Over the past few years, I have been a shareholder and big fan of footwear and accessory company, Steven Madden (NASDAQ: SHOO), largely because of its CEO, Ed Rosenfeld. Ed has a real skill for improving and growing businesses. Unfortunately, at an EV/EBITDA multiple of 10.5x, the stock price (as of February 9th) now seems to reflect his success, the strength of his team, and this year's expected growth.
In fact, the industry as a whole seems to be pretty richly valued. Wolverine Worldwide (NYSE: WWW) currently trades at 9.5x EV/EBITDA. Decker's Outdoor (NASDAQ: DECK) is valued at 12x EV/EBITDA, and LaCrosse Footwear (NASDAQ: BOOT-OLD) trades at 10.5x EV/EBITDA. When I make an investment, I try to buy value. I don't like paying up for growth. That's why I cashed out of SHOO and purchased shares of a small footwear company called McRae Industries (OTC: OTC:MRINA).
Headquartered in the town of Mount Gilead, North Carolina (located an hour east of Charlotte) McRae Industries has become a leader in the manufacturing and distribution of cowboy and cowgirl boots, work boots, and combat boots. The company was founded in 1959 and has thrived under the stewardship of the current leadership team. With a top auditor like Grant Thornton and brands like Dan Post, Laredo, Dingo, John Deere, Original Johnny Poppers, McRae Industrial, and McRae Footwear, the company is hard not to like.
Before I begin though, let me just say this. Don't let the fact that this stock trades on the OTC Pink exchange deter you from exploring the company's value and investment potential. Management is smart about how it allocates the company's resources. For example, management would rather pay more to be audited annually by Grant Thornton (a top accounting firm) then pay a premium to trade on the Nasdaq exchange. As a shareholder, I tend to agree with this thought process. Corporate governance is worth more than liquidity.
In an effort to be succinct, I want to focus on three main points: 1) a strong balance sheet 2) a high free cash flow yield and 3) a solid dividend. McRae Industries has a market capitalization of $32 million. As of October 31, 2011, the company had $11 million of cash (including $2.3 million of cash surrender value of life insurance). The company also had $15.2 million of accounts receivable (turning roughly 5x per year), $18.5 million of inventory (turning roughly 3x per year), $3 million of net PP&E, prepaid expenses of $307k, real estate held for investment of $3.7 million, and $2.8 million of trademarks.
McRae Industries had total liabilities of $6.2 million (accounts payable of $3.3 million, accrued expenses of $1.9 million, and other accrued liabilities of $1 million). Therefore, McRae Industries is currently trading well below its intrinsic value. The sum of cash, accounts receivable, and inventory is $44.7 million. If we subtract total liabilities from this figure, we arrive at $38.5 million or $15.61 per share (approximately a 20% premium to the February 9th close). If we include the net PP&E value as well as real estate held for investment, the value of the company is over $45 million or roughly $18.32 per share (over a 40% premium). The current book value per share is $19.55 (roughly a 50% premium). For all of you Benjamin Graham followers out there, it doesn't get much better than this.
McRae Industries currently trades at an EV/EBITDA multiple of 3.1x. If the company sold its real estate investment holdings at the balance sheet mark as of October 31st and generated $3.7 million of cash, McRae Industries would be trading at 2.5x EV/EBITDA. According to Capital IQ and financial reports posted by the company on pinksheets.com, McRae Industries has generated approximately $6.9 million of EBITDA over the last twelve months and spent roughly $800k on CAPEX. The company generated $6.7 million of EBITDA during fiscal year 2011 (the fiscal year ended on July 31, 2011), and it generated $5.2 million of EBITDA during fiscal year 2010.
Over the past five years, the company has spent an average of $780k on CAPEX annually. However, in fiscal year 2009, McRae Industries spent $2.1 million on CAPEX. Of that $2.1 million, $1.4 million was used to purchase a new military boot production line (military boots averaged 20% of sales over the past three fiscal years). If we strip out that $1.4 million, the average annual CAPEX spend over the past five years has only been $500k. On a LTM basis, the company has generated a free cash flow yield (defined as [EBITDA - CAPEX]/Enterprise value) of 29%. This compares to roughly 9% for SHOO, 10% for WWW, 8% for DECK, and 5% for BOOT. McRae Industries appears to definitely be the value play in the group.
Lastly, management believes in rewarding shareholders. The company pays a 2.8% annual dividend (9 cents per share each quarter totaling 36 cents per share annually). It's not quite as nice as the 4.1% dividend yield shareholders of BOOT receive, but it's not a bad inflation hedge. Shareholders of SHOO and DECK don't receive any dividends. Management has also been spending $200k to $400k annually repurchasing shares since 2007. It spent approximately $2.8 million in fiscal year 2006 repurchasing shares.
Based on the balance sheet, I believe McRae Industries is worth at least $18.32 per share (a 40% premium). Because of the company's strong cash flow, however, it is probably worth closer to 6-7x EV/EBITDA or $21 to $24 per share (a 63% to 84% premium over the current share price). Even at that valuation, it would still trade at a significant discount to other industry players.