Description

Dorel has benefitted from exceptionally strong demand for bicycles and furniture as a result of COVID-19 while continuing to trade at deep-value metrics including 3.7x EV/EBITDA and a 25% levered FCF yield.

Dorel Industries Inc. (DII.B)

Current Price: C$14.39 / Target Price: C$25.87

As of October 30, 2020 

Summary: Dorel Industries Inc. (“Dorel”, “DII-B”, or the “Company”) manufactures and sells bicycles, home products, and juvenile products under the Dorel Sports, Dorel Home, and Dorel Juvenile segments.  Dorel Sports sells bicycles, electric bikes, bicycle trailers, and related parts and accessories.  Dorel Home sells a wide variety of ready-to-assemble furniture for home and office use as well as folding furniture, mattresses, hand trucks, ladders, and outdoor furniture.  Dorel Juvenile sells car seats, strollers, high-chairs, playpens, and infant health and safety aids.  Dorel has two classes of stock with Class “A” stock carrying ten votes per share and Class “B” stock carrying one vote per share.  The Class “A” stock is controlled by the Schwartz family who also hold most senior management positions within the Company.  Dorel is headquartered in Montreal, Canada and has 8,900 full-time employees.  The Company’s shares trade on the Toronto Stock Exchange under the ticker DII.B and on the U.S. over-the-counter market under the ticker DIIBF.  While listed in Canada, Dorel’s results are reported in U.S. dollars and all currency references in this report will be in U.S. dollars unless otherwise noted. 

 Investment Thesis: Our investment thesis for Dorel is based on the following:

-     Dorel is a market leader in each of its three segments with strong market share and powerful brands. 

-     Demand for bicycles has soared as a result of COVID-19, and we expect demand to remain strong. 

-     Demand for furniture has also been very strong, and Dorel has further benefitted from a shift to e-commerce sales.

-     New product introductions in the Company’s Juvenile segment should lead to improved profitability. 

-     Dorel has a large base of owned assets with sizeable manufacturing operations across the globe. 

-     Dorel is expected to utilize the free cash flow to repay debt with the possibility of later reinstituting the Company’s dividend. 

-     Dorel’s valuation metrics are attractive, Dorel is trading at 0.1 Price/Sales, 3.7x EV/EBITDA and at a levered FCF yield of 35%. 

Company Overview: Dorel was founded in Montreal, Canada in 1962 by Leo Schwartz as a small manufacturer and distributor of juvenile products.  Dorel expanded operations and by the early 1970’s had established a national sales network for its products.  Dorel went public in 1987 on the Montreal Exchange, and the Company’s common shares were listed on the Toronto Stock Exchange in 1990.  In 1998, Dorel expanded into the furniture industry with its purchase of Cosco, Inc., a manufacturer of children’s furniture, folding metal furniture, and step stools.  In 2004, Dorel expanded into the bicycle industry with the Company’s purchase of Pacific Cycle.  Dorel continued its expansion through both organic growth and acquisitions.  Today, Dorel generates over $2.6 billion in revenues, has 8,900 employees in 25 countries, and sells its products into over 100 countries.  Each of Dorel’s segments generates nearly $1 billion in annual revenues and has its own President and CEO.  The Schwartz family controls the Company through its holdings of the super-voting Class “A” stock and members of the Schwartz family hold most senior leadership positions within the Company. 

Following the Company’s initial entry into the furniture and bicycle markets, Dorel generated consistently strong results for a number of years.  Between 2008-2012, Dorel generated annual revenues over $2.5 billion and net income over $100 million.  In 2013 and 2014, Dorel embarked on a series of international acquisitions that overextended the Company and left it with an excessive level of debt.  Operating results deteriorated over the next few years as poor execution, stiffer competition, and higher interest expense negatively impacted performance.  Dorel’s results suffered further in 2018 after key customer Toys “R” Us declared bankruptcy, leading to increased bad debt expense, lower sales, and excess inventory.  In 2019, the U.S. implemented additional tariffs on Chinese imports of bicycles and furniture, stressing the Company’s supply chain.  Dorel raised prices to offset the tariff impact, but this resulted in lower sales and gross profit dollars.  Dorel’s financial struggles forced the Company to renegotiate terms on the Company’s outstanding debt balance several times in 2019.  To preserve liquidity, Dorel cut the Company’s $0.30 quarterly dividend to $0.15 in April 2019 and eliminated its dividend entirely in September 2019. 

