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Lets face it, the search for companies trading below their net current asset value is the ultimate treasure hunt. Like finding a diamond in the rough, that is assuming its really a diamond and not just an under baked piece of coal. This week’s company may be more of a diamond company in the rough:

Lazare Kaplan International
Ticker: (LKI)
Price: $7.85
Share Out: 8.34 million
Market Cap: $65.4 million
Average Daily Volume: 9600
P/E: 13
NCAV: $81.2 million
NCAV/Market Cap: 1.24

New York based Lazare Kaplan is in the diamond business…many facets of it (no pun intended) including cutting, polishing and selling ideally proportioned diamonds worldwide under the Lazare Diamonds brand name.

What initially caught my attention is that this company not only trades below its NCAV, but is also profitable. You may recall the rarity of this from previous Cheap Stocks Research. Furthermore, the companies inventory also caught my attention, but more on that later.

The Fundamentals
Fiscal Year 2005 sales rose 79 percent to $421.4 million from 2004s $235.8. Net income rose 118 percent in the same period, from $2.4 million to $5.2 million. The diamond business is somewhat cyclical based on the company’s prior years numbers (net losses in 1999 and 2002, slumping sales in 2001 and 2002). For the 3 month period ended 8/31/05, sales rose 77 percent to $138.9 million, while net income decreased 64 percent to $.9 million.

The Balance Sheet

Cash stood at $6.7 million as of 8/31/05, while long term debt was $61 million. The company also listed short term debt (curr portion of long term debt) of $43.2 million. Adding in the debt and subtracting the cash from market cap gives Lazare an Enterprise Value of $163 million. Sure would be more attractive without that debt.

On the plus side, and the other thing that caught my eye was the company’s inventory. As you may recall, inventory is a crucial part of the NCAV calculation, because it’s a sizable component of a company’s current assets. Unlike cash, the true value of inventory is not fixed, the value depends on the quality of the inventory, and ability to convert it into cash. For instance a company whose inventory is composed of last years hottest fashions would have trouble converting that inventory into cash at anything near its carrying value. But a company with an inventory composed of dollar bills (as ridiculous as that seems) would have no trouble realizing that inventories listed value.

Lazare Kaplan’s inventory is composed of the following:
Rough Stones: $26.62 million
Polished Stones: $104.2 million

That’s a lot of diamonds, but impressive because those diamonds are carried at the lower of cost or market value. I don’t purport to know the actual markup of diamonds, but do know that it is substantial. I also assume that Lazare could convert its entire inventory into a substantially larger amount than carrying value.

The NCAV calculation:
Current Assets:
Cash: $6.7 million
Accounts Rec: $118.8
Inventories: $130.8
Prepaid/other: $10.7
Def taxes: $1.8
Total: $268.8

Current Liabilities
Accts Payable: $83.4
Curr portion LT Debt: $43.2
Total: $126.7

Long Term Debt: $61

NCAV: $81.2 million

Institutional Ownership
Total Institutional ownership is about 18.5 percent. The top 5 holders

Source: Lazare Kaplan International: A Diamond in the Rough? (LKI)