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Envoy Global, Inc., was founded in 2001 to pursue investment opportunities in turnaround and restructuring situations both in private and public companies. Casino Capitalism, the research arm of the company, periodically publishes reports on specific companies, as well as general articles on... More
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  • Lakeland: Excellent Business At Discounted Price

    There was a recent article on, which claimed that Lakeland Industries (NASDAQ:LAKE) has significant downside given that it's recent gains were predicated on a small one-time event. While, I have not read the article, since access is restricted to only Pro subscribers, as an investor in LAKE for a few years now, I wanted to take the opposite stance here and clarify why LAKE's stock offers an excellent risk/reward at current prices ($13.85), and why the recent jump in the stock price is fully warranted.

    What Does LAKE Do?

    Before getting into a discussion of LAKE's prospects, it is important to quickly review LAKE's business. Interestingly, LAKE is incredibly simple business to understand, which is precisely why I like the company as investment. The company is merely a specialized clothing manufacturer.

    Specifically, LAKE manufactures and sells a comprehensive line of safety garments and accessories for the industrial protective clothing market. The company sells this clothing directly and via distribution to a wide range of end users, which include integrated oil, chemical/petrochemical, utilities, automobile, steel, glass, construction, smelting, munition plants, janitorial, pharmaceutical, mortuaries and high technology electronics manufacturers, as well as scientific and medical laboratories. In addition, LAKE supplies federal, state and local governmental agencies and departments, such as fire and law enforcement, airport crash rescue units, the Department of Defense, the Department of Homeland Security and the Centers for Disease Control.

    Recent Financial Improvements Are Not Simply Due to a One-Time Event

    Before getting to the long-term investment case for LAKE, it's best to clear up the one-time event negative bearish argument. Presumably, the one-time event the author in the negative article about LAKE is referring to is the revenue generated this current quarter by LAKE related to the Company's response to the bird flu. While it is true that revenue due to sales of items as a response to the bird flue is a one-time event, and investors should not place much value in revenues generated by LAKE due to orders from emergencies (e.g. Ebola, Bird Flu), the fact is that LAKE's business grew by double-digits, even if one completely ignores revenue associated with the bird flu.

    Specifically, LAKE reported a nearly 30% increase in revenue from continuing operation in Q2, to around $29.5 million. Of that revenue management noted on the conference call that approximately $5 million was due to orders related to the one-time bird flu event. Removing the full $5 million to be conservative, yields revenue for the quarter of around $24.5 million, which would still represent a nearly 8% year-over-year growth rate in the continuing business. Furthermore, this growth is somewhat understated, since currency headwinds due to a strong dollar, reduced revenue in the quarter by around 10%, give that nearly 50% of LAKE's business is actually outside the US.

    Whether, the strong dollar is one-time event or not is anyone's guess, but the fact remains that the company's order growth excluding one-time events is well over 10%, significantly above the industry growth rate. As an investor, order growth excluding non-recurring factors is the important figure to focus on, as it represents the long-term value of the business. Management summed up the growth in the quarter by stating:

    "Excluding non-recurring demand, U.S. sales grew by 23% in the second quarter. On a consolidated sales basis excluding emergency orders, revenues during the second quarter increased by nearly 12%, as compared to the second quarter of fiscal 2015, despite the negative foreign currency impact."

    In terms of the bottom-line impacts from one-time bird-flu related sales, it is true that these additional sales must have helped margins in the quarter. However, even ignoring the effect of these incremental sales, LAKE would still have posted impressive profit growth in the quarter. Notably, in Q1 of this year on a similar level of sales, LAKE reported $0.30 from continuing operations, which would have also been quite impressive earnings number for Q2, as well, even if it is significantly less than the $0.50 LAKE actually reported.

    Finally, it is worth mentioning, that fully excluding revenue from emergency response orders from LAKE's business, is not fully justified. The fact remains, sadly, that the emergencies are a recurring aspect of the human condition, and virtually every year there is some sort of emergency, which requires products from LAKE. So even if each specific emergency is unique and non-recurring, emergencies, in general, which require LAKE products, are recurring. Nevertheless, revenues from emergencies remain a small portion of LAKE's business and are of course not central to any investment thesis in the company.

    Recent Growth Masked by Significant Financial Headwinds

    Another negative aspect of the LAKE investment story raised by the negative article, is supposedly due to the fact that the company has seen almost no growth over the last few years. This charge too is mistaken and does not fully reflect the impressive turnaround in the company's fortunes over the last few years.

