Not often does a dividend cut act as a positive signal, but I think that is the case for Collectors Universe (NASDAQ:CLCT). The market completely disagrees, as shares tumbled nearly 40% after the company halved its dividend and reported weak Q2 results. However, if we carefully examine the quarterly and first half results as well as the rationale for the dividend cut, then I believe it is fair to say that Collectors Universe is actually in a better shape than the market is crediting. I believe shares continue to look undervalued.
Q2 results weren't great, but H1 was fine
Without question, Q2 was terrible. In what is typically a fairly ho-hum business, revenue declined a whopping 21% y/y to $14.1 million, which in turn led earnings to fall to $200 thousand compared to operating income of $4.8 million in the prior year period. Adjusted for moving and lease exit costs, earnings were about $800 thousand.
China alone contributed $2.2 million or 58% of the decline in revenue. From its inception, Collectors Universe has noted that China will be cyclical and, importantly, that the Q2 period was essentially an incredibly difficult comparison due to the pent-up submissions. Year-to-date, the business in China is actually up 24% y/y to $6.3 million. Overall, this should continue to be a solid growth driver going forward, especially as the brand gains further recognition.
Importantly, the US business was also pretty poor. According to management, American Eagle Silver bullion sales contribute to the lion's share of bulk submissions, and apparently the 2017 set was manufactured with considerable flaws rendering the product ungradable. Overall, it seems like interest in the coin business during the quarter was fairly weak - perhaps collectors are too interested in the digital kinds of coins at present. For perspective, total coin revenue was down 0.9% year-to-date.
On the positive side, PSA/DNA posted a solid quarter, with revenue up 12% y/y to $4.6 million. Both of these businesses continue to have excellent competitive advantages that position them to be long-term market leaders.
Why I like the dividend cut
Dividend cuts are usually a pretty negative event, signaling that a company desperately needs to spare cash to run operations. Collectors Universe is actually fine from a cash perspective, and the company could probably continue to pay out the dividend for another few years - if it lacked growth aspirations.
My favorite investments tend to have one of two qualities. One, the company is capital light and can return cash to shareholders while growing quickly. The other company has the ability to invest its capital in opex and capex in order to grow. This capital earns high returns. I believe this is the case for Collectors Universe. Under the new management team, Collectors realized it has greater international growth aspirations than under the previous regime, so the company has decided to reset its dividend to spare capital for capex rather than dividends.
Dividends, in my view, should be treated like any other form of capital allocation, fluctuating depending on the needs of the business. However, when companies cut dividends, investors panic, as we saw with today's price action in CLCT. This is why companies prefer buybacks (aside from the tax efficiency).
Overall, my fundamental view of the company is unchanged
I've been following Collectors Universe for about eight years now. Until today, the stock had been on a nice run thanks to smart capital allocation that is allowing the company to increase efficiency in the US and grow its business overseas. I'm going to quote myself from the Q1 earnings report, when I noted:
"Going forward, I am not expecting the international business to grow at such an exponential rate, but I do believe China will make international revenue a much more important part of the overall revenue mix. Management has noted in the past that this part of the business will be lumpy, but I'm excited nonetheless to see how it progresses over the next few years."
This is how I continue to feel about the company. Yes, the international business is lumpy. So, no, I am not worried about the weaker performance in one quarterly performance.
Admittedly, I did not expect Q2 to be as weak as it was domestically, but I think the business fundamentals remain unchanged long term.
My valuation of CLCT remains unchanged, with a DCF fair value range of $27-32. Let's not forget that CLCT paid about 35.7% in taxes during FY17, so the company will see a nice benefit from the US tax changes. Additionally, the company's capex spend is elevated in 2018, and therefore, the company will see some decent cash savings through depreciation charges.
The only material downside risk I see from here is from dividend holders who still want to get out. I think I materially underestimated the amount of shareholders who simply liked the high dividend yield. I added a bit to my position today, which is admittedly not very large, and I may add some more after the dust settles.
Disclosure: I am/we are long CLCT. 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.