Description

I’m recommending YCC based on reasonable valuation of 15x next years earnings, continued 15% earnings growth, 48% ROE and continued share buybacks.

YCC generates its sales nearly equally from its 286 retail stores and 15,000 wholesale distribution outlets, with big box retailers BBBY and LIN the two biggest. Additional sales are from the company’s internet site and catalog distributions. Margins are impressive in this business, with gross margins of 58% and EBITDA margins closing on 29% for this year, resulting in an 48% ROE.

Earnings Growth Potential: I believe the company has sustainable 14-15% EPS growth potential from a combination of an incremental 45 stores at retail per year, 10% wholesale growth, and mid single digit retail growth (1-2% comp + new stores). Additional wholesale expansion should add 600-700 locations per year. Incremental SG&A leverage should add 20-30 basis point margin expansion per year. The candle category is growing at 3-5% annually, and the company’s launch into other areas including new candle lines and diffusers enlarges YCC’s potential addressable retail market to $2.5B from $1.5B currently. Shares trade at 17.7x and 15.4x 2004 and 2005 EPS estimates.

Competitors:
Illuminations – approx. $100 M in annual sales. Filed for Ch. 11
Blythe – Less focused on the premium candle market
White Barn (Limited Brands) – Sold in Bath and Body Works at a higher price point than YCC. White Barn tends to have a greater discounting policy relative to YCC.

Deferred Tax Asset: YCC has a $100M deferred tax asset on the balance sheet from the co’s 1998 recapitalization, which provides an annual $11.7M cash tax shield through 2013.

Share Repurchase Plan: With minimal annual capex of approximately $25M, the company is expected to generate more than $100 M of free cash flow this year (weighted towards the 4th quarter). In February 04, the company authorized a $100M share repurchase plan, and purchased $22M (800K of shares) in 1Q. Debt to capital is expected to remain at approximately 50%, which is helping its ROE to stay around 48%

Risks:
• Continued risk of multiple contraction due to sluggish same store sales. Operating margins continue to be impressive despite weakness in SSS. The company is working on initiatives to drive sales, but it might be several quarters before we begin to see improved comps.
• Essentially viewed as a one product company. The company is focusing on diversification into “candle accessories” but premium candles still represent 74% of sales. The company has multiple distribution sources through both retail and wholesale. Highly discretionary and focused on gift giving.

Background: The Yankee Candle Company, Inc. is a designer, manufacturer and branded marketer of scented candles. YCC is vertically integrated, and manufactures 76% of the candles that it sells. The company is the leading player in the $1.5B premium candle category, with approximately a 36% market share. The Company's products are available in approximately 180 fragrances and include a variety of jar candles, Samplers votive candles, Tarts wax potpourri, pillars and other candle products, all marketed under the Yankee Candle brand. Yankee Candle also sells a range of coordinated candle and home decor accessories and branded fragranced non-candle products including, Yankee Candle Car Jars air fresheners and Yankee Candle Bath personal care products. The Company has also extended its brand into the home fragrance market with products such as Housewarmer electric home fragrancers and Yankee Candle branded potpourri, sachets, room sprays and linen sprays.

Catalyst

Continued 15% earnings growth, and continued share buybacks