What is the free cash flow of the business after taking into account its one-time gain? From its income statement, if you reverse out the one-time $4 million gain on refinancing, that will yield an income before taxes of $6 mil, and assuming a 33% tax rate, a net income of $4.5 mil. From its cash flow statement, the $11.4 million cash flow from operations already excludes the $4 million refinancing gain (which is a non-cash accounting gain). From this $11.4 million we should subtract $0.4 million for capital expenditures, $2.6 million of deferred taxes, $1.5 mil accounts receivable adjustment, and $2.5 mil inventory adjustment, to give $4.4 mil free cash flow. Thus, an analysis of both income and cash flow statements suggests that an EPS of $0.44 is reasonable. With a conservative PE of 10, CRWS should be worth $4.40.
The cash flow statement also shows that, for the past 3 years, the company has added $1.8 to $2.8 million annually to cash flow from operations through inventory reductions. In other words, management has managed to decrease the working capital required to support the current level of sales, and the excess cash savings is apparent from the cash flow statement and balance sheet. Excluding inventory, and after subtracting current liabilities, the company has $11 mil of excess cash. Long-term debt is now $5.78 mil. Assuming that working capital is adequate at present, or even excessive, as shown by the continual reduction in inventory levels, then the excess $5 mil is not required to support operations. This excess cash adds $0.50 per share, bringing the intrinsic value of CRWS to $4.90. These are some fairly conservative assumptions I am using, since gross profit margins continue to improve, and there is a decent chance of top-line revenue growth, the true intrinsic value of CRWS is probably somewhere north of $5.
What is the likelihood of sustaining this level of earnings? Babies are born every day, and parents are typically willing to splurge on their babies, and so I consider Crown Crafts to be at least partially insulated from general economic conditions. Crown Crafts derives almost all of its sales to Walmart (NYSE:WMT), Target (NYSE:TGT) and Toys R Us, but as the CEO has pointed out, it is impossible to achieve any scale in this industry if you refuse to deal with the retailers that make up greater than 80% of all baby product sales in the US. Another point of concern is the fact that about 40% of sales is derived from the Disney (NYSE:DIS) Baby brand. (I know from personal experience that Winnie the Pooh products seem to have an almost hypnotic effect on new parents.) In addition to diversifying away from Disney brands, I think Crown Crafts should protect their crown jewel and make strenuous efforts to ensure the quality of their Disney products, maximizing the chances that Disney will stick with Crown Crafts in the future.
As for the Wynnefield proxy contest, while I agree in principle with the idea of an independent board member representing the interests of shareholders, I feel that their efforts seem entirely devoted towards seeking a buyout of Crown Crafts. I suspect that their prime motivation is to be able to unload their large position in one chunk to a bigger buyer at a more reasonable price, rather than at the current undervalued market price. Many hedge funds have a policy of holding a position only for a set number of years, after which if the original thesis has not played out, then its time to sell the position by whatever means possible. Given the outstanding performance of CEO Chestnut for the past few years, I'm inclined to give him a chance to complete the restructuring of the business and actually begin to grow top-line revenue.
Disclosure: Author has a long position in CRWS
CRWS 1-yr chart