Educational Development Corporation: Stock Decline, Management Incentive Alignment Indicate Potentially Attractive Entry Point
Summary
- While EDUC revenues are likely to decline modestly as people stop staying at home, we believe revenues will still be above pre-pandemic levels due to their consultant-style selling.
- We believe EDUC is an attractive investment opportunity backed by a superb balance sheet and aligned management through insider ownership.
- EDUC's recent decline in stock price is an overreaction and in our view presents a compelling entry point.
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Educational Development Corporation (NASDAQ:EDUC) has a strong balance sheet and cash flows and pays consistent dividends. It has had strong revenue growth over the last seven years. We expect this trend to continue. The stock has fallen recently, and we believe now is an excellent entry point. We're initiating with a buy rating and an $18 price target.
Investment Thesis Overview
- Educational Development Corporation is a profitable publishing company which has demonstrated impressive revenue growth of nearly 1000% over the last seven years.
- EDUC benefited from the stay-at-home environment. Active consultants increased significantly during 2020 (fiscal 2021). This caused a dramatic increase in sales during this year. While sales are expected to fall as children are back to school, sales remain up dramatically from fiscal 2020.
- We believe the overall positive growth trend has been impressive and should continue. EDUC’s stock price has fallen due to an overreaction in its revenue falling during the return to more normal environment. We believe this is an overreaction and is a buying opportunity.
- EDUC is undervalued at just 8.32 times our 2022 adjusted EPS of $1.13 and only 7.71 times our 2023 EPS of 1.22. Our price target is based on a conservative 15 times P/E relative valuation blended with a DCF model price.
Primary Risks
- EDUC’s recent fall in sales has been expected due to the change in the stay-at-home environment. If this fall is larger than expected or continues, it could have negative implications for the stock.
- The increase of active consultants and sales was impressive from 2020–2021. We expect the number of consultants to fall this year – but remain elevated. If consultants return back to the levels of FY2020, this will impact future growth expectations.
Investment Thesis
Educational Development is a publishing company specializing in books for children. EDUC is the American co-publisher of the UK-based Usborne Books and owns Kane Miller, which publishes children’s literature from around the world. EDUC’s current catalog contains more than 2,000 titles, with new additions semi-annually. Both Usborne and Kane Miller products are sold nationally by about 45,000 direct sales consultants, as well as in 4,000 book, toy and specialty stores.
Many of the books are interactive in nature, including touch and feel board books, sticker books, language books, adventure books and “internet-linked” books. Their selection includes science, math, novels and chapter books. The company mostly markets their books through commissioned consultants using a combination of direct sales, home parties, book fairs and social media platforms (where they could have “online parties”). These consultants are a key driver to the company’s business. Active consultants increased significantly in 2021 during the COVID-19 pandemic as people were looking for more non-traditional employment opportunities during this period. The number of active consultants and revenue have fallen over the last couple of quarters as students and people return to a back-to-school and back-to-work environment.
Our thesis is that Educational Development Corporation is an undervalued, compelling company which will deliver value for shareholders because:
- Educational Development Corporation is a profitable company with a strong balance sheet. It pays a dividend yield of about 4%, participates in a share repurchase program and has significant insider ownership.
- While we expect sales to fall over the next two quarters versus previous year sales, we expect these sales to be up dramatically from fiscal year 2020. This continues an impressive growth trend since 2015.
- Because of difficult comparisons and the fall in revenue, EDUC is trading down near year lows. We believe this overreaction is an opportunity for investors.
Educational Development Corporation has consistently been profitable with periods of strong EPS growth
While EDUC is a small cap company, the firm has been consistently profitable. Below is a chart of the company’s TTM Fully Diluted EPS since 2016.
Exhibit 1: Education Development Corporation's TTM Fully Diluted EPS
Source: Education Development Corporation and Singular Research
Because of the company’s solid balance sheet, it currently pays $0.40 dividend which is yielding 4.3%.
The company has also demonstrated strong revenue growth over the last seven years. The company started to benefit from the ability of its consultants to leverage Facebook and other social media platforms beginning in about 2014. From 2014 to 2019, sales increase from $26 million to $118 million. Before 2014, sales growth had been generally flat for seven years (2007-2014). Social media allowed the process to be a lot easier. The number of consultants also increased during this period.
During the stay-at-home environment in 2020-2021, the ability to sell products remotely led to even more growth. During this environment, sales went up by 81% from $113 million to $204 million. From 2014 to 2020, sales have risen nearly 1,000%. While the reopening environment is expected to show a reduction in sales from FY2021 to FY2022, the sales increase from FY2020 to FY2022 should still be significant (from $113 to our estimate of $153).
Exhibit 2: Annual Net Revenues (Fiscal Year)
Source: Education Development Corporation and Singular Research
Educational Development Corporation is a company that benefits from the stay-at-home environment caused by COVID-19
Investors are well aware by now that the stay-at-home environment caused by the COVID-19 pandemic impacted various companies in different ways. Many were adversely impacted by the environment while some companies experienced sales increases during the stay-at-home environment. EDUC was a company whose demand increased as school closures, travel restrictions and social distancing requirements resulted in an increased demand for quality, educational children’s books at home. EDUC’s revenue grew year over year in fiscal 2021 by 81% and profits grew by 124%. This also gave them $17 million in operating cash flow which they used to pay down debt in order to improve their balance sheet.
The market reacted to the dramatic sales increase. The stock rose from about $5 in early March 2020 to over $17 a year later. Since that time, investors reacted to the realization that the 81% revenue growth was unsustainable. The stock is still above $5, but it is now below levels seen in 2018 when sales were 27% less than our FY22 expectations.
