Diversified Opportunities With Compass
Summary
- The company has diversified businesses in its portfolio and is positioned well post-pandemic.
- Compass has a strong track record of acquiring great companies during times of economic weakness.
- Through reduced expenses and operating costs, payout commitments to bond- and shareholders appear manageable.
- Insider buying has been high, particularly during the intensified sell-off in March.
Introduction
Compass Diversified Holdings (NYSE:CODI) operates as a middle-market private-equity firm. They acquire, operate, and divest businesses in several niche consumer and industrial end markets.
Since the company's IPO in 2006, Compass has made 20 acquisitions and has performed 11 divestitures. These divestitures have generated realized gains in excess of $1 billion.
Source: Investor Presentation
The company has proven to do better than Mr. Market expects during a crisis (due to its diversification) and outperforms in a recovering economy (through its timely and opportunistic acquisitions).
Background
Compass is structured as a publicly traded partnership and hence, its investors are limited partners who would receive K-1 tax forms. This can result in tax advantages on the distributions for investors, but at the same time, increase complexity of the taxes. Please consult with your tax advisor to understand your situation better.
Compass owns 8 businesses and these "assets" constitute a diversified portfolio of leading brands.
Information Source: Company form 10K
Source: Investor Presentation
Dividend
Compass issues a $0.36 quarterly distribution, representing a 7.9% yield.
Source: Investor Presentation
The company distributed $101.3 million (including both common and preferred distributions). The company's Cash Available for Distribution (CAD) in 2019 was 1.03 times the total amount distributed. Further, the company has low leverage at this time and based on Q1 conference call discussions, management is prioritizing its liquidity for preferred and common distributions alongside providing support for its companies.
High Insider Buying
Insider ownership in the company has been at its highest level in the past 10 years.
Source: GuruFocus
It is encouraging to see significant insider buying in March when the stock dipped to a 5 year low point due to the intensified COVID-19 sell-off
Source: Insider Monitor
"Essential" segments of Compass
Sterno (represents ~28% of the 2019 Adj EBITDA) on an initial look appears to be extremely vulnerable during this time of restrictions on gatherings. This company largely supplies to the food service industry, which has been heavily impacted by COVID-19.
Sterno has switched focus to assist with the nation's COVID-19 response by re-purposing its factories to produce washable cotton masks that can be worn by patients, clinicians, non-medical essential workers, and by individuals when going to the supermarket or pharmacy.
Currently, the company is shipping all available inventory to hospitals to free up surgical-grade masks for front line medical staff. However, the company intends to make masks available to the food service industry and the general public in the near future. I believe this will be much needed as cities begin to open.
Sterno is also manufacturing bulk-sized packages of hand sanitizers and providing them to food service and healthcare customers.
5.11 (represents ~20% of the 2019 Adj EBITDA) is an essential business and has been providing essential services and uniforms to first responders. The company's website, distribution center and support center continue to be open to meet customers' needs during this time.
Other trends during the pandemic
Compass is cutting discretionary spending and capital expenditures to operate lean.
During this pandemic, several parts of the US saw increased outdoor activity in the form of hunting and fishing. Game and fish agencies from Minnesota to New Mexico have reported an increase in either hunting license sales, permit applications, or both this spring.
The month of March also saw the second highest demand for guns in a 20 year period. These directly benefit 5.11, Velocity Outdoor and Liberty Safe.
Source: NY Times
As a result, Compass revealed during its Q1 conference call that Velocity Outdoor (represents 9% of 2019 Adj EBTIDA) saw increased product demand in March. I expect this trend to continue for Q3 and Q3 as the weather will be more favorable for these outdoor activities.
Several segments of Compass are open to provide essential services. Certain segments are seeing increased demand due to trends during the pandemic. Business divisions like Foam Fabricators, Arnold Magnetics, Ergobaby are seeing significant slowdown in bookings and sales due to reduced demand, store closures, etc.
This is why a Compass' diversified operations is beneficial for investors, in times of good and bad economy.
Leverage
Ergobaby and Liberty Safe were acquired by Compass in 2010 when the economy was beginning to recover from the financial crisis of 2008. In my opinion, these were great acquisitions made at the right time.
