Description

SLGD is a $15.7mm market cap company that owns, manufactures, and distributes Scott’s Liquid Gold wood cleaner (26% of gross profit) and distributes other consumer products with Batiste dry shampoo being the largest, (74% of gross profit). Upside in SLGD shares come from (1) an attractive valuation at 2.6x NTM EV/EBIT and 7.1x P/E (2) FCF generation of $0.21/share annually which increases fair value even if earnings are flat (3) sales growth which has been over 20% in the last couple years (4) operating margins which have expanded from -3% in 2012 to 10.8% in 2Q15 and may continue to expand (large consumer products earn 20% EBIT margins). Fair value is $2.50 based on 6.0x NTM EV/EBIT and 12x NTM P/E.

SLGD faced pressure from an activist named Tim Stabosz in 2013, and after defeating the activist in a proxy fight because management and employees own ~45% of shares, began running the business like a company rather than a country club. Management sold a $10mm investment property and repaid the associated mortgage in 1Q13 which marked the start of the turnaround. Sales growth has been around 20% annually since the turnaround started and management has controlled costs causing operating margin to expanding from -3% in 2012 to 10.8% in 2Q15. The growth in sales has been driven primarily by sales growth in Batiste dry shampoo which they distribute in the US for Church and Dwight. However, shares are undervalued even with no incremental growth. The dry shampoo category has been a fast grower and reviews indicate the Batiste is one of the top three dry shampoo products on the market. SLGD’s other big product is Scott’s Liquid Gold wood cleaner which they own the brand and do their own distribution to Walmart, Walgreens, and other retailers, in addition to selling direct to consumer.

SLGD will earn $4.1mm in EBIT and $0.21 of EPS (fully taxed at 35%) in the next 12 months and that earnings power is sustained at least at that level going forward. Sales have grown 20% in the last couple years and were +27% in 1Q15 and 2Q15. The company is well capitalized with $6.8mm of cash and no debt. FCF tracks net income over a 1-yr period but swings quarter-to-quarter from working capital movements – Walmart, Walgreens, and Ulta are big customers so they dictate the accounts receivable payment terms which typically include big cash collection in 4Q and less in the other quarters.

The business is worth at least 6.0x EV/EBIT or $31.4mm which is $2.50/share, giving 70% upside. Alternatively, SLGD can be valued at 12x P/E on $0.21 of fully taxed EPS which also puts fair value at $2.50. Valuing on P/E does not give credit for SLGD’s $0.57/share of net cash. 6x EV/EBIT and 12x P/E are reasonable multiples if we assume no growth going forward, but one could argue for a higher valuation given larger, slower growth staples typically trade 18-20x P/E and 14-16x EV/EBIT; though, SLGD’s distribution part of the business is likely a lower multiple than large staples companies. An alternative measure, SLGD’s book value is $1.11 which is primarily current assets so is a reasonable estimate of liquidation value.

SLGD entered a distribution agreement in 2009 with Batiste which was a private company at the time and introduced the dry shampoo product in the US in 4Q09 through SLGD’s distribution channels. Church & Dwight acquired Batiste in 2011 and the original distribution agreement remained in place through December 31^st, 2014. SLGD signed a new distribution agreement with Church & Dwight in September 2014 which grants SLGD exclusive distribution in the specialty retailer channel which includes primarily beauty supply stores, such as Ulta, SLGD’s largest customer, apparel retailers, department stores, hair salons and distributors to hair salons from January 1^st, 2015 until December 31^st, 2016 and automatically renews for successive one-year terms until terminated by either party. Church & Dwight retained the rights to sell Batiste products to the remainder of the market in the United States.

Going into 1Q15, it was unclear how much the renegotiated contract with Church and Dwight would impact sales of Batiste which was SLGD’s fastest growing product. According to the original agreement, SLGD had exclusive distribution for all of the US, but under the new agreement, CHD retained the distribution rights to retailers outside of specialty retail. The impact was much less than feared. Batiste segment sales fell from $5.0mm to $4.5mm from 4Q14 to 1Q15 ($4.6mm in 2Q15) but were still up 40% y/y. The potential bright spot from CHD distributing to non-specialty retailers in the US is that CHD has a much larger marketing budget than SLGD so could drive a further acceleration in US sales across all channels.

1Q CHD Earnings Call – calling out growth in Batiste

<A - James R. Craigie>: Lauren, I want to add too that we have some, Matt said local brands, some of them have

travelled in various markets. Two brands in particular, Batiste, which is a dry shampoo business we bought a few years ago, is growing like fire right now.

The biggest risk is that CHD decides to change the distribution agreement with SLGD which is up for renewal on Dec 31^st, 2016. Batiste may get as much as 60% of sales, and is lower gross margin so as much as 50% of operating income. SLGD just resigned the new agreement in Sept 2014 which indicates that SLGD is bringing value to the relationship. Notably, in resigning the agreement, SLGD very little sales so it may be that CHD wanted to more aggressively market into channels which SLGD does not have much penetration (outside of specialty retail). Another risk is that the CEO controls the company, owning 25%, so as a minority shareholder, your fortunes rest with his ability and willingness to operate the business well and allocate capital. The activist investor in 2013 published several problems with the CEO including overpaying himself with a $600k salary, a board that lacks power to confront him, and annual operating losses (at the time) since 2002. The turnaround has been impressive thus far. So far, the company has piled up cash and it is not clear how the CEO will allocate capital. He was on the record saying he would sell for $100mm when the activist was involved.

Catalyst

Continued revenue growth and recognition that stock is undervalued.