Description
An overlooked, undervalued story trading at a 40% discount to its peers despite double-digit sales growth, rapidly expanding operating margins, $5/share in year-end cash and no debt. We believe the shares deserve a $50 valuation, nearly 65% above the current price. This opportunity is simply not yet well known as the Company currently receives no coverage from Wall Street and management does not provide EPS guidance.
ALDA operates in the growing category of branded graphite golf shafts and benefits from its vertically integrated manufacturing structure, which has enabled it to take advantage of a global carbon-fiber shortage. The Company continues to post impressive growth and enjoy expanding margins from both its improved branding presence as well as its internal access to carbon fiber. Sales grew 40% and 45% in 2004 and 2005, respectively, and operating margins expanded from 18.5% in 2004 to 25.8% in 2005. The Company currently trades at less than 12x 2005 EPS, 9-10x our range of 2006 EPS estimates and it currently has over $3.00 of cash on its balance sheet and no debt.
Background:
ALDA is a leading designer and manufacturer of branded graphite (carbon fiber-based composite) golf shafts. ALDA is widely considered the leading premium shaft within the golf industry with its collection of various NVS branded shafts and the Company sells it shafts to all of the leading manufacturers, including Calloway, Acushnet (Titleist, Cobra), and Ping. In 2005, over 97% of all wood clubs were manufactured with graphite shafts and over 24% of iron clubs were manufactured with graphite shafts. ALDA is estimated to have a 30-35% market share of graphite shaft sales. Top competitors include privately-held Fujikara and Graphite Design (Japan-based manufacturer). TruTemper is the dominant steel shaft manufacturer with over an 80% market share of steel shafts. TruTemper has a very small presence within the graphite shaft sector.
ALDA targets customers searching for a premium golf product and therefore most of its sales occur within the premium on-course and off-course golf shops. These premium retail outlets account for 75% of total golf equipment sales. The off-course golf shops are dominated by four primary retailers: Golf Galaxy, Edwin Watts, Dicks Sporting Goods and Golfsmith. May, June and July are high seasonal months for golf equipment, although this seasonality continues to smoothen as manufacturers introduce new lines throughout the year. Over $3-4 billion of golf equipment was sold in 2005.
Investment Highlights:
The hybrid golf club is a high growth category that is in the early stages of introduction.
The hybrid club is a recent innovation that combines many of the characteristics of a wood club and low iron club to create a unique design that provides the golfer the ability to hit a higher loft shot with an incredibly improved level of accuracy. Over 90+% of hybrid clubs are manufactured with graphite shafts. The hybrid club is generally expected to replace a 2 or 3 iron within the standard golf set. The long narrow face and wide sole of hybrid clubs utilizes a low center of gravity cog, which helps players with slower swing speeds launch the ball with little effort, making a hybrid club similar to playing a wood in that it lends itself to the sweeping style swing rather than picking the ball off the turf with greater effort and a traditional iron. Effectively, all players benefit, but particularly grateful are those players who have lost swing speed due to age, injury or other physical conditions that have prevented them from making a full shoulder turn on the backswing. Hybrids allow for a shorter backswing while launching the same distance you would experience with a wood.
Initially, hybrid clubs were targeted toward the older golfer. However, as pro tour players have begun to adopt these clubs and displaced the stigma that these clubs are for ‘older’ golfers, younger players are now beginning to purchase the hybrid club. Beginning this year, golf club manufacturers are selling pre-assembled sets with hybrid clubs replacing the 2 & 3 iron clubs.
Our channel checks of the largest golf retailers all confirm that this category has just recently come onto the scene and shows no sign of slowing down in 2006. With orders for the high summer season already placed, our retail channel contacts all expect hybrid club sales to be 50% higher than last year. Most retailers expect hybrid clubs to represent 15-20% of all store golf club sales this year.
ALDA presents an inexpensive opportunity to capitalize on the global carbon fiber shortage.
Public companies such as Zoltek Companies (ZOLT) and SGL Carbon (SGG) have experienced tremendous growth as the price of this commodity has increased due to a global shortage. ALDA owns a 50% interest with SGG in a carbon fiber manufacturing facility (“CFT”) in Evanston, WY. The Company sources all of its internal carbon fiber need for producing golf shafts from CFT. In addition, the Company uses the carbon fiber from CFT to support its fast-growing business line of selling prepreg composite material to outside vendors. Prepreg sales grew 67% in 2005 and over 40% in Q1 2006. Management has just recently implemented another prepreg line that should increase its capacity over several hundred thousand tons in 2006. At over 25% margins, this profitable business line allows the Company to develop a side business that can capitalize on the carbon fiber commodity market.
Due to carbon fiber shortage, price increases are being implemented industry-wide.
Graphite golf clubs have experienced 6+% annual price increases over the past few years as shaft manufacturers have struggled to cope with the tight carbon fiber market. Due to its vertically integrated structure (which none of its competitors possess), ALDA has been able to capture this price increase and translate it into operating margin expansion. As indicated by the 8% gross margin expansion in Q1 2006, these price increases show no sign of abatement.
Expansion of branded/co-branded golf shafts is creating greater consumer awareness and pricing power for ALDA.
Three to four years ago, graphite shaft manufacturers such as ALDA and Fujikara began to brand and co-brand their shafts with golf club manufacturers. This significant evolution in the market has enabled ALDA to shift from a relatively unknown private label manufacturer to an emerging consumer brand. Its neon green lettering on its shafts has helped it to solidify its reputation within the golfing community as the leading brand of graphite shafts (as confirmed from our retail channel interviews).