Dorel’s financial prospects have improved dramatically as a result of the COVID-19 pandemic.  Demand for the Company’s bicycles and furniture soared, resulting in improved sales, higher margins, and lower inventories.  The improved results have allowed the Company to generate significant free cash flow, which Dorel has utilized to reduce the Company’s net debt balance by almost $100 million in just the first half of 2020.  Dorel has committed to utilize excess cash flow to repay debt.  We expect this conservative approach will put the Company on firm financial footing and increase the likelihood that Dorel reinstates the Company’s dividend at some point in the future. 

Dorel Sports (LTM Revenues: $960 million, Adjusted EBITDA: $71 million): Dorel Sports manufactures and sells bicycles, electric bikes, bicycle trailers, and children’s electric cars.  Dorel entered the bicycle market in 2004 with the $311 million purchase of Pacific Cycle.  Pacific Cycle’s portfolio consisted of strong brands including Schwinn, Mongoose, GT, Roadmaster, and InStep.  At the time of the acquisition, Pacific Cycle generated annual revenues of $325 million and sold 5 million bikes, representing 27% of the total U.S. bicycle market and 44% of sales in the mass market.  Dorel continued to expand their bicycle operations through acquisitions including the purchase of Cannondale in 2008 ($202 million), PTI Sports in 2008, Iron Horse Bicycles in 2009, and Caloi in 2013.  Today, Dorel has a strong portfolio of well-known brands with a full product offering serving both the premium and mass markets.  Dorel competes in the U.S. and internationally with Huffy, Trek, Specialized, Accell, Dynacraft, Giant, and Kent.   

Dorel serves the mass bicycle market in the United States through the Company’s Pacific Cycle group with brands including Schwinn, Mongoose, and Roadmaster.  Dorel serves the premium bicycle market through the Cannondale and GT brands which are generally sold through Independent Bike Dealers.  Dorel also owns Caloi, the largest bicycle brand in Brazil.  Dorel sells bicycle trailers under the InStep and Schwinn brands and sells children’s electric cars under the KidTrax brand.  Geographically, approximately 65% of segment sales are from North America, 20% from Europe, 10% from Latin America, and 5% from other countries including Asia.  Dorel sources most of its products from Asia and has additional manufacturing and assembly capabilities in the Netherlands and Brazil.  Dorel sells its products to mass merchant retailers, e-commerce retailers, sporting goods chains, and Independent Bike Dealers. 

 The global retail market for bicycles is estimated to be nearly $50 billion.  Approximately 64% of sales originate in Asia-Pacific, 20% in Europe, and 12% in North America.  In the U.S., approximately 18 million bicycles are sold each year, a number that has been relatively constant since 2000.  The mass market represents approximately 75% of U.S. bicycle sales and is served through mass merchandisers, e-commerce, and sporting goods stores.  Independent Bike Dealers represent a smaller portion of the market and generally sell premium branded products.  In the United States, almost all bicycles are imported from abroad, with most imports originating in China or Southeast Asia.  Dorel Sports has historically generated annual revenues between $800 million-$1.0 billion and adjusted EBITDA of $50-75 million.  Operating margins that previously ranged between 7-8% have declined to low single digits in recent years as international expansion has proven to be more challenging than anticipated.  During the fourth quarter of 2019, Dorel Sports initiated restructuring activities in order to better integrate the segment’s global operations.  Among the initiatives, Dorel Sports is centralizing the Company’s European CSG operations in the Netherlands, closing excess facilities, and consolidating the Company’s Latin American operations. 

The COVID-19 pandemic caused demand for bicycles to spike as people looked for opportunities to exercise outside and commuters sought alternatives to public transportation.  Bicycle stores were deemed to be essential in the United States and bicycle sales took off.  Disruptions in foreign manufacturing caused bicycle imports to fall sharply in February, March, and April, causing bicycle inventories to decline just as demand was increasing.  Strong demand for bicycles has continued throughout 2020, with the NPD Group estimating that retail bicycles sales rose 112% in April, 61% in May, and 63% in June. Bicycle imports have increased substantially in the last few months but have not kept up with demand.  According to PeopleForBikes, wholesale inventory units for Independent Bike Dealers have declined from 600,000 bikes in August 2019 to just 81,000 bikes at the end August 2020.  We expect demand for bicycles will remain strong as social distancing efforts continue and bicycles prove to be a popular gift for the holidays.  Additionally, we expect both retailers and wholesalers will look to replenish inventories, which should provide a further boost to bicycle manufacturers.  While we do not expect bicycle sales to remain at current levels well into the future, we do expect long-term demand for bicycles to increase as cities and municipalities build infrastructure to facilitate the use of bicycles. 

