Collectors Universe: Reviewing The Bull And Bear Cases For Investment

| About: Collectors Universe, (CLCT)
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Collectors Universe (NASDAQ:CLCT) has had quite the run over the last year (up 70%). As the leading provider of authentication and grading services to dealers and collectors of high-value coins, trading cards, event tickets, autographs, and memorabilia, the company has tons of leverage to demand in the collectibles market. I do expect at some point, we will see another boom in the industry, and the company also now has leverage to a growing China. The company has a 7% dividend yield, which is currently not fully supported by free cash flow, but supplemented by the company's balance sheet.

For this article, I wanted to take the time to review the bull and bear cases on the stock to give investors the opportunity to judge the merits of an investment for themselves.

Business Overview

As we noted above, CLCT the leading provider of authentication and grading services to dealers and collectors of high-value coins, trading cards, event tickets, autographs, and memorabilia. The company is heavily leveraged to the coin space:

Source: CLCT Investor Presentation

The company had a tough run at it during the recession, as the value of collectibles tanked. Not only is the company leveraged to the market in collectibles, it's leveraged to the price of collectible. The company is focused on high-end collectibles (or basically collectibles that are worth grading);the higher the value of the collectible, the better the value proposition for CLCT's customers. The company is also now expanding into China, which we will talk about later in this article.

The Bull Case: A Solid Dividend Investment With Upside

The company has a current dividend yield of 7%, which is quite attractive for a pretty steady business. As opposed to some investors out there (as shown by the almost 10% short interest ratio), I believe that the dividend is very stable. The company pays out about $11MM in dividends annually on about $10MM of run rate free cash flow. This is concerning at first, but there are three items which I believe make the dividend stable:

  1. The company has $17MM of cash on the balance sheet and very minimal capex
  2. The company could easily put at least $20MM of debt onto the balance sheet in order to maintain the dividend
  3. The company is growing with its expansion into China and we will eventually get a bigger rebound in the collectibles market

Taking these facts into consideration, I can't see a scenario where the company would cut the dividend unless something materially changed in the business.

But, as I noted above, the company's short interest would suggest otherwise. About 500K shares are short, with an average daily volume of 40K shares. This creates the opportunity for a short squeeze on good news, such as progress in China, which could propel the stock higher.

Considering most of the business is pretty steady in nature, the China piece of the business is the attractive aspect of an investment in CLCT. The company entered China full-time in 2013. As I noted above, the company has minimal capex, and was able to transition into China fairly quickly with its bullpen of international coin experts. A growing middle class in China could turn out to be very profitable for CLCT. I'm not placing much value on this business until I see strong results, but there could be upside here, and if there's not, it wouldn't cost much to close down. Over the long-run, this business could help support, or even help grow, the dividend.

The other piece that could help grow or maintain the dividend is a rebound in the collectibles market in the US. As our economy improves, we will eventually have another boom in the collectibles market, and this time around the values on high-end collectibles will be better than the last boom (revenues are higher today than the last boom already). Considering the steady margins in the business, this should translate into higher earnings power.

Some investors are concerned about the impact EBAY and the internet have on CLCT. Yes, a more transparent market with greater supply puts downward pressure on collectibles, but the dynamic actually helps CLCT. Though pricing on collectibles is lower, the spread between graded and non-graded collectibles has increased. Now that supply is higher, if you have a good item, you have to grade it since the value proposition for grading has improved.

Overall, it's a fairly stable business, with some upside, and a strong dividend that is more stable than consensus thinking.

The Bear Case: Over-Valued When Looking At Run-Rate Performance

The bear case on the stock really comes down to valuation. As you can see from the slide below, the company's business is fairly stable:

Free cash flow as averaged $9MM annually over the past 5 years, but that includes part of the recession, where the value of collectibles plummeted due to a lack of demand. Considering run-rate free cash flow is about $10MM, and the fact that the company is a slow grower, I place a value on the business of about $100MM, or $12.

Yes, the dividend is attractive, but that 7% yield is equivalent to a move down to $18.50 in the stock, which could easily happen and wipe out your profit. I think part of the run in the stock is due to the expansion into China, which might not materialize. Additionally, we don't know how long we will have to wait for the collectible market to significantly improve, making other investments more attractive.

Overall, at this price there are just too many risks to the share price to get me interested.

Risks

Risks for the company include:

  1. As seen by the recent performance during the recession, the company is highly dependent on the collectibles market
  2. The company could be unsuccessful in its attempt to enter China
  3. The company's current free cash flow does not support the dividend, though we have reviewed why a dividend cut is unlikely
  4. The company's key ingredient is its people, and losing top graders could hurt the business

Catalysts

Catalysts for the company include:

  1. Successful expansion into China
  2. A rebound in the collectibles market
  3. An increase in the dividend due to strong operating performance

Conclusion

At it's current valuation, I don't see it as a good investment. That could change if the company sees good results in China, but I think at its current levels, the stock is somewhat pricing this in. If we get a big sell-off in the stock where you can get a 10% yield (about $12-13), I would buy the stock, hold it, and get paid to wait until the next big boom in collectibles occurs.

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.