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I get interested in stocks once they have had huge drops and not before. This strategy has served me well over the years because one can pick up great companies at bargain prices due completely to market insanity - particularly in the laughable quarterly "missed expectations" circus. Does any real "investor" want to dump a quality stock that is down 40% due to a single quarterly report that misses "expectations" (whose expectations are these, anyway)? Often times with these misses there is nothing wrong with the business, nothing wrong with the financials or the management or the products or the customers or the business plan, just a blip that happens to any company that operates in the real world - which world happens to exclude Wall Street and usually the "market".

A good recent example of this strategy was last August when DG FastChannel (NASDAQ:DGIT) dropped 40% in one day due to an earnings report which, although quite strong, "missed expectations". DGIT is a strong company that had been a stellar performer through the year and the stock got hammered from the high 20s to 15 in one day. It closed the year at $28. I made enough on that one trade to pay a year's living expenses. Thank you, market insanity.

A more recent, similar situation that has caught my attention is Primo Water Corporation (NASDAQ:PRMW). It went public last November at $12, stayed at or above that level for the entire year, did a secondary in June at $11 that was over-subscribed, climbed to over $15 by August 3rd then announced earnings on August 10th. Holy crash, Batman! I was checking out my Big % Loser's screen that I use in my Ameritrade account and was curious - what was this PRMW that was down 60%? I was expecting a biotech company whose main product was disapproved by the FDA - usually the case for monster one-day losses like that.

What I saw was a small growth company with a very appealing business model that was delivering 70% growth for the quarter but "missed expectations" and guided a bit lower for Q3 and Q4. However, they reaffirmed the 2012 estimates set by the mighty analyst community (boy, those analysts are never wrong!) and those estimates and the reaffirmed guidance are impressive. The lack of a couple of million bucks in earnings for Q3 and Q4 in the guidance cost the company a 60% loss in a single day - over $200 million in market cap! This is a small growth company in the beginning stages of a serious growth curve so it's not even sensible to look at these early quarters as meaningful from an earnings "miss" standpoint.

So I started digging deeper and found what I believe to be a most exceptional opportunity to make a LOT of money by holding for a 2-5 year period. Here's the story:

Primo Water was founded by Billy Prim, who developed the Blue Rhino concept for propane cylinder exchange service. He started Blue Rhino as a local-regional operation, went public with the company in 1998 and in a few years it was national in 50,000 locations. Ultimately the company was sold to Ferrellgas Partners (NYSE:FGP) for $17 per share in 2004. Blue Rhino had its ups and downs - hitting a low of $2 at one point over an auditing controversy that was ultimately meaningless and appreciated 850% from the low. I like that sort of return. It was a very successful business model and they have returned a lot of the proprietary MIS technology and management expertise to the Primo enterprise.

Primo Water's main business is similar in many regards - they operated exchange and refill services for 3 and 5 gallon bottles of purified water in 15,900 locations at the end of Q2 and growing that number rapidly - the expressed goal is 50,000 locations. What really caught my eye is the fact that they can reach these 50,000 locations with just the 10 biggest customers they are currently serving. These companies include Walmart (NYSE:WMT), Kmart (NASDAQ:SHLD), Target (NYSE:TGT), Kroger (NYSE:KR), Safeway (NYSE:SWY), Albertsons (NYSE:SVU), Food Lion (Belgian-owned), Walgreens (NYSE:WAG), Lowes (NYSE:LOW), Costco (NASDAQ:COST) and CVS (NYSE:CVS). How many small growth companies can you name with a list of customers like this who all want your presence in their stores? They like having Primo in the stores because it drives return visits and they get a nice cut in return for providing underutilized floor space. Outside services maintain and stock the Primo operation. Primo's proprietary system tracks all the locations and notifies the suppliers when it is time to restock - they don't have to send anyone out to check - just wait til they get informed of the need before they send a truck. That's a huge savings in labor, vehicle wear, fuel costs etc. Management estimates the total market opportunity to be as large as 200,000 locations - that's over 1,000% growth for the long term picture.

