Escalade (ESCA)

We view ESCA as a compelling value investment opportunity.  It is misunderstood, cheap and has significant insider ownership.  It is a small-cap stock with no Wall Street coverage, under-utilized balance sheet and an attractive dividend yield.  It is currently undergoing a strategic review and will be divesting a non-core business to focus on its high margin core sporting goods segment.  We are long ESCA.  The stock has doubled in the last twelve months.  We think the stock can double again in the next three years.

Background: 

Escalade is based in Evansville, Indiana and was founded in 1927.  ESCA operates in two segments: (1) Sporting Goods (81% of sales), and (2) Information Security and Print Finishing (19%). 

Sporting Goods:  The Sporting Goods business manufactures and distributes highly recognizable, respected and marketable products such as archery bows, basketball backboards, outdoor children play sets, pool tables, pool cues, darts, and table tennis tables.  The company maintains a high market share in the majority of its product categories.  The common thread to the sporting goods niche is top quality product in each segment.  Management has done an impressive job growing sales at a 15% CAGR over the past three years in the sporting business. If you participate in any of the below niche activities (“sports”), we are guessing you have heard of the brand.

Product Segment                    Brand Names

Archery                                   Bear Archery, Trophy Ridge, Whisker Biscuit, Cajun Archery

Table Tennis                           STIGA, Ping-Pong, Prince, Head

Basketball Backboards           Goalrilla, Goaliath, Silverback

Play Systems                          Woodplay, Childlife

Fitness                                     The STEP, USWeight

Game Tables                          Harvard Game, Atomic, Accudart, Redline

Pool Table Accessories          Mosconi, Mizerak, Minnesota Fats

Darting                                                Unicorn, Accudart, Arachnid, Nodor, Winmau

Information Security and Print:  The non-core office supply business includes shredders, paper folders, letter openers, paper cutters, and other small office items.  It operates under the Martin Yale and Intimus brands.  The office business can be characterized as a business in secular decline. Sales have declined 18% in the past two years and are likely to fall going forward.  When ESCA filed their most recent 10K, the company announced they were undergoing a strategic review of this business. We think this divestiture will be the catalyst for the stock to appreciate further as the economics of the sporting goods become more apparent.

Table 1

Office business masking an attractive underlying business

ESCA has generated approximately 10% sales growth over the past several years.  However, underlying growth in ESCA’s core business, sporting goods, has ranged in the mid-to-high teens. Consolidated sales have been significantly weighed down by poor results in the office business.  As we show in the table below, the office business has been in a decline for over the past five years. In addition, profitability has eroded. The office business was a ($0.20) earnings drag to ESCA’s 2013 reported earnings of 72c.    

Table 2

We think management is prepared to enhance shareholder value through a divestiture of the office businesses which will allow management to focus solely on growing the attractive sporting goods business. A sale of the office business would be a significant catalyst for the stock as it would transform ESCA into a sporting good pure play with double-digit sales growth.

ESCA’s has an attractive, niche sporting goods business

ESCA’s sporting goods business has a very diverse set of products.  Its product segments include: table tennis, pool tables/accessories, basketball backboards and goals, hockey/soccer game tables, archery products, fitness items, and outdoor play houses.  Management’s focus is on operating in niche sporting goods categories where they have high market share.  Given the niche product categories ESCA operates in, many outsiders may not be aware of their strong brand portfolio.  However, virtually all of the company’s brands are well known in their respected product category and can be found having shelf and floor space in retailers such as Dicks and Cabela’s. ESCA’s key brands include Goalrilla basketball hoops, Bear Archery, Trophy Ridge products, Woodplay play sets, Mizerak pool products.

The sporting goods business has transformed itself post the loss of the Sears business.  In 2006, Sears represented approximately 26% of the segment’s sales.  By the end of 2009, ESCA’s derived no sales from Sears.  ESCA was a provider to Sears for over 30 years; however, in 2008 the company was unable to negotiate satisfactory terms for continued sales of table tennis and billiard tables, which represented approximately 50% of total sales to Sears in 2007.  As shown in Table 3, ESCA’s sporting goods business has experienced very strong sales growth over the past four years as the Sears’ business is no longer a headwind.  Also, ESCA has been able to gain market share in many of its categories and gain distribution with retailers.  ESCA growth has mirrored its retail partners such as Dick’s, Cabela’s and Academy Sports.  Sales have grown over 15% in the past two years and operating momentum is expected to continue going forward. A key contribution to the sales growth has been driven by ESCA benefiting from the growth at Dicks combined with new products in areas such as archery that is driving incremental market share gains. In addition, ESCA’s has been able to generate leverage on accelerated sales growth. Margins have more than doubled since 2006 as shown in Table 4.

Table 3

 Table 4

We see upside in the stock given the attractive valuation

Consolidated sales and earnings understate the attractiveness of ESCA’s sporting good business.  ESCA currently trades at 17x p/e 2013 earnings of 72c.  However, we believe this valuation is misleading considering the 20c earnings loss associated with the office business.  Earnings for 2013, excluding the office business, of 92c implies a valuation 13.5x p/e and a 2.9% dividend yield.  We think this valuation is attractive considering the company’s 10%-plus sales growth and improving margin profile.  We estimate ESCA earnings excluding the office segment should grow to at least $1.05-$1.10 in 2014. If we assume a 15x-16x p/e  on earnings ex office, we derive a value of $16-$17 per share (excluding any value from the office business).   

The sale of the office business is an important catalyst that should drive a re-rating of ESCA’s multiple as it will enable investors to focus solely on ESCA’s attractive sporting goods business.  We believe management is focused on monetizing the office business and potentially using cash proceeds from a sale along with higher leverage to engage in value enhancing acquisitions which could potentially drive shares substantially higher.  We conservatively estimate the office business could be sold for between $15mn to $20mn, which is roughly 0.5x to 0.7x 2013 sales. Post a potential sale of the office business, ESCA generates $20mn in EBITDA.  Assuming leverage of 3x (the company has indicated that level to us), we estimate management has $60mn+ in funding capacity for acquisitions. If we assume ESCA uses $60mn for acquisitions (transaction ~1x sales, 7% funding cost), and ESCA acquires a business with a similar margin structure – we estimate approximately 35c in potential annualized accretion.

We think core sporting goods earnings can grow 15% over the next few years driven by market share gains, new products, and increased distribution. In discussions with management, they see low hanging fruit via product extensions in archery and outdoor gaming. Sporting goods earnings growth combined with the sale of the office business and the use of higher leverage to do accretive deals should drive at least $1.50 in earnings 2-3 years out. Assuming a 15x-16x p/e, we believe share could double while getting a 3% dividend along the way. 

Management and Insider Ownership:

Directors and executive officers along with family and friends own roughly 35% of shares outstanding. Robert Griffin, is the Chairman of the Board and was CEO of the company from 1976 to 1999. He is largely credited for the success of the company in the previous decades as he grew the company organically and through accretive acquisitions in niche sporting goods categories. His son, Patrick Griffin, currently works at the company and sits on the board. Collectively, Robert and Patrick own approximately 21% of the company’s shares. Robert Keller is the current CEO. He joined ESCA as CEO in 2007 after jobs at Kennametal, Russell Corporation, and Coca-Cola. Keller can be credited for improving the company’s sporting goods growth profile through a push into new products, a more aggressive effort to gain distribution, and bolt-on acquisitions over the past several years.

Risk:

Weaker consumer spending in the US

Dicks and Sports Authority concentration