Crown Crafts: A Small Company With Powerful Free Cash Flow

Summary

• Rising inventory levels and fear of recession cause the stock to fall.
• Hidden return beats the market, while stock price remains anemic.
• Customer concentration is not concerning but undermines direct-to-consumer potential.

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Crown Crafts (NASDAQ:CRWS) is a cash flow machine in a consistently growing industry. Retail store closures and elevated inventory levels are an overblown fear that will dissipate as we move out of the all but confirmed recession.

Thesis: Crown Crafts is shareholder friendly and fiscally responsible. Free cash flow is strong, and the company is trading below 1.5 tangible book value. The attractive dividend yield is safe, with potential for special dividends.

While scouring my stock screeners for undervalued, yet quality businesses, I came across Crown Crafts. In fact, it was one of the few businesses that popped up when I screened for healthy free cash flow and low P/B value.

This made me wonder why Crown Crafts is undervalued and if it's warranted.

Reason for Crown Crafts' Undervaluation

Fears of a recession in 2023 and building inventory levels are the main cause for fear and undervaluation. Crown Crafts has an NCAV of $48.8 million and $27.74 in inventory. That's just over 50% of total current assets.

The fear is if this inventory needs to be heavily discounted the inventory on the balance sheet may need to be written down, affecting the overall value of the company and stock.

While this may seem dire, inflation still has yet to dissipate and fears of a write-down of inventory value are likely overblown.

Inventory levels are only elevated because of the massive disruption in the supply change which made it difficult to gauge demand, which should be easier moving forward.

Dividend Performance and Yield

Crown Crafts currently sports a mouthwatering 5.85% dividend yield. This dividend has remained constant since before 2020 and has a safe sub-50% payout ratio.

Instead of buying back shares, Crown Crafts instead favors a special dividend payout when times are good. This is in direct contrast to many popular stocks.

Share buybacks may seem like a better tax advantaged system, but when they are done at higher book values, they indirectly destroy shareholder equity.

There were, however, some token stock repurchases that are held as treasury stock, but it is immaterial to the overall value of the company.

Hidden Return Beats the Market

If you had held on to Crown Crafts over the past two years, you would have achieved a more than 30% return in dividends, beating the market in special dividends alone.

So, while the stock price may not have elevated all too much, leading to less excitement, the stock would have been a winner. Moving forward, I don't see this changing as cash flows remain consistently strong.

Crown Crafts cash flow (Finbox)

These strong cash flows are the bedrock of the returns of Crown Crafts and its ability to pay out special dividends.

Cash flows will likely remain elevated as it sells down its high inventory levels.

Heavy Reliance on Key Customers

Crown Crafts relies heavily on two key customers that exceed 10% of total sales.

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Walmart sales have also increased substantially over the past couple of years, which bodes well for a company focused on sales in a possible recession. The growth in Walmart (WMT) e-commerce may be a reason for this overall increase and bodes well for Crown Crafts sales.

While customer concentration is alarming, the customers are also the largest players in the retail space and don't pose immediate bankruptcy risk.

Since there is a heavy focus on selling directly to Walmart and Amazon (AMZN), the potential for its own direct-to-consumer sales channel is limited. These keep margins lower, but since margins are over 20% there isn't too much need or concern.

Closure of Unprofitable Division and Future Expansions

The closure of Carousel, a low-margin business of Crown Crafts, occurred in 2022. There were some losses associated with this but overall sales were stronger in 2022 than previously.

This move should strengthen margins in 2023 and increase focus. Possible acquisitions could also be on the horizon if Crown Crafts seeks to fill in its revenue gap outside previously established brands.

Earnings growth is nothing to write home about as it currently stands, but it's steadily above 10% and with a PE ratio sub 10 signifies a value buy.

Overall, Crown Crafts could increase growth if it stopped paying so many special dividends, but its steady growth is enough to look past them and praise steady and calculated expansion.

Nonexistent Properties Pose Long-Term Risks

Since Crown Crafts leases all its properties, this poses an issue in an inflationary environment. Their California location lease agreement is also up in May 31st, 2023 which could see a big bump in potential costs.

This is their largest facility by far as its square footage is 157,400 compared to just over 20,000 for all other locations. That's more than 85% of their total square footage.

It may be beneficial to buy crown crafts right before or after the announcement of its new lease agreement as it will likely weigh on the stock price until then.

If Crown Crafts were to instead own some of its own real estate, it could negate some of these costs and increase its asset valuations over time and benefit from inflation.

Overall Thoughts on Crown Crafts

The strong cash flow and conservative nature of management make me confident that the stock will either be worth more in the future or the dividend payouts will sufficiently beat the market.

The nonexistent debt is also a positive in rising interest rates.

However, the lack of focus on growth may limit the potential of this company. Competitors may begin to chip away at it, and without cash savings or debt, it won't be able to absorb competition or expand operations.

This stock would be great for a retiree in a tax-advantaged account but may not be suitable for younger investors looking for quicker returns.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.