Primo has developed into the single largest seller of water dispensers in the country. Utilizing updated designs and a brand new bottom-loading dispenser they have literally transformed the dispenser into an attractive and affordable home/office appliance. They sell the dispensers at a minimal markup - the water repeat business is what they want. This is a very profitable business, generating a gross margin of 34.6% for Q2. Overall gross margin was 27.1%. Overall sales grew by 70.1 % and water sales grew a whopping 115% for Q2. Mind you, this is on locations of 15,900 - the goal of 50,000 is 200% growth in location number and revenue growth should follow closely.

Sales through Q2 were $37 million and the guidance for Q3 and Q4 imply full-year 2011 revenue of about $90 million (I used the midpoints of their quarterly guidance). Guidance for 2012 is a range of $177-187 million, basically 100% growth over 2011. Since they are essentially at breakeven today and can leverage the business tremendously with minimal incremental expense (yet another benefit of the business model) they are guiding to GAAP earnings for 2012 of $.82 to $.96 per share. This makes perfect sense to me since future growth over the breakeven level they are at today will generate net profits close to the gross margin level since they have such minimal incremental expense. Like many other startups, they have experienced losses which are carried forward so it will be 2-3 years before any actual taxes are due.

2012 location guidance is 23.7 to 25.7 thousand and revenue guidance is $177 - $187 million (100% growth over 2011). If they can generate sales of $180 million on 25 thousand locations they should easily top $360 million on 50,000 locations. That's $250 million over breakeven at roughly 27% margin or profits of $68 million. With 23.600 shares outstanding that's earnings of $2.86 per share. Just a market PE of 15 gets a stock price of $42.90, That's a +1,000% gain from the ridiculously low price of under $4.00 as of Friday's close.

This is all just from the basic water business they have today. Other kickers include new products, possible acquisitions etc.

In Q4 of this year they are introducing the first real competition for SodaStream's (NASDAQ:SODA) home carbonation beverage machine in the Omnifrio appliance. This is similar to the Keurig coffee machines, containing a water receptacle (using pure and tasty Primo water, of course) then a flavor "S" cup which is loaded into the mixing chamber. Close the lid of the mixing chamber and the CO2 cylinder (which loads into the appliance and is removable and will be exchangeable at Primo Water locations - handy!) injects carbonation into the mix and voila - bubbly home soda, soda water, vitamin water, fruit drink - whatever the current 30 flavor lineup can produce. This appliance and the next generation of water dispensers will be introduced in Q4 for the holiday selling season. This will be accompanied by an advertising and promotional campaign run by the new Chief Marketing Officer - John Maples, a PepsiCo alumnus instrumental in the success of the Gatorade brand.

So we have a unique business model with virtually guaranteed - and profitable - growth just from executing the growth-in-units plan; all with established customers with national footprints. A seasoned management team who has previously executed a very similar national expansion is at the helm. Proprietary MIS technology gives them enormous efficiences at the supplier level. Despite the fact that small revenue "missed expectation" they are executing the growth strategy nicely and are poised for a major advertising promotion and new product rollout in Q4. They have grown to nearly 16,000 locations and 100% sales increases with very little advertising, so what happens when a big ad campaign starts to take effect?

Also, insiders have been actively buying the stock over the last week.

Last but not least, they are debt free since they paid off all debt with the June secondary offering. At 6/30/11 they had cash over $10 million and access to a line of credit around $40 million. Future operating cash flow should be plentiful with the healthy margins.

No one can ultimately predict the future and as the Safe Harbor statements insist on stating, things are subject to change. I just think an 80% haircut is seriously overdone and the original story remains intact - phenomenal and profitable growth is close at hand. People buying the IPO and secondary in the $12 range weren't buying thinking about Q3 2011 guidance, one can be sure. They were looking to the future and probably running the same numbers I have run here.

I think the story is compelling and I can generate some gargantuan returns for my portfolio by holding for a few years. I'm sure there will be many others eager to dismiss this article and claim the company is headed for extinction.

Sources:

Source: Primo Water Sell-Off Is Seriously Overdone: Original Story Remains Intact