Collectors Universe: Dividend Still Appears Golden

| About: Collectors Universe, (CLCT)

After an abnormal drop in the share price of Collectors Universe (NASDAQ:CLCT) on Monday, October 3rd, I started to take a close look at recent events. After deciding the move lower was unwarranted, I got in for $12.8699 on October 4th and started work on a SA article, Collectors Universe: What to make of recent events. By the time my article was published on October 11th, the share price had recovered most of what it lost on October 3rd and began its usual climb into the ex-dividend date. I sold all but a token amount of shares at $15.5001 after it went ex-dividend, collecting the $.325/share in dividend and over $2.50 per share.

I tell you this for 2 reasons (although if you count my bragging it's really more like 3):

1: In the interest of full disclosure: while I'm technically still long CLCT, it is truly only a token amount of shares and I am waiting for the price to drop further before I get back in.
2: What I described above is not unusual price activity for shares of CLCT. While the move down on October 3rd was abnormal, the stock does usually trade down between dividends, bottoms out, and then rises nicely into the ex-dividend date. It trades on very light volume and will often toss out a great buying opportunity near the bottom, such as the one I took advantage of.

The reason I'm writing this article is that CLCT declared earnings for the first quarter of fiscal year 2012 on November 7th and there is a lot of interesting material to glean from the release and subsequent conference call. This includes material that has led me to write about whether or not the dividend is safe, particularly upcoming tax liabilities.

Collectors Universe will begin paying income tax

The following text comes straight from the 27th page of the 10-K filing/Annual Report released August 26, 2011:

In addition, our financial position is impacted by the Company’s tax position as the Company may only be required to pay minimum taxes, when it has net operating losses and other tax attributes available to offset taxable income. However, once those tax losses or other tax attributes have been fully utilized, the Company will then be required to pay taxes at an estimated annual effective tax rate of 40%, as adjusted for timing differences.

In 2009, Collectors Universe made the decision to divest and sell its highly capital intensive and low-margin jewelry business. The company has recorded losses as a result of the discontinued operation that has enabled it to pay little to no taxes depending on the period. CEO Michael McConnell stated during the November 7, 2011 conference call (thank you SA for transcribing these) that Collectors Universe expects it "will have utilized all {of its} federal net-operating losses and other tax attributes sometime in the second half of fiscal 2012." He stated that the company will begin making estimated federal income tax payments in Q2, the quarter we are currently in.

Since this hasn't been an issue for some time, this upcoming tax liability gives legitimate reason for concern that the dividend won't be viable moving forward.

Great growth in coin grading/authentication fees

Collectors Universe's coin grading business, PCGS, is the gold standard in the realm of coin grading and authentication. If you want to invest in physical gold that is also collectible rather than buying bullion or through an ETF like the popular SPDR fund (NYSEARCA:GLD), you will probably find yourself buying a coin that has been graded and authenticated by PCGS. Its operations accounted for 55% of the overall revenues of Collectors Universe. While this is a slightly unnervingly high concentration of revenues from one source, the business is strong.

Compared to the previous Q1, coin related revenues increased 32% on a 7% increase in coin volume. This means that the mix of coins that were graded was higher margin (they charge different rates based on the coin type) and bodes well for the fact that modern and world coin grading services are quickly growing. Revenues from modern coin services rose 42% while revenues from world coins grew 275%, both compared to the previous Q1.

What is so promising about this information is that world coins represent the largest untapped market for PCGS and modern US coins...there's a lot of them to grade and they keep on coming. CLCT states that it is benefiting from US Mint promotions and initiatives. As long as the US Mint remains in the business of producing what are essentially collectors items, PCGS and Collectors Universe will benefit.

Additionally, the company recently purchased If you have never checked out the site, you should. It provides melt values for many of the world's coins and it has inspired me to buy a whole bunch of moderately old pennies and melt them down. Just kidding. CLCT reported that in the 18 days between the acquisition and end of the quarter, contributed $22,000 in revenue. If I can assume this rate to be constant, Coinflation will contribute just under $450,000 annually in revenue. But when CLCT purchased Coinflation it didn't just get the website and all of its traffic/ad revenue. The company also hired Alec Nevalainen, creator of Coinflation. CLCT is still searching for a Chief Digital Officer to oversee the company's focus on growth through digital channels and I am certain Nevalainen will be an important part of that strategy.

