Description

CCA Industries

CCA Industries (CAW) has been written up on VIC three times previously, most recently last August by chuck307.  The stock has appreciated by 45% (from $3.75 to $5.42) since chuck307's write-up, but I believe the story remains extremely compelling at today's price, for reasons discussed below.

The bottom line is:

(a)    We are paying a stock price of $5.42 for a company which has net cash of $2.74 per share, or just over 50% of the stock price, providing a balance sheet which can weather a severe downturn;

(b)    The company is consistently profitable, and in fact makes strong returns on the capital necessary to run the business (i.e. after stripping out the excess cash on the balance sheet);

(c)    While we wait for capital appreciation, we are receiving an annual dividend yield of 5.2% on the current stock price; and

(d)    There is reason to hope that the company may eventually be sold, possibly to a strategic buyer.  (The controlling shareholders are both in their late 70s, and have repeatedly indicated that they would be willing to sell at the right price.)  A recent acquisition suggests that a buyout price could be double (or more) of the current stock price.

I refer readers to the prior write-ups, which extensively cover the business.  Rather than repeat what has been said before, my write-up will focus on aspects that have not been addressed in detail previously, and discuss recent developments that help back up my contention that the stock is good value today.  Specifically, I will:

(1)    Provide a brief summary of the business, and discuss the company's performance during the recession, and the impact of Wal-Mart's decision a year ago to reduce its business with CCA.

(2)    Analyze the economics of the underlying business, which are very good, despite the headwind faced by the company's compensation of the two controlling shareholders (Ira Berman and David Edell).

(3)    Finally, I compare CCA's valuation in light of the just-completed acquisition of Chattem by Sanofi-Aventis.

I.   A Brief Summary and Recent Performance

CCA Industries is a small company (less than $60 million in annual revenues) in the health & beauty aids business.

CCA does not manufacture any of its products, instead using contract manufacturers, while focusing on the design and marketing of its products.  Key brands include Plus+White (toothpaste); Bikini Zone (pre- and after-shave products); Nutra Nail and Power Gel (nail treatments); Hair Off (hair removal); Wash 'N Curl (shampoos); Scar Zone (scar diminishing cream); and Mega-T (green tea and chewing gum dietary products).  Products are sold through major drug and food chains, mass merchandisers, warehouse clubs, and wholesale beauty-aids distributors.  Foreign sales accounted for just 4% of total sales in 2008.

Wal-Mart is CCA's largest customer, accounting for 44% of sales (about $25 million) in 2008, followed by Walgreens (10%), CVS (7%), Rite Aid (5%), and Target (4%).  CCA's dependence on Wal-Mart came to haunt it early last year, when Wal-Mart informed CCA that it would no longer carry Plus+White toothpaste effective March 2009.  Sales of Plus+White to Wal-Mart alone represented about $6 million in annual sales, or 10% of the company's total sales.  Despite the loss of this business, the company has performed relatively well financially during this past year (the fiscal year ends November 30^th), with results improving as the year has progressed.  In the first fiscal quarter (which was not affected by Wal-Mart's action), sales were up 9% to $14.8 million, and pre-tax income was down by almost half, from $0.5 million to $0.3 million.  In the second fiscal quarter, when Plus+White sales to Wal-Mart ceased, sales were down about 16% to $14.6 million, but pre-tax income was only down 10%, to $1.3 million, as a result of active cost-cutting.  In the third quarter (which ended August 31^st), sales were up 8.5% to $15.1 million, and pre-tax profits increased by over 30%, to $2.4 million.  The sales increase was a result of strong sales of other products, particularly Mega-T dietary supplements, which more than offset the loss of Plus+White sales to Wal-Mart.  Fourth-quarter results will be reported before the end of this month.  The company has indicated that it has had a strong year, and I expect sales and profits to be relatively strong in the fourth quarter, particularly in comparison with the previous year, when the recession hurt sales (which were down 16%), and the company made a loss (compared with a solid profit the previous year) as a result of the lower sales and aggressive advertising.

II.  Quality/Economics of business

A key element of CCA that helps make the investment attractive is its strong balance sheet.  The company had net cash of $19.4 million at 8/31/09, or $2.74 per share, representing just over half of the current stock price of $5.42.  Additionally, the company has been consistently (if somewhat erratically) profitable.  This combination of the strong cash position and steady profitability serve to ensure that the dividend of $0.28 is unlikely to be cut, and could be raised over time.  This translates into a juicy dividend yield of 5.2%, while we wait for the stock to appreciate further, or for the company to be sold.

Less obvious is that CCA's underlying business has attractive economics, employing very little capital to generate its sales and earn its profits.  The company farms out the manufacturing of its products, and needs only $0.7 million of net PP&E to generate almost $60 million of revenues.  Also, if you strip away the cash on the balance sheet, the net capital employed by the business (working capital + PP&E) is about $10 million, on which the company earns very high rates of return (see table below).  This is in spite of the high, and arguably unearned, compensation (approximately $1.3 million each) paid to the company's two controlling shareholders, Ira Berman and David Edell.  I would thus argue that we are investing in a high-quality, albeit slow-growth, business, and earning a good cash yield, while we wait for capital appreciation.

III.  Chattem Acquisition by Sanofi-Aventis

On 12/20/09, Chattem announced that it was being acquired by Sanofi-Aventis for $93.50 per share in cash.  The transaction closed last week.  This price translates to multiples of about 4.6x revenues, 17x peak operating income, and 27x peak EPS (see table below).

Chattem, while much larger than CCA, has a somewhat similar range of products and sells through similar channels.  Hence its acquisition provides a convenient benchmark to estimate what a strategic buyer could be willing to pay in the current environment.

It would be overly optimistic to hope that CCA is acquired for anything approaching 4.6x sales.  In fact, Ira Berman, who is Chairman, has long said that he would consider selling the company for 1.5x sales plus cash.  Today that translates to about $14.65 per share, a premium of 170% over the current stock price.  But it's nice to fantasize about selling the company for a higher multiple of sales.

Operating income (which excludes interest and dividend income) was $8.3 million in 2006, $8.8 million in 2007, $2.0 million in 2008, and should be about $5 million for the year ended November 2009.  2008 was likely an aberration because of the recession.  If we assume that the current earning power is $5 million, 17x that number will give us a number similar to the 1.5x sales metric, once cash has been included.  A lower multiple, say 10x operating income, translates into a purchase price closer to $10 per share.

I don't know what an appropriate P/E multiple is in a buyout, but 27x seems like a high number.  The current EPS run rate is probably about $0.45 to $0.50 (excluding interest income).  A multiple of 15x in a sale again gives us a price of about $10 (after including cash).

Risks:

Poor performance by company for an extended period.  Mitigating this is the strong balance sheet and the high dividend yield of 5.2% while we wait.

Catalyst

(1) Improved performance over time.

(2) Sale of company.