Through Q2 2020, results for Dorel Sports have been positively impacted by the COVID-19 pandemic.  Q2 2020 segment revenues for Dorel rose 43% in Europe and 19% in the United States as demand for bicycles boomed.  These sharp increases more than offset soft Latin American sales, which were down 33% due to bicycle store closures across many Latin American countries.  We expect segment sales and profitability to remain strong through the remainder of 2020 and into 2021 as demand for bicycles remains robust and stores reopen in Latin America.   Strong bicycle demand is also expected to improve gross margins, as price promotions are reduced, warehouse costs fall, and fixed costs are leveraged.  Historical results and our forecasts for the segment are provided below.  We forecast the segment to generate over $1 billion in revenues and over $100 million in Adjusted EBITDA in 2020. 

Dorel Home (LTM Revenues: $882 million, Adjusted EBITDA: $75 million): Dorel is a leading competitor in the $105 billion furniture and mattress industry.  Dorel is one of the top five North American manufacturers and marketers of furniture and is the second largest manufacturer of ready-to-assemble furniture in North America.  Dorel entered the furniture market in 1988 with the purchase of Cosco Inc.  Dorel has expanded operations over time both organically and through a number of acquisitions including Charleswood Corporation (1990), Carol Ann Furniture (1993), Ameriwood Industries (1998), Okla Homer Smith (1998), Carina Furniture Industries (2003), Alphason (2018), and Canbest Marketing (2019). 

Dorel Home consists of four operating divisions, Ameriwood Home, Cosco Home & Office, DHP Furniture, and Dorel Home Europe.  Ameriwood specialized in the domestically manufactured ready-to-assemble furniture and is headquartered in Wright City, Missouri with additional manufacturing and distribution facilities in Ohio, Georgia, Michigan, and Ontario.  Ameriwood also operates an import division called Alta Furniture which focuses on the home entertainment and home office categories.  Cosco Home & Office is located in Columbus, Indiana and specializes in the design and manufacture of folding furniture, step stools, hand trucks, ladders, and outdoor furniture.  DHP is based in Montreal and is a leading manufacturer and importer of futons, mattresses, and bedroom furniture.  Dorel Home Europe is based in the United Kingdom and designs furniture in the home office and audio-visual categories. 

The segment’s products are sold to internet retailers including Wayfair and Amazon, mass merchants including Wal-Mart and Target, warehouse clubs, home centers, and office superstores.  Dorel Home has a strong e-commerce platform, with 62% of 2019 sales generated through internet retailers.  Dorel competes with Sauder Manufacturing and Whalen Furniture in the ready-to-assemble category, Meco in the folding furniture category, Tricam in step stools, Werner in ladders, and Zinus in mattresses.  

Demand for home furnishings has increased substantially as a result of the COVID-19 pandemic as stay-at-home workers have refurbished home offices and homeowners invested money in their homes that was previously spent on travel and leisure activities.  E-commerce sales have been exceptionally strong, as many bricks and mortar retailers were forced to close in the spring and many customers remain hesitant about shopping in stores.  Wayfair (one of Dorel’s largest customers) has generated exceptionally strong results, with U.S. revenues rising +19.1% in Q1 and +82.5% in Q2.  Revenues at physical locations have rebounded after stores re-opened, with the Commerce Department reporting a 7.5% increase in September retail sales for the Furniture and Home Furnishings market.  We expect Dorel Home’s financial results will continue to benefit from strong industry demand, with revenues and profitability remaining strong through 2020 and into 2021.  Historical results and our forecasts for Dorel Home are provided below.  We expect Dorel Home to generate $934 million in sales and $85 million in Adjusted EBITDA in 2020. 

Dorel Juvenile (LTM Revenues: $804 million, Adjusted EBITDA: $64 million): Dorel Juvenile manufactures and distributes juvenile products including infant car seats, strollers, high-chairs, playpens, swings, and developmental toys.  Dorel Juvenile is one of the largest juvenile product companies in the world with a strong brand portfolio including Maxi-Cosi, Quinny, and Tiny Love.  Dorel Juvenile also has a strong collection of regional brands including Safety 1st, Bebe Confort, Cosco, Mother’s Choice, and Infanti.  Dorel enjoys strong market share in each of their markets and competes internationally with Graco (Newell Brands), Evenflo (Goodbaby International), Uppababy, Chicco, and Britax.  