While we expect revenue to be down since last year, we expect a significant increase in growth since FY2020. Many of the consultants are expected to remain as people remain in a hybrid environment where many people are working from the office certain days and at home other days. Also, book fair, booths, home shows and in-person events are expected to increase as people are willing to participate in these types of events.
Consultants Are Key Driver for Sales
Educational Development Corporation uses a multi-level direct selling platform to market books through independent sales consultants located throughout the United States. Revenues are primarily generated through book showings in individual homes, on social media collaboration platforms, through book fairs with school and public libraries and other events. This past fiscal year continued with a significant shift toward internet sales via social media platform events, such as Facebook parties.
An important factor in the continued growth of the company is the addition of new sales consultants and the retention of existing consultants. Current active consultants (defined as those with sales during the past six months) often recruit new sales consultants. EDUC has eight levels of sales representatives.
Home parties occur when consultants contact hostesses to hold book shows in their homes. The consultant assists the hostess in setting up the details for the show, makes a presentation at the show and takes orders for the books. The hostess earns discounted books based on the total sales at the party, including internet orders for those customers who can only attend via online access. Home party orders are typically shipped to the hostess who then distributes the books to the end customer. Customer specials are also available when customers, or their party, order above a specified amount. Additionally, home shows often provide an excellent opportunity for recruiting new consultants.
The company’s net revenues also include sales to schools and libraries through educational consultants. The school and library program includes book fairs which are held with an organization as the sponsor. The consultant provides promotional materials to introduce our books to parents. Parents turn in their orders at a designated time. The book fair program generates discounted books for the sponsoring organization.
There was a significant increase in the number of consultants during 2020 as there was an increased demand for non-traditional employment opportunities. This number has fallen since 2020 but is still up dramatically since the beginning of 2020.
Exhibit 3: Strong Relationship Between Net Revenue and Number of Consultants
Source: Education Development Corporation and Singular Research
Management and Shareholders
Craig White became the President and CEO on July 13, 2021. He joined the company in 1983 and served in various roles including Chief Operating Officer since August 2018. He follows his father, Randall White, who had been the president and CEO for 35 years. His father is now the executive chairman.
On EDUC’s ownership summary report, the Company reported ~8.7 million shares outstanding. There are no institutional holders with an over 5% of holdings. A summary of insider shareholdings and institutional holdings is below.
Source: Education Development Corporation and Singular Research
Q2:22 Financial Results
EDUC’s second quarter results for FY2022 showed revenue of $33 million versus second quarter FY2021 revenue of $59.3 million. This was a decrease in revenue of $26.3 million or 44%. It was also an increase of $8.6 million or 35% from the revenue from two years ago which produced sales of $24 million.
The quarter also showed a decrease in net earnings. The most recent quarter showed net earnings of $1.9 million compared to $4.3 million, representing a decrease of $2.4 million or 58%. Compared to two years ago, earnings were up from $1.0 for the quarter (90%).
Working capital increased during the quarter as the company increased inventory and their capital borrowings in order to meet expected demand. As inventory turns to cash, they expect to pay down borrowings and to normalize working capital towards the end of the year.
EPS Guidance and Estimates
We expect sales to fall over the next two quarters versus the previous year’s results although we expect these sales to be up significantly compared to two years ago. We estimate that sales will fall about 20% during the third quarter. This is an increase of 30% from the same quarter two years ago. We also estimate that sales will fall 35% during the fourth quarter as we expect a 30% increase in sales from the same quarter two years ago. The 30% sales increase compared to two years ago still demonstrates that the firm is producing solid growth even as we move back to a more normal environment.
We expect EDUC to deliver adjusted net income of $9.6 million or $1.13 per share for the year (FY22). This compares to $12.6 million or $1.50 per share in FY21 and $6.6 million or $0.68 per share in FY20. We also forecast net income of $10.3 million or $1.22 per share for FY23.
Investment Risks
With the return-to-work environment, sales could fall more than our expectations. The stay-at-home environment has benefited EDUC. We estimate that even with a fall in revenue since last year, sales will increase 30% versus two years ago for the next two quarters. We feel these are conservative expectations. If sales fall more than expected, this could impact the stock.
A substantial fall in consultants could occur as we return to a more normal environment. The increase in consultants from FY2020 to FY2021 was impressive (from about 30K to almost 60K in one year). As we mentioned above, the number of consultants is a key driver to the business. We believe the number of consultants will remain elevated, but if this assumption is incorrect, it could impact sales and the stock price of the company.
Valuation
EDUC trades at 8.32x our expected FY2022 EPS estimate of $1.13 and 7.71x our expected FY2023 EPS estimate. As shown in exhibit 5, these ratios are significantly lower than other book publishing companies. We value EDUC using a blended valuation methodology where we blend 50% of EDUC’s price target to relative P/E ratios and the other 50% to EDUC’s DCF model displayed on page 12.
In our relative valuation, we assume a more reasonable P/E ratio of 15. This valuation leads to a price target of 17.
In our DCF model, we estimate the firm would earn a return on capital of 12%, reinvesting 16% of this return into their business and growing after tax operating income by 1.9% over the next seven years. We believe these assumptions are conservative especially with EDUC’s recent earnings history and potential for growth. These assumptions lead to a DCF price target of $19.
We then equally blend the relative valuation price target, $17, and the DCF valuation price target, $19, to come to a final target price of $18.
Exhibit 5: Educational Development versus Other Book Publishing Companies
Source: Education Development Corporation and Singular Research
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This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of EDUC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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Comments (5)
For me, it is cheap, and the stock could work, but the mechanics of how the business operates when they have to shed consultants is not clear and could result in unintended and unforeseen consequences. If there was no debt, it would be a different story, but debt on pre-covid financials looks to be 3x (on 10M in EBITDA). Worth keeping an eye on and if convinced they would not shed consultants, I might buy-in to the thesis.
