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Paradise Inc. (OTCPK:PARF) is a Florida-based company mainly focused on producing candied fruit for over 50 years now. Over time they ended up commanding a significant market share. The management notes that it is likely that 85% of the market is covered by the company with a minimal number of competitors which are also likely to be more focused on other products. PARF distributes its products nationwide and has only a minimal exposure to international customers. The company also manufacturers various molded plastics which it partially uses for its own packaging of the candied fruit products.
It segments its revenue according to these two activities as seen below.
As you can see the company derives roughly 70% of its revenue from candied fruit and 30% from the molded plastics. This split also roughly holds for the operational profit that the company derives from these segments. Overall the company achieved 3.37% operating margin for FY2015 at a gross margin of 24.14%.
Customer-wise the company has exclusive agreements with Wal-Mart (NYSE:WMT) for its candied products. WMT accounted for 21% of the total revenue from this segment in FY2015. Aqua Cal Inc. a company that purchases molded plastics from PARF accounts for 51.6% of the revenue from that segment in FY2015. These percentages are consistent with the past.
The company regularly files with the SEC and the company's auditor is Warrent Averett LLC which is a mid-sized accountancy firm operating in Florida, Alabama and Georgia.
I believe that PARF is showcasing an interesting opportunity due to the following points;
- The company has been able to operate in an extremely stable manner. The revenue and profitability did not fluctuate significantly over the past 10 years. The revenue stream was moving in a range of $23 million to $26 million without any discernible trend. This data also includes the financial crisis during which PARF saw only minor revenue declines of around 8% which then had a limited effect on profitability. This stability likely stems from the fact that PARF is controlling what could be 85% of the candied fruit 'market'. On its own this market is significantly stable as there are not many growth opportunities but on the other hand due to the US tradition of baking fruitcakes around Thanksgiving and Christmas, it is also unlikely to disappear soon. Thus PARF could continue to showcase similar results.
- Given this operational situation the valuation of the business in unreasonable. The current market cap is 16% below the NCAV value which is likely to be fairly liquid. This also completely omits the value of the real estate that the company owns and which is likely to be significantly depreciated. The company's large production facility could be worth at least $5.5 million while the whole PP&E item on PARF's balance sheet amounts to $3.9 million (which includes a significant portion of machinery). This presents investors with a straightforward upside.
- This then means that there should be a clear catalyst. The company is certainly worth more than on the market right now therefore either it could be taken private (which could also save costs) or taken over. Apart from the current valuation the acquirer could also benefit from the fact that there are opportunities to increase operational efficiencies (management structure). There could also be a possible buyer. Seneca Foods (NASDAQ:SENEA) have recently acquired two companies that are partially focused on candied fruit (mainly glazed cherries) and thus could find significant synergies in acquiring PARF.
Due to these points, one has to wonder why the stock has not appreciated more and do not trade at least above the NCAV value. I believe the lack of stronger appreciation could be because of the following;
- The most obvious challenge to the realization of the inherent value could be the management. The company is a family business run by people closely connected to each other, especially on the board of directors. The family also owns a significant portion of the stock (39.7%) and thus allows them to exercise control over the company. They then do not have to be incentivized to sell the business or push for increased operational efficiency due to the status-quo and comfortable compensation. That being said the longstanding CEO, Melvin S.Gordon, resigned last year due to health issues which could mean that his son, Randy S. Gordon, who is the new CEO might possibly be more incentivized to break the mold.
- Connected to this is the fact that as the management might not be incentivized to sell or try to realize the value of the business the only catalyst might not be attainable and therefore investors could think of this stock as 'dead' money.
While these points are valid, I believe that until the operations do not change significantly there is no reason for the stock to see a significant downside. Even if the management keeps the control over the company, there is value here. Although due to the uncertainty about the catalyst and its timing I think that as of now only a statistical position is warranted.
Stability of Operations
As mentioned the candied fruit market is likely to be stable and despite the fact that some might think the tradition of baking fruitcake is somewhat past its due date, PARF's operational results would disagree as seen below.
The last time the company saw a significant increase in its revenue from candied products was in 1994 when it acquired another candied fruit brand. Despite the inactivity of the revenue the company has been able to maintain profitability in the segment which also fluctuated only insignificantly.
The only two times when the margins were slightly lower was in 2014 and 2005 when the company experienced a timing issue with regards to orders of some of its products.
I believe that this stability is unlikely to change anytime soon as there is no viable competition and also due to the fact that PARF likely holds exclusive agreements with key players such as the aforementioned Wal-Mart. Moreover, the operations do not seem to showcase any trend and therefore it is unlikely that the demand for candied fruit should drop. If this ever happens it is going to be likely a change fueled by demographics which can take years rather than quarters.
While this makes sense and is likely to hold in the long-run, the downside risk is greater than upside regarding the fundamentals (i.e. if there is going to be a change it is likely to be negative rather than positive). It could be that Wal-Mart might discontinue its offering or that the company mismanages its delicate working capital cycle (the company sells most of the products in Q3 and Q4 with the other half of the year preparing the inventories for that).
