Description

At 3-4x 2004 free cash flow (real cash flow), Aldila is incredibly inexpensive and represents an attractive investment opportunity for value investors. Moreover, we believe that certain catalysts now make this a particularly timely play. We view Aldila as being very similar to the Salant (SLNT) story, which we posted here about 2 years ago: a simple business which, while competitive, is easy to understand and to analyze; a company that is poised to reap the benefits of past investment and restructuring; a stock with a reasonable chance of being bought out at a higher price in the near term; and value in the form of a very low cash flow multiple, a pristine balance sheet, and a $0.20 dividend, all of which provide safety in the event of operational hiccups or if a takeout never materializes.

We refer investors to the company’s financials for a more comprehensive overview of ALDA’s business. We will present a summary here, but our preference, as usual, is to focus on the investment story.

ALDA designs and manufactures graphite shafts for golf clubs (80% of revenues), as well as hockey sticks (20% of revenues). Shaft manufacturing is intensely competitive, particularly in the lower end of the market, which is where ALDA was positioned for many years. In response to particular market turmoil in the 1990s, ALDA decided to gradually shift its focus on, and its resources to, the premium and branded segments of the market. Doing so required greater investment in R&D, marketing, brand awareness programs, customer service, etc., as well as a greater involvement with the golf club OEMs themselves. ALDA even went so far as to become vertically integrated, through the purchase (and now JV) of its own raw material production facility (which thus far has not benefitted them as carbon fiber has been in excess supply). The end results have been successful thus far, although we expect that real upside has only started to materialize.

While we are somewhat skeptical of the concept (and value) of a branded shaft, ALDA apparently has a very strong reputation and, after several years of investment, a real brand name. While we would never argue that any company in this industry has a significant competitive advantage, ALDA appears finally to have established a position as the premier higher-end shaft manufacturer and has used the opportunity to integrate more completely with OEMs (although not contractually), to continue to lower costs, and to enter new markets (more on this later).

In addition to a much more efficient cost structure, ALDA has started to experience both unit AND pricing growth, which has resulted in very strong revenue AND profit growth over the past 9 months. Pricing growth is rare in this business and when it does occur, it is usually due to pass through of carbon fiber costs, which have been on the decline for the past few years. And while a shorter supply of carbon fiber may be a short-term phenomenon, it appears that ALDA is actually differentiating itself from other manufacturers and is realizing some pure pricing power. Unit growth in the current slower growth golf environment generally must come from competitors (whether in the form of new products, better service to OEMs, etc.), which ALDA appears to be doing. Tru-Temper, which is a private company but which has public debt, reported a weak quarter yesterday – and this only confirms our unit growth assumptions. As do our dealer and field checks, in which most sources recommend only ALDA or Furukawa by name.

We are very encouraged by recent results, as well as by potential upside catalysts. ALDA has clearly solidified its position as the leading premium/branded manufacturer of graphite shafts and now enters a sweet spot. It is taking the opportunity to launch an initiative into the graphite shaft for irons market. Thus far, graphite shafts for irons have not been particularly well-received by the market (about 25% of all irons are graphite vs 90%+ for woods). We view this, however, as an opportunity to realize significant value if in fact the Aldilla brand can be transferred across segments. In any event, ALDA’s existing relationships with OEMs, its selling infrastructure, its vertical integration, etc. significantly reduce the risk of such a venture. We do not count on significant upside from this initiative nor do we model unrealistic assumptions re ALDA’s core business. Rather, we prefer to analyze ALDA as is, and to view everything else (mkt share growth, irons success, continued short supply of carbon fiber [which helps ALDA’s JV], etc.) as upside.

And this is why we currently like this opportunity. Because with a market cap of $62 million and EV of $47 million, and with much of ALDA’s potential future success already paid for, and the results of which are already apaprent, the valuation is just too compelling to ignore. We present some numbers below in support of our view:

For 2004E (9mos YTD in parenthesis)

Cash: $16.5 million ($15mm)
Debt: none
EPS (2004E): $1.40 ($1.16)
EBITDA (2004E): $13.7 million ($9mm)
Sales (2004E): $53 million ($40mm)

Valuation

2004 EV/Sales = < 1x
2004 EV/EBITDA = 3.4x
2004 P/E = 8.6x (or 6.4x backing out cash)
2004 EV/FCF = 3.6x


What is ALDA worth? We believe that ALDA has become attractive as a potential buyout candidate, both to financial and strategic buyers. Financial buyers tend to pay more than they should for companies like ALDA, in which the allure of being involved with a sporting goods company, the golf industry, etc. seem to make grown men do funny things with excess cash. And strategic buyers now generally view ALDA as less risky than before, as ALDA's vertical integration (i.e. its own supply) protects results in the event of raw material shortages. Such an outcome, however, is not critical to the success of the ALDA story. The basic math is simple, regardless of the catalyst -- ALDA trades at between 3-4x FCF, has $15mm in excess cash (and will have more shortly), and is experiencing some momentum -- applying reasonable single-digit multiples to FCF or low double-digit multiples to EPS produces, as a start, a reasonable target of $20-25 per share.

Risks:

Many, including...

Competition
Customer concentration/loss of customers
New irons venture/cash drain on other projects
Slower growth industry
Manufacturing
Weather
etc.

Catalyst

Q4 results should be very strong and will stand out against tru-temper and other related companies. Value guys will not be able to resist.

Graphite irons launch in January.

Use of excess cash, including MBO, LBO, etc.