Dorel Juvenile’s U.S. operations are headquartered in Foxboro, Massachusetts with manufacturing and warehousing operations located in Columbus, Indiana and additional distribution facilities in California and Toronto.  In North America, the segment competes principally under the Maxi-Cosi brand name and distributes its products through mass merchants, Internet retailers, and department stores along with smaller boutiques and specialty stores.  In Europe, Dorel is a market leader with strong brands including Maxi-Cosi, Quinny, Safety 1st, Tiny Love, and Bebe Confort.  Products are marketed at mid-level to high-end price points and distributed through specialty chains, Internet retailers, and independent boutiques.  The segment’s European head office is located in the Netherlands with additional facilities in France and Portugal.  Dorel Juvenile also has a strong presence in Latin America with operating locations in Brazil, Chile, Peru, and Mexico.  Dorel Juvenile Brazil is one of the largest juvenile product companies in the country and Dorel Juvenile Chile operates 90 retail locations in Chile and Peru that feature Dorel’s Infanti brand.  In Asia, Dorel serves the Chines market under the Maxi-Cosi and Safety 1st brands and also owns and operates two manufacturing facilities in China that supply all Dorel divisions along with third-party customers outside of China.  Dorel operates in Australia and New Zealand under the Mother’s Choice brand. 

In Q1 2019, Dorel Juvenile initiated a restructuring program to simplify the organization and optimize the global footprint.  In Europe, Dorel Juvenile streamlined operations in order to reduce costs and incorporate new technology.  In Latin America, distribution locations were closed, and operations were consolidated.  In Asia, unprofitable operations were exited, and the sales organization was reoriented to sell directly to the consumer.  Additionally, Dorel introduced a series of new innovative products in late 2019 including an award-winning infant carrier and a new rotating car seat that have been well-received. 

Operating results for Dorel Juvenile have been negatively impacted by the COVID-19 pandemic, as many retail stores devoted to baby or juvenile products were closed and stay-at-home customers reduced spending on car seats.  Importantly, Dorel expects that many of these purchases were deferred and not cancelled and expects pent-up demand to improve sales through the remainder of 2020.  Historical results and our forecasts for Dorel Juvenile are provided below.  In 2020, we forecast the segment to generate revenues of $805 million and Adjusted EBITDA of $71 million. 

Management and Shareholder Base:  Dorel is led by descendants of founder Leo Schwartz.  Martin Schwartz (CEO) has led Dorel since 1992.  Martin co-founded Ridgewood Industries in 1969 and joined the Company when Dorel purchased Ridgewood in 1987.  Jeffrey Schwartz (CFO) previously led Dorel’s Juvenile segment and has been CFO since 2003.  Alan Schwartz (Executive VP of Operations) was also a co-founder of Ridgewood Industries and joined Dorel in 1987.  Jeffrey Segal (Executive VP of Sales and Marketing) is a brother-in-law of the Schwartz family and was also a co-founder of Ridgewood Industries.  Each Dorel segment has its own President and CEO.

Dorel has two classes, of shares, including 4.2 million Class A shares with ten votes and 28.3 million Class B shares with one vote.  Dorel’s senior management team most of the Class A shares and has effective control of the Company.  Other large shareholders include Letko, Brosseau & Associates, Brandes Investment Partners, Foyston Gordon & Payne, and Fidelity.  The current management team oversaw both the growth of the Company as well as the later decline in profitability and operating results.  While the family-control aspect of the Company could raise numerous issues, we expect the Company management was trouble by the decline in profitability that led to the discontinuation of the dividend.  Going forward, we expect the Company to prioritize repaying debt and reinstituting the dividend over pursuing additional acquisitions. 

Balance Sheet: Dorel has a solid balance sheet and ended Q2 2020 with $52 million in cash and $418 million in debt for a net debt balance of $366 million.  Dorel has a net working capital balance of $457 million which include $440 million in accounts receivable and $452 million in inventories that partially offset by $448 million in accounts payable.  Dorel has approximately $150 million in net property, plant, & equipment which includes the ownership of manufacturing facilities and distribution locations in the United States, Canada, Brazil, the Netherlands, and China. 

As of June 30, 2020, Dorel’s debt structure includes a $124 million revolver due in July 2021, a $112 million term loan due July 2021, and $127 million 7.5% senior unsecured notes due July 2024.  Dorel took a positive approach to liquidity at the onset of COVID-19, as Dorel drew on its revolver and increased its cash balance in March 2020.  During March, Dorel also renegotiated the covenants on the Company’s bank to facilitate additional borrowing and prepare for softer operating results.  Fortunately for Dorel, operating results in Q2 were much better-than-expected, as strong demand for bicycles and furniture buoyed results.  Dorel generated over $100 million free cash flow during the second quarter and repaid almost $100 million in net debt.  Dorel’s current net debt balance of $366 million is the lowest level the Company has had since 2012.  Over the last twelve months, Dorel generated adjusted EBITDA of $195 million, resulting in a Net Debt / Adjusted EBITDA ratio of 1.9x. 

