Chesapeake Corporation: Strategic Goals Are Spot On

We have owned Chesapeake Corporation (CSK) for a little over a year. What attracted us initially was the 5.8% dividend and low price. Our first position was to buy the stock long and write puts. That strategy worked like a charm in 2006. The puts expired and we sold 1/5 of our holding in late 2006. However, it is now May 2007 and they just cut the dividend. The stock promptly fell 12% on the day. We have no dividend and the stock is low again (albeit just under our current average price of $13.85).

We think the company has been making the right moves and tough choices. Cutting the dividend is the latest right move and tough choice for the board of directors, since it has payed a dividend for over 40 years.

We listened in on the most recent earnings call. Management use word ”suspend” (instead of "terminate") regarding the dividend payment, so we suspect a return of payouts at some point in time. More to the matter, they have talked about using the funds toward capital expenditures. They are in the process of building facilities to cater toward their strategic partners in Agro Chemical and Pharmaceutical.

We think their strategic goals are spot on. As the pharma industry continues to grow with the baby boomers, we see demand only continuing to grow in this area. Secondly, counterfeiting drugs is a huge business, so we see their value added proposition for counterfeit protection as a huge selling point to the pharma industry (most likely dictated by the buyer). We are thankful management decided not to take on more debt or dilute the shareholder. The dividend was clearly the cheapest source of funds. We thought a lift-off would have taken place by now, but the loss of the tobacco business really delayed our growth scenario for the moment. However, it sounds as if the cost structure is being brought in line with both the physical facilities and pension liability. We suspect management will move beyond their initial $25 million cost cutting target. Given the possibility of a global slow down, we like their exposure to defensive industries.

In light of the book value and potential for upside revenue growth, as seen ex-lost business, we think the stock could be set for a good climb up in the next 12 months. Since the stock has moved below $14 a share, we strongly recommend this stock. We own the stock in our portfolios and continue to accumulate shares with any new drop in price. We have written long dated puts with a strike of $15.

Disclosure: Author holds a position in CSK

CSK 1-yr chart