I approach a bullish article on Summer Infant (NASDAQ:SUMR) with more than a little trepidation, as I have been burned by writing favorably about this name once before. I previously underestimated the serious operational challenges that the company faced after a series of debt-fueled acquisitions and the resulting missteps with new product introductions, not to mention challenges at major retailers like Toys R Us/Babies R Us and the increasing penetration of private label competition.
Even with the stock up more than 80% over the past year, I do wonder if Summer Infant is back on stronger footing and has further gains ahead of it. Management has elected to discontinue low-margin licensing arrangements, is rationalizing its SKU count, and is broadening its retailer base. What's more, it would seem that conservative estimates for revenue and cash flow (not to mention discount rate) still leave appreciation potential in excess of 40% from today's levels. It has to be noted, though, that Summer Infant is a tiny player in the baby care products market and has yet to demonstrate that it can deliver consistent organic revenue growth, let alone attractive margins or cash flow.
Turning Away From Low-Margin Business
Doing business with companies like Disney (NYSE:DIS) and Carter's (NYSE:CRI) is a mixed blessing. It's true that slapping a Disney character or logo on a product can draw eyeballs to your product and generate sales you wouldn't otherwise get. It's also true that these companies don't just give away their reputation, and the margins that Summer Infant was generating from these products just weren't worthwhile.
With that, management has made the decision to discontinue low-margin licensed products. That's having a very real impact on present-day sales and does put some of the company's shelf space at retailers at risk, but I think it's a solid long-term decision. If Summer Infant couldn't generate enough volume to overcome the weak margins, what would be the point in continuing to sell these products?
Along similar lines, the company has been "rationalizing" its SKU count, eliminating products that don't generate enough revenue or margin (or both) to justify ongoing support and sales. I realize it goes against many investors' wiring to think that smaller can be better, but Summer Infant's persistently unattractive margins relative to Mattel (NASDAQ:MAT) and Newell Rubbermaid (NYSE:NWL) had to be addressed.
Broadening The Retail Base
One of the long-standing risk factors for Summer Infant has been the extent to which its sales were dependent upon Toys R Us/Babies R Us. It wasn't long ago at all that Summer Infant generated more than half of its sales from this one retailer (or rather two retailers owned in common). Since then, the percentage of business generated from them has fallen to about one-third of the total. Some of that can likely be pinned on Summer Infant's own operational missteps, but some too has to be attributed to the desire of Toys R Us/Babies R Us to give more shelf space to its own private label products.
This hasn't been a complete dead loss for Summer Infant. While losing share at Toys R Us/Babies R Us stings, the company has been gaining share at Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), with the two combining for almost 30% of sales (about two-thirds from Wal-Mart). I think it's also worth noting that Amazon.com (NASDAQ:AMZN) is the company's fourth-largest retail partner and baby care products have been a growth category in the overall online space.
Summer Infant is going through a difficult adjustment period as running down the licensed business saps revenue. To counteract this in part, the company has been staying relatively active in promotional activities - including directing more efforts towards online retailing. Summer Infant is going to still have to work hard to build up the value of the Summer Infant and Born Free brands, but they seem to be going about it in a cogent way.
It Doesn't Take Big Leaps To Generate Some Interesting Targets
One of the things that surprised me about Summer Infant as I was refreshing my due diligence is the extent to which an investor really doesn't need to make heroic assumptions for revenue growth or margins to generate some interesting fair value numbers.
Summer Infant is only about 3% of the baby care market today, and it is basically a rounding error compared to Mattel and Newell and about one-fourth the size of Dorel (OTC:DRLAF). Although the company has a notable presence in the monitor segment and has tried hard to establish a presence in the car seat market (without much success so far), they're not big enough to really attract concerted counter-marketing or product development.
Although the birth rate in the U.S. isn't great and private label penetration is a threat, I don't believe that a long-term revenue growth assumption of 4.5% is all that extreme for Summer Infant, as it would suggest less than two points of market share growth (unless U.S. population growth actually goes into decline).
On the margin side, I do believe that the company's re-emphasis on products/lines with worthwhile margins will make a difference. I don't necessarily believe that Summer Infant will get to the same margin levels as Mattel or Newell (due in part to the difficulty of building brands as valuable as Fischer-Price or Graco), but I think even single-digit sales growth and better discipline on the operational side can support a mid-single digit free cash flow margin.
The Bottom Line
Discounting those cash flows back at an elevated rate (12%) and fully incorporating the net debt still leads to a fair value of $3.75. That's pretty attractive relative to a share price in the neighborhood of $2.60. Certainly plenty can go wrong with that scenario - Summer Infant hasn't really proven that it can deliver organic revenue growth, and major product launches have been iffy at best over the last 24 months. Likewise, skeptics can rightly question whether there is any reason to believe that Summer Infant can achieve, let alone hold, margins good enough to generate even mid-single digit free cash flow as a percentage of revenue.
Even so, I'm encouraged by the progress the company has made at Wal-Mart, Target, and Amazon, and I'm likewise encouraged by management's decision to get away from low-margin licensed business. With a strong foothold in monitors and upside in areas like strollers and car seats, I do see enough potential here for risk-tolerant (not to mention, patient) investors to take a closer look and consider whether Summer Infant's turnaround may prove fruitful down the line.
Disclosure: I 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.