Description
Dac Technologies is a growth at a (very) reasonable price company, which is expanding into higher margin/higher price point products with a potential boost provided by congressional largesse.
Currently, Dac distributes products for gun owners and hunters. It sells gun cleaning equipment, gunlocks and gun safes (in order of revenue) along with a few other minor items. It contracts the production of these products out to Chinese firms, so in reality, the company is primarily a marketing and distribution enterprise. This shows up in the 31% ROA and 57% ROE the company has achieved over the past 12 months as the company has minimal overhead and need for investment outside of working capital.
While gun-cleaning kits may seem like a rather mundane business, Dac has many advantages that position it incredibly well against its competition. To sum up the business, guns are one of the most American products ever manufactured. While they may one-day outsource my job, guns will always be produced in this country. This prevailing attitude has extended to the production of gun accessories as well. This is where Dac, came along and said “You guys can make the guns, but we will make the same $130 gun cleaning kit in China for $6 and sell it for a 50% margin.” They then spoke with mass retailers like Wal-Mart who have trouble selling high priced kits. Wal-Mart can sell these cheapie kits by the thousands. Hence a business was born, and Dac has continued to branch out into equipment including gun safes and gun locks (more on that later).
Lets jump right into some numbers here. There are 6.193m shares outstanding with another 394,000 warrants priced at 2.57 that don’t expire until 2009. There are no stock options outstanding.
All numbers in millions except per share numbers
Q1 ’04 Q2’04 Q3 ’04 Q4’04 Q1 ’05 Q2 ’05
Revenue 1.34 1.62 2.10 4.30 2.26 2.26
Gross 0.54 0.62 0.82 1.51 0.80 0.81
SGA 0.35 0.42 0.47 0.66 0.49 0.48
Opp Inc 0.19 0.20 0.35 0.85 0.32 0.34
Tax 0.03 -0.02 0.12 0.26 0.11 0.12
Income 0.12 0.19 0.19 0.51 0.17 0.19
Inc Shr 0.02 0.03 0.03 0.08 0.03 0.03
6.193m shrs
In summary, for FY04, the company did $9.36m in revenue and $1.59m in income before tax. It must be mentioned that in 2004, the company benefited from prior NOLs that were used up during Q2.
Coming right from the most recent 10q,
“For the six months ended June 30, 2005, the Company’s net sales are up 53%, while operating expenses are up only 25% over the same period in the prior year. This has resulted in a 70% increase in income from operations and an 82% increase in income before taxes. This growth is on target for the Company to reach its anticipated (2nd half—they left these two crucial words out of the 10q but kept them in the press release) goals of $9 million to $11 million in sales and $0.23 to $0.26 earnings per share for the 2005 year.”
Clearly, this is a rapidly growing company where incremental sales growth can have a large impact upon a fixed cost structure. I think that management’s guidance is very much doable, especially in light of sales announced for the months of July (740k), August (1,114k) and September (1.339k), which is 3.193m in third quarter sales and puts sales for the first nine months at 7.713m vs. 5.09m for the first nine months of 2004. During the fourth quarter, we will see how revenues look for the critical deer-hunting season along with Christmas—rednecks give each other hunting toys. Assuming the company hits the middle of their guidance, the company should have about 14.5m in revenue and a corresponding increase in operating margins. After tax income is something of a wild card because the company used up all its NOLs last year.
For 2005, I assume 14.5m in revenue, 35% margin (last year was 37.2%), SGA is 18% of revenue (20.3% last year and we know that revenue is growing faster than SGA), interest of $150,000 (was $77,000 for first six months of year), finally, the company will pay federal and state taxes at a 38% rate. For 2006, I assumed that revenue grew by 30% and all other variables remained at 2005 levels except interest, which went up by $50,000.