ALDA will benefit from eventual migration from steel shafts to graphite shafts within iron golf clubs.
Graphite shafts provide for an easier and more forgiving backswing while providing greater club speed vis-a-vis a steel shaft. Over time, it is expected that graphite shafts will replace the other steel shafts within an iron set. The hybrid club has provided graphite shafts an introduction into the iron set of a golf bag collection and in many ways, the hybrid club has ‘allowed the fox [graphite shafts] into the henhouse [iron clubs]’.
National Golf Federation indicates that rounds played through first quarter of 2006 are up 10% versus 2005.
Last year rounds played were down 11%. The early rebound is beginning to validate the general expectation that the industry would rebound from last year’s poor performance. According to multiple analysts who cover Callaway Golf (ELY), their channel checks are indicating strong sell-through of equipment, particularly some of Callaway’s new clubs. ELY is one of ALDA’s largest customers (18% in 2005).
2006 is benefiting from the rebound of its hockey stick business post NHL strike.
Albeit a small part of the business, the Company expects over a 50% rebound, thereby providing an overall 1% increase to the top line.
ALDA’s 2006 growth capex plan is a bullish signal from this conservative management team.
ALDA is planning to spend $5.5mm of growth capex in 2006 (versus normal capex spend of $1.0mm) to expand its prepreg line as well as to build a new graphite manufacturing facility in Vietnam. This new shaft manufacturing facility is not being built to replace any current capacity but rather it is to meet the growing demand the Company is expecting.
Valuation:
Strong Q1 Performance
2006 Q1 EPS experienced 29% y-o-y growth versus 2005 Q1. Sales grew 17% and gross margin improved to 46.5% versus 38.5% for 2005 as the Company continues to benefit from its vertical integration and greater pricing power as branded shafts now account for over 60% of ALDA’s shaft sales.
Conservative 2006 EPS of $3.00
Q2 is typically the strongest sales quarter in the calendar year. Based off of quarterly sales patterns from 2005, we have taken Q1 revenue and extrapolated a conservative revenue target of $90mm (16% annual growth). Despite 46% gross margins in Q1 2006 and the Company’s favorable cost structure in a tightening market, we have conservatively assumed 42% gross margins for the remainder of the year. Despite management guidance that SG&A will be flat for the year (one of the few times management has ever provided guidance), we have assumed a $0.5mm SG&A increase. On a fully diluted basis, this forecast projects 2006 EPS of $3.00. Based on our retail channel checks and the tightening carbon fiber market, we believe our estimates provide for a great upside surprise. If we keep gross margins consistent with Q1 performance, ALDA should achieve an upside EPS of $3.35.
Cheap stock even when using today’s discounted p/e and ebitda metrics
1. At 13x our base case 2006 EPS of $3.00, we believe the equity market cap is worth $39/shr – plus an additional $5/share of cash at the end of 2006 results in a $44 stock price, a 45% increase from today’s price levels. Our upside EPS case of $3.35 results in a $49 stock price, a 62% price increase.
2. We conservatively estimate EBITDA to be between $28m and $30m for 2006, implying an incredibly low EV/EBITDA of just 5.2x.
Comparable golf companies and carbon fiber companies support higher valuation metrics.
1. At just 5.2x our 2006 EBITDA estimate, ALDA trades at a nearly 40% discount to its peers (ELY currently trades at 8.5x). There are reasons why a discount might be appropriate (smaller publicly traded float), but there are also reasons why an equivalent or even premium multiple could be warranted (highest growth category within the golf sector, vertical integration). We believe the discount is predominantly a result of the Company not being followed by the Street. If ALDA’s discount were to be eliminated, the shares would trade at more than $50 (a 65% premium to today’s price).
2. The carbon fiber stocks (SGL Carbon – SGG and Zoltek Companies – ZOLT) have seen their stocks appreciate 60% and 200%, respectively since the beginning of the year. SGG trades at 18x 2006 p/e and ZOLT trades at 36x 2007 p/e.
Risks:
Slowdown in Hybrid club sales. Risk of the fad element of golf.
Our channel checks continue to support our investment thesis that this is a growing category in the introductory phase of its evolution. The hybrid club truly enhances performance and allows for an easier swing. We believe it is a category that is here to stay. We do believe that there are fad risks within the hybrid club category as manufacturers introduce new hybrid clubs with different technologies. However, by providing graphite shafts to all of the major manufactures, ALDA shelters itself from this risk.
Future capex requirements.
The Company has stated that 2006 is an expansion year in response to widening product demand. The plant addition in Vietnam will initially be at 20% capacity and only require minimal capital expenditures to expand. Capex is expected to return to more normal level of $1.0mm in 2007.
Insider selling.
The predominant insider sales have been from Lloyd Miller – a board member who is an active investor in multiple small cap stocks. Mr. Miller has been invested in the stock for over five years, since it was just around $2-3/shr. He initiated a 10b5-1 Plan in September 2003 and has been a consistent seller over the past 1-2 years even as the Company has continued to experience tremendous growth and stock appreciation during that timeframe.
Economic slowdown.
ALDA’s business is tied to consumption and so could be hurt by a downturn in GDP. However, helping to offset any change in GDP growth is the continued aging and retirement of the baby boom generation.
Catalyst
1. Execution – simply achieving our conservative $3.00+ EPS in 2006
2. Continued 2006 growth upswing in golf industry
3. Initiation of a share repurchase program
4. Coverage from a Street analyst