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Amcon Distributing Company, Inc. (NYSEMKT:DIT) operates in a low growth industry that not too many people usually get excited about. You won’t hear your friends discussing the merits of this company at cocktail parties. Also, with a name like Amcon Distributing, it certainly doesn’t sound like a very exciting investment. Without a doubt, a plain vanilla, old school business.

Well, having a non-descript name is part of the reason I like this stock so much. Often times, these types of businesses are not followed widely and, because they are not popular, may offer a good opportunity for investors to pick up a bargain. Of course you need more than just a non-descript name to qualify as a good investment opportunity. After reviewing Amcon’s stated strategic plan, financial performance and execution against its plan, I believe Amcon is an attractive value play at its current price.

Background

Amcon operates in two business segments; wholesale distribution and retail health food. The wholesale segment serves approximately 4,300 retail outlets in the Great Plains and Rocky Mountain region, primarily convenient stores, grocery stores, liquor stores, drug stores and tobacco shops. According to the company’s latest 10k filing, in October 2011, Convenient Store News ranked Amcon the sixth largest convenience store distributor in the United States based on annual sales.

During fiscal year 2011, cigarette sales accounted for approximately 72% of total revenue, with non-cigarette product categories comprising 28%. The company’s principal suppliers include such stalwarts as Phillip Morris USA (NYSE:PM), RJ Reynolds Tobacco (NYSE:RAI), Proctor & Gamble (NYSE:PG), Hershey (NYSE:HSY), Mars, Quaker and Nabisco. The company also markets private label lines of tobacco, snuff, water, candy and other products. For fiscal year 2011, wholesale distribution revenue came in at just above $1.0 billion and generated gross profits of $57.9 million.

The retail health food segment is comprised of 13 retail health food stores located in Florida and the Midwest. The food stores are operated as Chamberlin’s Market & Café and Akin’s Natural Foods, and offer thousands of different product selections to their customers. Fiscal year 2011 retail sales were $37.8 million and generated a gross profit of $16.2 million. The retail health business provides the company with some diversification and helps bolster profit.

Amcon’s Strategic Plan

When reading the company’s annual letter to shareholders, what struck me was how concise and clear their strategy is.

There is a clear focus on three strategic objectives that are summarized below:

“In the short term our strategic objective is to maximize balance sheet liquidity. We believe this balance sheet liquidity enhances our ability to take advantage of both merchandising and strategic opportunities. One of the critical elements of executing an acquisition strategy is to have the financial wherewithal to close the transaction in a condensed time frame … Our focus on liquidity also provides the flexibility to best position Amcon to develop merchandising opportunities that will directly impact our customers’ bottom line profits.

“In the medium term, we seek to generate free cash flow which we can use to reduce debt. We establish this objective as a medium term goal because we frequently leverage our credit facility as a profit enhancement tool … However, over time, through profits, we seek to reduce the total amount of debt outstanding … similarly we seek acquisitions or may open new stores, which will require cash.

“Finally, in the long term, our strategic objective is to increase Amcon’s penetration in the markets we presently serve, as well as to expand our geographic footprint. The wholesale distribution industry serving convenient stores is dominated by regional players with close relationships to their customers. As our customers grow, we continue to grow with them.”

The strategy seems reasonable and appropriate for this type of business. The question is how well have they executed? After reviewing the latest 10-k and previous public filings, it is clear the company places a lot of value in maintaining and improving liquidity. For example, Amcon’s current ratio (current assets less current liabilities) has improved significantly from 2.13x in 2007 to 2.55x in 2011. Additionally, the company has approximately $40.3 million available on its credit facility which it can tap to fund merchandising and acquisition opportunities. Perhaps most importantly, the company’s medium term goal of generating cash flow and reducing debt over time has progressed nicely as well. The following graph illustrates the company’s annual free cash flow (Operating cash flow less capital expenditures) from 2008 – 2011:


(Click to enlarge)

Although free cash flow fluctuated from year to year due to seasonal changes in inventory and accounts receivables, Amcon generated a total of $37.75 million of free cash flow over the last three years, or $12.6 million on average. The company used its free cash flow to pay off debt, invest in its business, and fund acquisitions. In 2005, the company had debt of over $60 million and in 2011 total debt now stands at $28.3 million.

As of September 2011, the company’s total debt ratio (Debt/EBITDA) is a comfortable 1.57x. As Amcon has earned profits and paid down its debt, stockholders equity has increased significantly over the years as show below:


(Click to enlarge)

Finally, the company completed the acquisition of L.P. Shanks Company during 2011 which will add an estimated $200 million in revenue. With the acquisition, the company now operates in 23 states and expanded their distribution network and market presence into the Mid-South region of the United States. Because of its liquidity and significant cash flow generation, the company was able to close this transaction at a price of approximately $16 million, close to L.P. Shanks book value, while reducing its overall debt for the year.

Based on the above, the company appears to be highly focused on a straight forward three pronged strategy geared to fuel long term shareholder value. Based on the numbers, Amcon has executed reasonably well against this plan.

Valuation

As of December 31, 2011, the stock traded at $64.4 per share indicating a total market capitalization of just over $40 million. At this price, the company trades at slightly under its net book value (.96x) and has a P/E of 6.17x, which is very reasonable. Shares of distributing companies frequently trade at or near book value because they are asset intensive and traditionally have low profit margins. With an enterprise value of approximately $69.6 million, the company generates a free cash flow yield of over 18% based on its three year average cash flow. This indicates an excellent return on capital. Even if there are no catalysts to expand the pricing multiples, the stock could easily double in three or four years through free cash flow generation, debt reduction and executing strategic acquisitions. Sounds like a dull plan, but I sure like the potential return on investment.

Risks

  • Amcon operates in a highly competitive industry with a low profit margin. Additionally, sales volume is largely dependent upon the distribution of cigarette products, which is a declining sales category.
  • Continued consolidation within the convenience store industry may negatively impact sales in the future.
  • Amcon has very few shareholders of record (360) and if the number drops below 300, the company will no longer be obligated to report under the SEC Act of 1934 and may be delisted from NYSE Amex Equity, reducing the ability of investors to trade the stock.
  • Volatility in fuel prices could reduce profit margins in the future.

Strengths

  • Amcon has the size and economies of scale necessary to compete and allow for significant cash flow generation over time.
  • Management is focused on a solid strategic plan and has demonstrated positive historical results.
  • The company’s CEO (Christopher H. Atayan) has significant ownership in the company (36%) with a solid track record of managing growth. Additionally, his background in private equity is a plus.
  • At current prices, the stock offers an attractive valuation with a high cash flow yield. Based on ownership and cash flow metrics, a private buyout and or merger is a reasonable possibility in the future.

Conclusion

Amcon is a company that quietly goes about its business of generating cash flow, increasing stockholder’s equity and focusing on its customers. It will likely not draw much attention or fanfare. However, if you like your investments to be boring, and your potential returns to be exciting, Amcon is worth considering.

Disclosure: I am long DIT.

Source: Amcon Distributing Company: An Old School Value Play