of receivables and inventory. Further work is required in analyzing inventory and understanding the inventory methods used by the company. Along with unstable performances throughout the past 10 years, it is difficult to judge whether this recent turnaround can be continued.
I'm just throwing this idea out there. What do you think of LCUT in this market?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.