    Without getting into full specifics for every detail of LAKE's business, it is important to realize that around 5 years ago, LAKE was generating a large majority of it's business, from products supplied by Dupont. LAKE then lost the DuPont license in 2011. According to SEC filings, products containing these Dupont fabrics constituted 59.2%, 50.0% and 40.0% of LAKE's revenues in fiscal 2012, 2011 and 2010, respectively. Basically, the company lost nearly half of its revenue after the license of Dupont was terminated. This required the company to replace nearly half of the business since 2011, necessitating a complete revamp of the business with alternative products to the DuPont-related product line. Amazingly, by year-end 2014, the company had replaced all of this lost revenue with a higher margin product line to boot. So, in theory, if one looks at LAKE's business excluding Dupont over the last few years, I think it's clear that the company has shown substantial growth and more importantly resiliency, in the face of a huge hit to the business. In fact, in a recent investor presentation, the company estimates CAGR for sales of over 18% from 2006-2015 ex-Dupont.

    Furthermore, the massive loss of revenue from the termination of the DuPont license was not the only roadblock LAKE faced over the last few years. As it lost revenue from Dupont, the company also encountered huge problems in its business in Brazil, which caused further large financial losses for the company. In fact, issues in the company's Brazilian business, compounded by the loss of Dupont, nearly bankrupted LAKE back in 2013. The company survived only because of the some emergency, and highly-unfavorable, loans.

    Fast-forward 2 years, and LAKE has finally divested the money-losing Brazil business, and used additional capital to fully pay off high interest debt, and significantly improve the financial condition of the company.

    In sum, given the numerous travails faced by LAKE since 2011, it is quite remarkable that the company even exists in 2015, let alone is able to grow. It is not fair, or even accurate, to reference a lack of growth for LAKE in the last few years, given the company's near-death experience. The fact that the company's business is basically flat from a few years back, despite massive top-line and bottom-line losses, is actually an indication of the company's growth, and management's ability to capitalize on business opportunities. Furthermore, with the company's problems now history, recent financial results prove that the company is definitely growing again, excluding all one-time events, and more importantly has significant growth opportunities over the coming years.

    What's Next for LAKE? A Good Business with Excellent Prospects Available at a Discounted Price

    I've probably spent way too much time in this article dwelling LAKE's past, even if understanding the past history with LAKE is important to recognizing the investment opportunity. Truthfully, though, future business prospects are really the only important factor when evaluating any investment. So the question for any investor now is really, what's next for LAKE and what makes it a potentially good investment at current prices (around $14).

    While it is impossible to predict the future, there are several key factors in any business that reduce risk for an investor, and provide the possibility of large capital appreciation. Personally, what I look for in an investment opportunity is a stable, simple business, with a large recurring base of revenue, capable management, and the potential for significant profitable sales expansion with minimal cap-ex requirements (i.e. you want the business to be able to scale). Finally, one hopes such a business is available at a reasonable valuation relative to future profitability.

    I believe LAKE fits nearly every investment criteria mentioned above, which is why it's a good risk/reward at current prices. The main investment merits here, are as follows:

    • Simple and Stable Business: There is nothing complicated about LAKE's business, and unlike many of the very highly valued businesses in the current stock market, LAKE's business does not face continued potential for technological obsolecense. For all intents and purposes, they simply manufacture clothing, albeit in a specialized form. The company's business has been incredibly stable ($90 million to $100 million in sales over the last five years), despite significant difficulties, as mentioned above.
    • Recurring Revenue: Most of LAKE's business is in disposables, which is simply a fantastic business, as customers must continuously re-order the same products over and over. In fact, LAKE's management claims that 90% of the company's business is recurring in nature. This implies around $80+ million in recurring annual revenue for LAKE.
    • Minimal Cap-Ex Needs: LAKE spends a miniscule $1 million a year, and if my memory serves me correctly, LAKE currently has capacity for nearly $140 million in annual sales, which represents a 40% increase from the current sales levels.
    • Improving Margins: Given the manufacturing nature of LAKE's business, and it's excess capacity, LAKE's margins can grow significantly now, with any increase in sales. In fact, last year the company's gross margin increased to nearly 34% from 27% the year before. In the latest quarter, LAKE's gross margin topped 40%.
    • Stronger Balance Sheet: While the company's balance sheet is by no means pristine, it is vastly improved from just 2 years ago, when LAKE was facing imminent bankruptcy. During the last year, the company repaid expensive subordinated debt, and refinanced other high-interest debt, significantly reducing interest expenses. Importantly, the company's liquidity is completely satisfactory at this time and can support higher sales. Liabilities associated with the Brazlian operations have been mostly transferred to a new entity in Brazil, and the company's potential future liabilities associated with Brazil appear small and manageable, even in a worst case.
    • Capable Management: I have been very impressed with LAKE's management given their ability, as described above, to successfully navigate the company thru a massive upheaval in the last few years, returning the company to growth, and financial strength.I think management is best tested during operationally difficult times, as opposed to boom times. If management can get thru a bust and maintain shareholder value, I'm quite confident they'll do well for shareholders in a more normalized business environment.
    • Significant Growth Potential: LAKE is a tiny company in a very large industry, dominated by DuPont and Kimberly Clark. Specifically, the protective clothing market in which LAKE does business is an over $10 billion annual worldwide market. LAKE does a mere $90 million to $100 million in sales, or has less than 1% of this large market. Given this massive market, and management's ability to once again focus on growth opportunities, as opposed to fixing problems, I think it's very possible that LAKE could continue to grow organically at double-digit rates for many years to come, particularly since the protective clothing market, as a whole, is expected to grow over 5% over the next 5 or so years. It's entirely plausible to envision LAKE reaching full sales capacity in 3 to 5 years, with around $140 million in sales. This figure doesn't include sales increases from potentially accretive acquisitions.
    • Low Valuation:

      LAKE currently generates base free cash-flow (defined as adjusted EBITDA less interest, cash paid for taxes, and less capex) of around $10 million on annual basis on sales of around $95 million. I expect this free cash-flow to increase significantly as sales increase. Notably, in Q2, the company reported $5 million+ in free cash flow, suggesting the potential of nearly $30 million a year in free cash-flow on peak sales levels.

      Acquisitions in LAKE's industry are done at around 10X EV/EBITDA, while LAKE's current valuation is at around 7X EV to TTM EBITDA of $16 million. However, TTM EBITDA understates LAKE's EBITDA potential given that the company just reported $6 million in EBITDA in Q2 alone, and nearly $10 million YTD.

      Even assuming 10X EV/EBITDA on TTM, implies a fair market price for LAKE shares of around $22, or around 50% higher than the current stock price. The equity valuation at that target price level is also around 15X base free cash-flow of $10 million, which seems fair given the company's financial situation and growth potential. However, I think a $22 price, might prove low, as it does not take into consideration the company's future free cash flow potential as sales increase over the coming years both organically and via acquisition.

    In conclusion, LAKE has had a very tough few years financially, which masked the company's organic growth opportunities, in what is ultimately a very good business to be in. I think that as more investors recognize that the company's turnaround is complete and the business is returning to strong growth and profitability, LAKE's shares will continue to appreciate, particularly since the valuation of the company's shares remains depressed relative to other financial transaction multiples in the industry. Furthermore, I expcct that as LAKE's financial results continue to impress and the share price moves higher, LAKE will attract significant institutional coverage, which should help the company achieve the financial wherewithal to further expand the business dramatically, both thru organic investments and acquisitions. All in all, the story is just beginning with LAKE and the future looks promising, while the share price still reflects considerable skepticism regarding the company's future potential.

    Tags: LAKE
    Sep 30 10:52 AM | Link | Comment!
  • AIQ: Strangest Deal I've Ever Seen

    Well, as predicted Oaktree needed to sell their stake in AIQ. But, today's deal to sell the stake at a significant loss to an obscure Chinese real estate company, was completely unexpected. This is truly the strangest deal, I've ever seen. What value does a Chinese real estate company provide to a US based provided of radiology and oncology services? As always, I am holding onto the stock despite what has now become a massive loss, because ultimately AIQ has a solid business in the US, so in theory, nothing much has really changed.

    However, I assume there are two significant worries here:

    1. The Chinese investors will run this company into the ground, much like has happened repeatedly with other public US-based companies Chinese "investors" have acquired (e.g. STRI)

    2. Creditors may frown on the deal, which would pose serious liquidity issues for AIQ.

    I really don't know how to handicap the risks above, but presumably the massive decline in the stock price today on news of the deal is related to the above concerns.

    Tags: AIQ
    Sep 17 5:08 PM | Link | 2 Comments
  • Value Of Tax Loss Carryforwards In A No Tax World?

    My primary reason for holding IESC is because of their huge pile of tax loss carryforwards which the company can use to acquire profitable companies and reduce the target taxes. But, of what value really are tax loss carryforwards today when corporations have other ways to significantly reduce taxes to increase earnings? Is it merely the ease in which tax loss carryforwards can be implemented vs the other tax schemes? Perhaps, the drive by government to get corporation's to pay their fair share of taxes may drive up the value of tax loss carryforwards in the years ahead? As it now stands, though, my impression is that I have overvalued the value of tax loss carryforwards in a company, like IESC. The primary driver of value remains the ability of management to locate good companies at fair prices that have other synergies with IESC operating companies, other than tax benefits. Does management have the talent to do this? I'm not sure.

    Tags: IESC
    Aug 20 8:54 AM | Link | Comment!
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