Capital allocation: We expect Dorel will utilize future free cash flow to further reduce the Company’s debt balance and expect the Company to maintain a more conservative financial profile in future periods based on the liquidity concerns that arose at the onset of COVID-19.  Dorel historically paid an annual dividend of $1.20/share annual from 2013 through 2018 and had previously repurchased shares.  The dividend was cut in April 2019 and eliminated in September 2019 as the Company’s financial situation worsened.  While we expect Dorel to utilize free cash flow to reduce debt in the near-term, we expect the Company will look to reinitiate the dividend payment at some point in the future. 

Consolidated Projections and Discounted Cash Flow Valuation: We combined our projections for Dorel Sports, Dorel Home, and Dorel Juvenile with our forecast for $24 million annually in corporate expenses to forecast consolidated results for the Company.  Based on our forecasts, we expect Dorel to generate $2.8 billion in revenue and $246 million in adjusted EBITDA in 2020 and $2.7 billion in revenue and $218 million in adjusted EBITDA in 2021.  

We valued Dorel utilizing a discounted cash flow analysis.  We utilized our income statement forecasts combined with working capital and depreciation expectations to forecast operating cash flows.  We forecasted future capital expenditures at $45 million annually.  Following the implementation of new lease accounting in 2019, the Company’s rent expense is now split between depreciation expense and interest expenses, and we subtract the interest portion of lease expense from our free cash flow forecasts.  For our DCF analysis, we utilized a 12.5% discount rate and a 3% terminal growth rate to obtain a target enterprise value of $911 million.  We subtracted net debt of $366 million to obtain a target equity value of $546 million, or $19.28/share (C$25.68/share in Canadian dollars), representing 80% upside compared to the recent price of C$14.39.  In 2021, we forecast Dorel will generate $219 million in adjusted EBITDA and $80 million in free cash flow, resulting in a forward EV/EBITDA ratio of 3.3x and a leveraged free cash flow yield of 22.8%. 

Comparable Analysis: A comparable company analysis was also conducted to compare the valuation metrics for Dorel with other companies in the bicycle, furniture, and juvenile products industries.  Dorel’s valuation metrics including a 0.1x Price / Sales ratio and a 3.7x Enterprise Value / EBITDA ratio appear attractive both on an absolute basis and on a relative basis versus Dorel’s peer companies.  Additionally, if any of the Company’s individual segments were afforded the valuation metrics of their industry peers, we expect Dorel Sports, Dorel Home, and Dorel Juvenile could be worth the valuation currently being ascribed to the entire Company. 

Risks: There are several notable risks to the Company’s business that should be highlighted:

-     Dorel is controlled by the Schwartz family through their ownership of the majority of Class “A” stock. 

-   Dorel has a substantial amount of debt outstanding that could lead to financial distress if forecasted results do not materialize. 

-  The COVID-19 pandemic has increased demand for Dorel Sports and Dorel Home and the demand spike could prove temporary. 

-  An increase in COVID-19 cases could lead to additional store closures or disruptions to the Company’s supply chain. 

- Dorel manufactures and sells products designed for infants, toddlers, and children and the Company could be the target of product liability lawsuits. 

- Dorel operates as a multi-national company and is exposed to foreign currency fluctuations and country specific risks.

- Dorel has been acquisitive in the past and future acquisitions might not meet expectations and could increase financial leverage and liquidity risk. 

 Conclusion: Based on our DCF valuation, we derived a target equity valuation for the Company of $559 million or C$25.87/share, representing 80% upside compared to the recent price of C$14.39.  We expect strong demand within the Dorel Sports and Dorel Home segments to result in higher profitability and free cash flow at least through 2020 and into 2021.  Free cash flow will initially be utilized to reduce debt and could later be utilized to reinstate the Company’s dividend, which was consistent at $1.20/share for multiple years.  The Company’s strong global brands, multinational presence, and large base of owned manufacturing and distribution facilities provide a margin of safety if our forecasts prove overly optimistic. 

Disclosure:  This document is for investor informational purposes only.  This document does not constitute an offer to sell or a solicitation of an offer to buy.  The author may have a position in the securities mentioned and may add or exit these positions without notifying the reader. Although this document has been prepared from sources deemed reliable, no representations can be made as to its accuracy or completeness.  Past performance is not indicative of future results. 

Catalyst

Free cash flow generation, debt paydown, re-initiation of dividend policy