Regarding the molded plastics segment, the company also showcased rather stable results, although the management did note that recently one major customer slightly lowered its demand for part of the thermoforming plastics and thus the revenue is likely to be slightly depressed going forward. I do not believe though that this will impact the profitability significantly as currently the segment's revenue is down only 5.6% year over year and does not showcase a continuous decline.
While there does not seem to be many opportunities to grow the overall business, there is a room for operational efficiency. The corporate expense is likely to be excessive due to the management structure. The company currently has three key managers which all earn over $200,000 as seen below.
Note: Melvin S. Gordon resigned last year and is likely to receive only a minor board member salary.
It might be that the operations could be handled by a single person rather than three which would lower the compensation burden.
Finally, while the company maintained profitability the business is not well positioned to create much cash as seen below.
In the last 10 years, the company generated only $5.5 million dollars. This though could be altered by changing corporate structure and/or adjustments of the working capital cycle.
In the end though one can clearly see that there is value in the business and while it is unlikely to grow, shareholders could profit from it.
Given this the valuation is unreasonable as the market capitalization is now 16% below the NCAV value as seen below;
This is a snapshot from Q3, but at the end of the year they always hold significantly more cash due to the operational cycle. At the end of FY2015 the company held $8.7 million in cash. I believe that all of the items on balance sheet are highly liquid and if they were to decide to liquidate the company it should not be a significant problem to collect most if not all the value as the inventories are being sold on a regular basis.
On top of this undervaluation, one should also account for the possible value in real-estate which is likely to be severely over depreciated. The company owns a large 350,000 SF industrial complex in Plant City, Florida which they built in 1961 and partially expanded in 1985. I believe that the real estate should be worth at least $5.5 million which is the most recent property assessment by the local property assessor (as used for property tax). A possible sale price could easily double the value as the following similar industrial complex is selling the lot for $35 per SF.
We can discount this as the larger property the more likely that they would go down with price per square foot, but even if we say that they could charge only $25 per SF this still yields a significant amount of $8.75 million. Both of the possible values are higher than the current whole PP&E item which includes a significant amount of machinery as seen below.
Therefore the company also showcases clear value on its balance sheet.
Given the two preceding points, I believe that the main catalyst to open this value could be that someone would want to acquire the operations. The potential acquirer could see three main benefits from taking over PARF;
- I believe the acquisition could be done at a reasonable price given the current valuation. While this would, of course, depend on the negotiation with the management due to the current balance sheet, it is unlikely that the acquirer would have to pay significant premiums.
- After the acquisition, the acquirer could easily jump start return on investment through optimizing the corporate structure and operations.
- If it were to be a larger company that would want to either grow further or increase its capital, they could burden the asset base with sensible long-term debt as there is currently no mortgage or any other debt connected to PARF's properties. The company only has a small credit line.
While it is easy to paint this picture, the existence of such potential acquirer is a different matter. Although I believe that there is a company that could benefit from acquiring PARF. Seneca Foods a food processing company focused on a large number of diverse markets has recently acquired two companies that are similar to Paradise. First, it was the acquisition of Gray & Company which is mainly focused on candied cherries and then the acquisition of Diana Fruit Company which is again predominantly focused on cherries but do produce a smaller number of other candied fruit as well.
The possibility of an acquisition though of course relies on the management of PARF. The Gordon family has been with the company for over 50 years and has populated the board of directors with other family members as seen below.
As mentioned the family also owns roughly 9.8% through a trust where Mr. Melvin Gordon is the sole trustee and further 29.9% through individual stakes with Mr. Melvin Gordon owning the most (27.28%). While they are entrenched in the company by controlling the board and the ownership there is no poison pill and the board is not staggered which at least partially alleviates the challenge for the acquirer.
The other and the maybe less likely scenario is that the management or a private equity firm would want to take the company private or at least stop reporting to SEC in order to save costs.
There is also an outside shareholder present which could ensure that minority shareholders will be dealt with fairly. Mr. Muoio owns roughly 7.4% of the company and has been actively engaged in other stocks and runs a value focused fund.
This stock has a peculiar 'end of history' status. For 20 years they have been able to report the same operational results and while they did not make much money for the shareholders, they showcased that there is value in the fundamentals. More so when the real estate is likely to be significantly over depreciated. This then makes the current valuation unreasonable and should someone be interested in the company not only that it could acquire the company for an attractive price but it could also instigate several efforts that would increase operational efficiency and possibly allow an interesting return on investment.
This though depends on the management and the family that can exert significant control over the company. This means that the catalyst is uncertain, but unless the operations turn sour I believe this stock is not 'dead money'.
One final consideration should be the entry point of the investment. As you can see below the stock is currently near its all-time highs.
Investors could then benefit from tracking PARF and opportunistically building up a position over time.
Disclosure: I/we 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.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.