At Valuentum, we continue to search for undervalued, technically attractive companies with safe and growing dividend yields. We use the Valuentum Dividend Cushion as a way to determine how safe a firm’s dividend is, using forward-looking forecasts rather than backward looking metrics, and we employ our Valuentum Buying Index to pinpoint the best entry and exit points on a stock.
We stumbled across Collector’s Universe (CLCT) in the past and decided to revisit the name today due to its compelling dividend yield. The stock currently trades at roughly $15 per share, with a dividend yield of nearly 9%. When you consider the relatively mediocre performance of most markets across the globe, a 9% yield seems tempting.
However tempting the yield seems, we think shares are near the top-end of our fair value range. Collector’s Universe is a great company, with a boring and sustainable business, but we aren’t very excited for appreciation at its current levels. We’d be interested in the stock if it fell below $9, giving investors a sufficient margin of safety and perhaps an even better yield.
Strong, entrenched business model.
With a market cap of around $120 million, the company is off the beaten path of Wall Street. Its business model is simple; they grade coins, sports trading cards, stamps, and authenticate autographs. There aren’t many competitors in any of these markets, though there are 2 or 3 other privately held players in each one. We think their DNA/PSA grading and PCGS are likely the biggest in sports cards and coins, respectively, though the grading business is commoditized.
Grading a card or coin increases its value exponentially, and has become such an entrenched part of the process that it’s actually hard to sell cards near their value without a grading (a jump from an 8 to a 9 or a 9 to a 10 can create substantial value for the owner of the graded object).
A “9” rating from Beckett means the same as a “9” rating from PSA, but we don’t see a lot of cutthroat competition in the business. From speaking with owners of small collectibles shops, customers tend to just prefer one or the other, but the services rendered and prices are generally the same. However, the human capital required for the business is rather robust, and new competitors don’t have the experience to be considered professional graders. This is also why the cost of employing these experts is fairly high.
Recently, the company has greatly benefited from the surge in the price of gold and subsequent increase in the value of its coins (and therefore its service). Revenues have grown by over 10% the past two years, but the bottom line has not followed suit. After releasing a large tax-loss carry-forward in fiscal year 2010, operating income actually fell by 0.8% in 2011.
Poor investment record.
Though the company completed a successful Dutch Auction tender in fiscal year 2010, capital allocation at the company has been fairly poor historically. For instance, when the company decided to expand overseas last year, it spent loads of money flying grading consultants overseas to do coin shows, which of course also costs money for hotels and living expenses.
Collector’s Universe recently acquired coinflation.com, an online site dedicated to valuing the underlying value of coins’ metals, like gold, copper, and silver. The acquisition only cost $750,000 and a role with Collector’s Universe for the site’s founder, but we are skeptical that it will yield any short-term financial success.
Furthermore, the company owned a jewelry grading business that it heavily invested in, only to close shop a few years later while taking a huge loss. The location now generates some rental income, but the move was not only ill-timed, but ill-conceived.
We’re also worried about the firm’s ability to meaningfully grow revenues. Even as its backlog of business increases, its graders, though now aided by software improvements, can only take on so many cards or coins or autographs. We aren’t sure how they can grow revenues without adding more expensive grading staff, which could make the firm susceptible to profitability concerns if business turns sour.
The dividend is pretty large, and its safety is poor on our scale.
Assuming business grows slowly, but steadily, we rate its dividend safety as poor. Collector’s Universe scores 1.2 on the Valuentum Dividend Cushion. This implies a very thin margin of safety for dividend investors (1 equals complete dividend coverage with free cash flow into the future), and it also means we are less confident in the firm’s ability to raise the dividend going forward.
Further, we think investors should be mindful about acquisitions or new investment initiatives the company may engage in down the road. A single poor investment could cripple cash flow generation, and thus the firm’s ability to pay its lofty dividend. And finally, at its current price, we don’t think investors are provided with an appropriate margin of safety based on our discounted cash-flow process. All things considered, Collector's Universe is a name for the watch list and one where we’d only grow constructive on if its shares fell into the single digits.