Strong insider ownership (largely) unchanged

If you're following CLCT and don't know about the strong insider ownership, you're missing a key piece of the story. Here is a little spreadsheet that I maintain. Hopefully you find it as enlightening as I do.

click to enlarge

The takeaway from this should be that there is heavy insider ownership and that it hasn't changed much recently. In fact, the only changes reflected here look to be from stock allotments or options purchases granted to members of the Board and key officers. While there was some selling by two insiders earlier in the year, there hasn't been anything that concerns me regarding this recent development of upcoming income tax liability.

Assuming that the dividend were cut...what would that mean?

At the current $1.30 annual dividend, $13 for shares of CLCT is a 10% yield. It doesn't trade there often, in fact, let's call that a top for yield. It traded above $18 in August, that's still over 7%. The price came back down to earth pretty soon after that so let's call that a bottom for yield. Finding a happy medium, an 8.5% yield at the current dividend is a share price of about $15.30.

Let's take a look at what a dividend cut would do to the price if shares still yield 8.5%. If the dividend were cut by 10% it would yield $1.17 annually and, at our assumed 8.5%, shares would trade at $13.75. If the dividend were cut by 25% to $.975 annually, with our assumed 8.5% yield it would trade at $11.47. If the dividend were cut by 50% to only $.65 annually, our assumed 8.5% yield would have shares trading at around $7.65.

The question you think this dividend is in question? And if so, by how much? If the company paid out in dividend everything it made in earnings over the past 4 quarters (Q2, Q3, Q4 FY2011 & Q1 FY2012*) the dividend would be $6.24M as opposed to the current $10.4M, which works out to about $.78 per share annually. Based on our 8.5% assumed yield, CLCT would trade at around $9.20.

This is, of course, rather conservative since it is not factoring in any growth by using the TTM operating income (minus the effective tax rate of 40%). But it also assumes a payout ratio of 100%. *For the purposes of this example I am adding back in the $1.4M impairment charge from FY11 Q4 that would have otherwise been operating income. I am using the most recent number of shares outstanding, 8,085,676.

Conclusion: So is the dividend in question?

One way to answer this question is by looking to the insiders. These are the people that would know whether or not the dividend is in question and, since we're now out of the company's blackout period on insider trading surrounding the most recent earnings release and there is still no recent selling, I don't believe they are acting as if it will be cut. Per the insider trading policy, these directors couldn't trade based on knowledge that the dividend will be cut and it's walking a fine line for them to trade based on their opinion of what the company will end up doing since, obviously, they have material information we don't. This is standard.

That doesn't mean it won't happen, but now is one of those periods during which any kind of meaningful insider selling should be considered very bad. Richard Duncan, a 13% owner of the company, does not have the same restrictions as Board members and officers and can trade whenever he likes so long as the trades are reported. He did do some selling in September (27,000 shares) and it looks like he has been selling a few thousand shares every few months leading up to that but, since he still owns 1,065,554 shares, I find myself unbothered by that minor selling. In fact, given Duncan's stake, I would expect him to be one of the first to scale back if trouble was on the horizon. Keep an eye out for insider transactions.

What happens if they DON'T cut the dividend? The company would either have to grow into the dividend or would end up cutting it anyways in 2-3 years after it has burned through all of its cash by continuing to pay shareholders. I think a little of both will be the case. While the company is approaching its slow season, I expect world and modern coins plus digital strategy growth to produce solid numbers.

Whether or not I agree with the course of action, I think the Board will rely on the large cash position to buy the company time to grow into the dividend, which it will do through its new emphasis on digital operations, revenues from Coinflation explosive world coin growth, strong modern coin growth and stable growth in the core vintage coin grading business.

Disclosure: I am long CLCT.

Additional disclosure: I may initiate new LONG positions in the next 72 hours.