Description
How would you like to buy a company that is growing revenues in the high teens while growing income at about twice that rate? Interested? What if I told you that it came with a shareholder friendly management and high returns on equity? Now, here’s the kicker, it can be had for 6 times next year’s earnings. Welcome to the world of micro-cap investing and all the pricing inefficiencies associated with it.
A variety of one-time events have hidden the true operational performance of this company. Furthermore, events over the next year will lead to significant earnings growth that outpaces any sales growth.
YoCream International, Inc. manufactures, markets and sells frozen yogurt, sorbet, frozen custard, smoothie and ice cream products in a variety of low-fat and non-fat flavors in either non-organic or organic formulations. These products are sold to a variety of businesses and outlets, including convenience stores, restaurants, hospitals, school districts, food distributors, military installations, yogurt shops, fast food chains, discount club warehouses, business and industry locations, as well as other types of outlets.
If you look at the past few years, at first you will see very uninspiring numbers. In reality, a number of one-time events have slowly whittled away margins even while revenues have doubled over the past 5 years and tripled over the past 8. I am normally suspicious of companies which cite one time events, but you can judge for yourself.
In 2001, severe storms destroyed much of the world vanilla crop. Prices went up 10-fold, yet the company was obligated to continue using natural vanilla extracts. This severely dented gross margins. Since then, the company has begun to use artificial vanilla in most cases, or modified contracts to allow cost increases to be passed on.
In 2003, the company began supplying military bases only to have the entire standing army relocate to Iraq. The company was expecting 1.3-1.5m in revenue. Instead, the number will likely come in around 700k, yet the costs of distribution have not been absorbed as well and hence lower margins. Eventually our troops will return to bases in the US (even if they invade every country in the Middle East first).
Securing and upgrading the very significant Dannon partnership involved quite a bit of legal input. This cost the company a reasonable 300k or so over 2001-2003, yet for such a small company, this was a significant expense. This will not be recurring in future years in the same magnitude, yet the benefits will be growing annually. Dannon has already introduced the company to numerous large contracts (including the key military ones) and will likely continue to do so.
Finally, two years ago Costco demanded that the company ship its product using Aseptic packaging. At the time, the company did not possess the machinery and was forced to create product, ship it to a packaging plant and then ship it out. This led to multiple shipping and handling costs including the costs of having another company package the product. The result was that the company essentially lost a little money on a very large portion of its production. The company felt that the Costco contract was significant enough that they should continue with it until they could fix the problem. As you will see, this will no longer be a problem and will almost certainly be a catalyst for future growth.
I think that you can see that barring these four events; earnings would have been much stronger. In the future, they will be.
The main issue here is the aseptic line of packaging. The company spent $2.5 million building this over a two-year period. For those of you who are unfamiliar with the term, aseptic manufacturing and packaging produces shelf stable products that do not require refrigeration for shipping or storage. This will serve two purposes for the company. In the near term, this will allow YOCREAM to produce the Costco products in-house at near traditional gross margins of 30%. This is only slightly lower than the company’s other products. This will significantly raise 2004 margins and EPS, as they currently have to farm this out at a slight loss.
Looking forward, the aseptic line will be a significant growth driver and will help differentiate the company from others. For instance, it will likely expand the current military relationship. Aseptically packaged yogurt can be stored in hot Iraqi warehouses or aboard ships where refrigerated space is at a premium. It has already generated some interest from the Air Force, which sees it as a strong morale booster.
I think that this new product line will continue to generate interest from current customers and likely bring in new customers who have storage issues or irregular usage patterns like sports arenas.
Keep in mind that any additional revenue will have a disproportionately strong impact on margins and the bottom line since the company has already spent heavily on infrastructure and the added SG&A will get spread out over a larger revenue base.
Here are earnings for 2000-2005. 2003-2005 are estimates. All number in millions except per share numbers.
00 01 02 03(e) 04(e) 05(e)
Revenue 14.93 15.62 19.44 21.01 24.41 29.13
Gross 4.75 4.59 5.49 5.83 7.57 9.32
Gross % 31.82% 29.39% 28.24% 27.75% 31% 32%
SGA 3.21 3.47 3.94 4.6 4.6 4.9
SGA% 21.5% 22.22% 20.27% 21.89% 18.84% 16.82%
OPP Profit 1.54 1.13 1.4 1.07 2.97 4.42
EBITDA 1.92 1.71 2.01 1.58 3.77 5.32
Taxes 0.55 0.27 0.51 0.35 1.08 1.62
Tax Rate 35.03% 26.47% 37.23% 37% 37% 37%
Income 1.02 0.75 0.86 0.59 1.85 2.76
EPS 0.45 0.33 0.38 0.26 0.81 1.22
How I arrive at 2003 numbers is unimportant and they should be released any day now. Let me walk you through 2004 and 2005.
For 2004 revenues, I take the 2003 number and add 5% organic growth (a bit slower than in past years). To this I add 1m for the new Premier contract, as this is the midpoint of management estimates of 800k-1.2m. I have added 700k for the military sales that were missed on account of the Iraq war and some recent military contract wins. I am also adding 650k, which accounts for some other small contract wins (this is the low end of a management estimate).
For 2005 revenues, I take 2004 and add 5% organic growth and 3m in a new unnamed contract that should be fully ramped up by then (estimates of 2-4m). This does not include any other contract wins (which are quite probable).
The real earnings increase will come from higher margins on the Costco business, as the aseptic line will now be in- house. Margins on this will be in line with the company’s other products at around 31%. I am assuming that revenue growth will create economies of scale and am estimating 32% gross in 2005.
SG&A should stay pretty much constant or possibly drop because of lower legal costs and lower costs associated with installing the aseptic line and other expansion efforts over the past two years. I think I have been conservative with both numbers, even with higher rental costs from recent warehouse expansions.
The tax rate should remain at 37% and I am using 2.26m shares as the basic weighted share number for 2004 and 2005.
I think that these numbers are very conservative. As you can see, once the aseptic line beings showing up at the bottom line, you have a very fast growth company that sells at six times the ’04 number and four times the ’05 estimate.
I think that you should know how a typical long-term contract cycle works as it is necessary for interpreting the numbers. A company salesman spends money visiting a company and is then paid a commission for any completed long-term contract. Then a legal team draws up terms for pricing, delivery, etc. Next, a package is designed and/ or custom flavors created. Finally, delivery must be organized which takes money. These are all upfront costs that are expensed. If you were to amortize these costs over the life of a contract, earnings in the first year of the contract would be much higher. For the company, this means that growth is expensive at first and has a negative impact on EPS. Keep that in mind when looking at these numbers.
I had the pleasure to visit the facilities last month and was very impressed. Not a cent is wasted anywhere. The Hannas’ treat it like a private company, which is natural since insiders own 41% of it. Salaries are fair and option issuance is reasonable.
On a final note, the company trades only slightly above book value with only a hint of debt. This provides a nice cushion in case I am wrong.
With any situation, there are a few negatives.
This is one small company and the float makes it not ideal for everyone.
Family businesses have a bad history for frauds. There are quite a few Hannas’ involved. Let me tell you that I was there and they do indeed make yogurt. There was nothing that would lead me to ever believe that anything dishonest was going on.
Customers are very concentrated, but the company is working to spread the customer base.
The founders are getting older and may eventually loose interest or become less involved. David Hanna has already retired.
Annual yogurt consumption has fallen for a number of years, though this looks to be leveling off.
Disclosure: Long
Catalyst
Increased margins from the newly completed aseptic line.
Recent contract wins that should ramp up in a few months.