Description

Zindart Limited manufactures die-cast toys (cars, trucks, planes) and holiday ornaments. They also manufacture ‘pop-up’ books. For much of the last decade they earned near or above $1/share but have been unprofitable for the past year and the stock has fallen significantly. I believe that within the next few years ZNDT will once again be able to earn near $1/share, which makes the stock very attractive at the current price of $1.78.

Mattel and Hallmark are Zindart’s two largest customers. They mainly make things like replica cars (Mustangs, Corvettes, etc.), planes, and trucks. For Hallmark they make "Keepsake Ornaments." They also have a papers division that produces packaging products and pop-up books for children. I believe that most of the companies products have a lasting appeal and aren’t faddish products.

Many of the company’s competitors have been through comparably rough times recently. RACN and ACT are the two most notable examples and both have been coming out of their funk in the past year. ZNDT’s biggest problem (and most unprofitable division) is now the die-cast division. RACN bought out a large customer, Ertl, in ’99 and ZNDT has yet to really recover from the loss in sales. However, I think ZNDT can turn the corner and once again return to profitability.

Why I think ZNDT can turn the corner:

1) Corgi, their UK subsidiary, has shown decent growth in the past couple of years and is now their biggest revenue producer. In the latest quarter Corgi reversed the past year of losses and showed an operating profit. This is on top of increased advertising expenses to try to build a presence in the US market. Corgi is IMO their most promising division and the fact that it returned to profitability in a very tough quarter is encouraging.

2) The die-cast division is now the biggest drag on the business, but it may be turning around due to a couple of factors. In the latest earnings report management stated that orders should increase due to two new product introductions. Also, they recently hired a new president for the die-cast division, Richard Tong. Tong was previously CEO of Magician Industries where he turned it around from a big money loser into a profitable business. I think he can do the same at Zindart.

3) The paper division has actually been profitable so far this year although sales and margins have suffered. They’ve added some new packaging business and this should help to increase sales and margins. The paper division has a new president as well.

4) There isn’t much differentiation in this business. ZNDT is fairly similar to both RACN and ATN and if they can just do half as well as these two companies in terms of margins then they’ll be earning $0.55/share. Before the problems of the past couple of years ZNDT regularly had higher margins than both these companies.

5) In '99 they reported $12.2million in earnings on revenues that were lower than the current run rate. The industry dynamics haven't changed all that much since '99 so it should just be a matter of getting their cost structure back in line.

At $1.78/share ZNDT has an equity capitalization of $15.7million. They have net debt of $23.3million which gives an EV of $39million. Tangible book is $25.8million, or $2.92/share. The balance sheet is less than pristine with a current ratio of 1.06. Trailing sales are $124million and the price/sales is 0.13 so the stock is leveraged to any improvement in margins.

It should also be noted that last year they had $0.22/share in goodwill amortization. They don’t have to amortize this anymore and while it won’t do anything to cash flow it will increase the headline EPS number.

This isn’t without risk. The debt will become a problem if the turnaround takes too long. Given the fact that their largest division has returned to profitability and they appear to be taking the right steps to turn around the die-cast division, I believe that the turnaround has begun and this company will return to good profitability. They’ve historically shown good cash generation so when they return to profitability they will be able to pay down their debt and create additional value for shareholders. In 5 years this could possibly be a company with little debt and EPS of $1/share or more.

Catalyst

A continued turnaround in their business over the next few years should result in a large improvement in EPS and will allow them to pay down debt.