2004 2005 YoY % increase 2006
Revenue 9.36 14.5 55% 18.85
Gross 3.49 5.075 45% 6.60
SGA 1.9 2.61 37% 3.393
Opp Inc 1.59 2.465 55% 2.67
Interest 0.19 0.15 -21% 0.20
Tax 0.39 0.88 126% 0.939
Net 1.01 1.435 42% 1.73
Net per share .16 .23 44% .28
I think you will agree that these are some conservative estimates, especially considering that revenues are tracking well ahead of plan over the past few months—we see them coming in at over 16 million. 2006 is just a conservative guess based on new products and talks with management. We see core business growing at about 10% before new products, and hence 18.85m implies less than 3m in new product sales, which we also think is very conservative. We also think the margin numbers are very conservative as the new products will have much higher margins.
As you can see, based on today’s share price, the stock is trading at about nine times 2005 earnings and less than eight times 2006 earnings. That seems like a decent bargain for a company with 30% top line growth, better bottom line growth and excellent returns on capital. There is an added kicker, which we have not put into the numbers.
On October 17th, Congress will debate S. 397 “The Protection of Lawful Commerce in Arms Act.” This law, “Reaffirms the basic principle that manufacturers of lawfully sold non-defective products should not be liable in the event of subsequent criminal misuse of these products over, which the manufacturer have no control.” The Democrats—never wanting to appear soft on guns—did add one interesting provision mandating that firearm dealers provide a “secure gun storage or safety device” with the sale of every handgun. This is where things can get interesting as this is almost assured of passing—and has already been passed in the senate by 65-31.
During 2004, the company sold $1.57m of gunlocks and 375k of gun safes. This number should grow to about 2.2m for 2005. Should this bill pass; it should add an additional 2-5 million in annual run rate sales. Dac currently sells these products mostly to Wal-Mart where the gross margin is around 25%. If independent arms dealers are forced to purchase trigger locks and safes, margins should increase to at least 30% and bring in an incremental 600k to 1,500k in gross margin and 303k to 763k in after-tax income, which will add between a nickel and twelve cents a share to earnings.
There is some uncertainty as to when this law will take effect and how much of a one time bulge is created as the channel is filled, so let’s just add this to 2006 earnings as if it were to begin on January first. This would give us an earnings range of 33c-40c. I think that a company like this should trade for 20-25 times earnings and that gives us a price target of $6.60 to $10.00. As I have said throughout this write-up, I think I am being rather conservative and have posted a conservative scenario. I personally see the company earning somewhere in the mid thirty cent range next year, and this is excluding any incremental gain from congressional legislation.
Lets face it, none of these products are real growth gems, but they do bring in steady cash flow. With additional penetration into the Wal-Mart system and other distributors, I think that the company can grow about 10% a year without any new products. For instance, in 2005, Dac did not have all of its models in all Wal-Mart stores and was not added to the core module until the middle of the year. For 2006, Dac is exploring the production of game cameras, additional food processing items and ATV accessories. To me, the most exciting of these products is in the ATV arena. These accessories are predominantly produced in this country and carry high margins. Dac should be able to produce these through their existing Chinese manufacturers at a much lower cost and then sell them directly into the Wal-Mart distribution system. Wal-Mart has already expressed a strong interest in these products. Most excitingly, these products carry much higher price points than gun cleaning kits and should be a boon for revenues and earnings.
I’d be derelict in not mentioning the symbiotic relationship between Dac and Wal-Mart. 55% of Dac’s revenues are to Wal-Mart, and they are on very good terms with the superstore. Wal-Mart seems rather excited to sell products that previously were only produced in this country—and hence too expensive for its core customer group. Naturally, the biggest risk is if Wal-Mart stopped purchasing from Dac as they are the majority of revenues. I personally do not see this happening, but it is always a possibility.
In the risk category, I should also mention that CEO David Collins runs the whole show here. Without him, there is no company. Sarbanes-Oxley is an added expense that the company has not determined the cost of. They do not think it will be too high however. I am not a gun owner or user. I have seen their products and compared them to those of the competition (Hoppes and Outters). I think that Dac makes a better-looking product at a better price point, but I cannot quantify this. We have given kits to a few gun owners and they seemed satisfied. It is an admittedly small sample set. Finally, my firm owns a half million shares, and I am obviously talking my book here.
Catalyst
Continued growth
Passage of S. 397