My investment thesis was based on the following points:
- The valuation seems to be attractive on both absolute and relative valuations, but the median price to tangible book is not showcasing a definite opportunity.
- Furthermore, while DIT's wholesale segment is stable and does not face material challenges, the retail segment is likely to continue to struggle as the competition will continue to pressure margins.
- Lastly, the management is posing a significant amount of risk as the CEO, who is also a Chairman and biggest shareholder, can exert power over the rest of the shareholders.
- Therefore, while DIT is an interesting niche business that is unlikely to go away, it is better to stay on the sidelines and wait for a more suitable share price.
I think that all these points continue to hold. While the company did start to be more shareholder friendly and paid off a portion of its debt, the operational results continue to be pressured by retail, which poses challenge for the future of the company.
Share Price Reaction
As you can see since my initial article in late June, the share price is slightly higher despite the downturn which occurred around earnings results on the 8th of November.
I believe that the sharp rebound in the last two days might not be entirely reasonable given the fact that the retail results continued to decline and the segment slipped into operational losses (in Q3 & Q4). The wholesale segment continued to be stagnant and the management did not mention any significant change of plans. Valuation-wise, the company is also not presenting a significant upside.
On the other hand, the management did continue paying dividends and did announce the reinstatement of a share buyback program, which could boost the prospects of the share price in the short term. Despite this, I believe it might be beneficial to remain on the sidelines for now, because should the retail segment continue to struggle, the management might be prompted to increase capital expenditures and strain cash flow. The operational results could also continue to get hit as the company's operating income is minimal and exposed to the retail losses.
Decline in retail
The main issue of the company is its retail segment, where DIT operates several stores aimed at healthy food offering. This segment's margins peaked in 2010 and have been decreasing ever since as seen below.
The reason for this is most likely the trends in the broader market environment where Whole Foods (NASDAQ:WFM) was able to push the prices down by its aggressive expansion. It is also likely that it is now harder to compete in this space as there is little room for differentiation. While the operational losses are so far minimal ($0.4 million in the past two quarters), should the decline continue the segment could easily disrupt the operational income of the wholesale segment which is roughly only $17 million per annum.
The management mentioned that they are committed to the retail segment and that they are likely to either open new stores and/or rebrand the old ones. The company mentioned that it already rebranded its flagship store in Florida, so we could see if these efforts are going to bring in any value.
The core segment of DIT remained stable both in terms of margins and gross profit, which is a more suitable performance tracker than revenue due to the product pricing which can increase revenues but not gross profit.
The company mentioned that it remains the seventh biggest distributor in the US, which for now is beneficial as scale is of the utmost importance in distributing. The management though mentioned that the industry could undergo a consolidation, which could increase pressure on the margins even more in the long run.
On the other hand, the segment was able to support cash flow generation this year as the company shed a significant amount of inventories, which in turn helped DIT to continue to pay off its debt.
It also allowed the company to continue its minor dividend ($1 per share) and announce that the company is likely to continue its share repurchase program. While these are likely to create some short-term shareholder value, I would not say that they are going the solve fundamental issues of the company.
As mentioned in my initial article, I believe that in the case of DIT it is useful to look at price to tangible book ratio in order to approximate if the stock is trading at a favorable price. The reason being that while Core-Mark Holding (NASDAQ:CORE), a competitor of DIT, is trading at much higher multiples, the market might be inclined to 'discount' DIT due to its management that controls the company.
As you can see, the current share price is potentially implying an upside only via the seven-year median. Therefore, it is likely that the stock is not offering a unique upside opportunity, especially when one has to remember that the company is potentially facing a change in fundamentals if the retail segment continues to decline and pressure the overall margins.
I believe that DIT has a solid business in place, which would be attractive should the fundamental outlook be different. As the retail continues to slide towards operational losses, the wholesale distribution is likely to continue to be pressured. The company's cash flow could also be strained due to a potential increase in capital expenditures. It is, therefore, likely to be beneficial to stay on the sidelines for now, at least until the management shows that it can stem the decline in retail.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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