Compass currently has $300 million in cash / cash equivalents, $910 million total debt out of which $594 million in long term debt. Current leverage ratio calculates to 1.3x. In my opinion, the company is in a great liquidity position at the present time and is well positioned to make acquisitions.
Source: Investor Presentation
Compass announced the acquisition of Marucci Sports, a manufacturer of products and apparel for baseball, for $200 million in early March. This is a new entry in Compass' portfolio.
The company's track record of enhancing shareholder value through acquisitions is well known. Compass had great success with a similar acquisition from 2008 in the sporting equipment space.
Compass purchased a controlling interest in Fox Factory Holding Corp. (FOXF) in January, 2008, for approximately $80.4 million. In 2017, the company completed the divestiture of Fox and announced total gains realized for shareholders to be over $775 million, including FOX secondary sales and past opportunistic sales of subsidiaries. This calculates to an impressive 28% CAGR, beating
Based on the comments during the Q1 conference call, Compass is prioritizing its liquidity in order to accomplish the following (in the listed priority order)
Support portfolio companies during the pandemic
Maintain preferred and common distributions
Look for investment opportunities, acquisition targets in 3-6 months after (1) and (2) are fulfilled.
Conclusion
Despite certain segments being operational and seeing increased demand, 2020 may not be a year for overall portfolio EBITDA growth for Compass due to the pandemic. We have seen Compass pick up high growth businesses during the financial crisis. Hence, in my opinion, the company is well positioned to acquire future winners businesses as the economy slowly recovers from the pandemic.
The current drop due to the pandemic surely brought great buying points for long term investors. In my opinion, we may see more such opportunities in the near future due to business being difficult during the pandemic and during the course of the recovery.
This article was written by
Hidden Opportunities, aka Venkat Raghavan, is a former management consultant with a Masters in electrical engineering. He is an expert in high yield/high growth energy stocks
. He contributes to the investing group High Dividend Opportunities led by Rida Morwa and a team of other top Seeking Alpha income investing analysts. The service focuses on sustainable income through a variety of high yield investments with a targeted safe +9% yield. Features include: model portfolio with buy/sell alerts, preferred and baby bond portfolios for more conservative investors, vibrant and active chat with access to the service’s leaders, dividend and portfolio trackers, and regular market updates. The service philosophy focuses on community, education, and the belief that nobody should invest alone. Learn More.Analyst’s Disclosure: I am/we are long CODI. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (24)
I find this article provides very good detail about MLP and tax obligations.
seekingalpha.com/...I personally own a few MLP's which do not have UBTI,and have found that the taxable income is often $0, hence there is no tax paid on the investment now. However, as the author of the article outlines, these distributions will lower the cost basis of the investment, and I will owe taxes when I sell units (capital gains + distributions).I have only acquired CODI units this year, so I am unable to comment on the tax experience yet. It would be nice to have a CODI unitholder share some comments on how CODI manages the reporting of UTBI and taxable income, so you and I can have some insight on what we will face next year.
It frustrates few people who would like their refunds early.Enrollment online - www.taxpackagesupport.com/... will get you real time notifications when your K-1 is ready. So you don't have to wait for it in the mail.It helps to have everything else ready in the interim, so you can file quickly when the K-1 arrives.
Since you are using a preparer, it should be fine I guess.
Thanks for reading my article and sharing your comments.
My article publication timing unintendedly coincides with the shareholder dilution (though it was submitted several days prior).You mentioned K-1, so I had a quick question about the one issued by CODI. Could you tell me which US states CODI reports income in as on the K-1?
Thanks!
I see CODI's business fundamentals to be weak in Q2 and Q3, because that is where I see the true impact of COVID-19 on businesses.
Compass raising cash through dilution and additional borrowing is perhaps with an eye on an acquisition target. To summarize, I see some short term disappointments are likely, but this is a good long term hold!
Q2 began in April.
The firm paid out its previous distribution end of April, a time when business was the most difficult (end of Apr, early May). If the company felt the need to hold back the distributions for liquidity, they could have done so in April. Several companies announced their dividend cuts in Apr.CODI has maintained the $0.36 quarterly dividend since Q2- 2011.
