Earlier this year I looked at Atlantis Plastics (NASDAQ:ATPL) after the company announced a one-time, debt-funded special dividend payment of $12.50 per share. It generally pays to be wary of companies that finance any kind of a dividend with debt, but there's more to the story in Atlantis Plastics' case.
The company didn't incur $220 million in new debt back in March simply to pay a large one-time dividend. Yes, insiders hold a large number of shares at this small company, so they certainly benefited from the dividend, but only 47% of the $220 million credit facility was used toward the dividend. The other half of debt was used to retire existing debt and to pay a cancellation fee to holders of stock options in exchange for canceling those options.
By paying out such a large dividend, the company essentially recapitalized itself and pulled forward the rewards for long-term shareholders. So, while the $12.50 per share dividend directly benefited only those who were shareholders of record on April 1, there is potential opportunity in the shares today -- if you believe the company can employ price increases and efficiency improvements to continue growing at fairly benign rates.
The large amount of debt on the company's balance sheet brings financial leverage with it. True, more debt means larger interest payments, which has lowered earnings initially. But all other things being equal, a company with leverage can drive larger percentage increases in earnings than one without. The net effect of the higher debt level is to increase profit margins and magnify the effects of revenue growth on the bottom line. Make no mistake: This is not a risk-free way to generate higher returns. If revenues don't grow or -- gasp -- if they decline, the company's increased leverage could lead to significant losses rather than gains.
The question now is whether investors still have an opportunity to take advantage of the company's increased financial leverage. After paying the one-time dividend on April 8, Atlantis Plastics' shares immediately dropped by the $12.50 payout, which is to be expected. The shares continued to drift lower until they hit bottom in mid-June, at a little under $5.40 per share. However, since June, the shares have been bid up by 60%, to around $8.50 per share. I'm guessing that the stock's rise stems from investors betting that the company's increased financial leverage will allow it to convert relatively small gains in revenue into large gains in net income. The results of that bet won't become fully clear until next year, when the company has year-over-year comparisons with the leverage in place.
There are signs that the leveraged strategy is playing out; if operating income is adjusted for non-cash charges, it's up 18% versus last year. However, on a trailing-12-month basis, the company is free cash flow-negative to the tune of $21 million.
Final thoughts
Atlantis Plastics is a bit different from large plastics players such as General Electric (NYSE:GE), BASF (NYSE:BF), and Bayer (NYSE:BAY). Although Atlantis competes with the big boys to a certain extent in the plastic film arena, the big boys are more focused on the chemistry and development of plastics, while Atlantis is more focused on extruding plastics into a finished form. Though the big boys don't get into the extrusion business, Atlantis faces competition from numerous small players in an industry that presents few barriers to entry.
As mentioned above, Atlantis' leveraged strategy may be bearing fruit. Nevertheless, the high level of competition in the plastics industry, the chance that leverage might work against the company, and Atlantis' negative free cash flow are going to keep me on the sidelines for now. However, I think Atlantis is a stock worth paying attention to. If revenues do rise, the company's financial leverage could lead to outsized returns in the future.
Nathan Parmelee has no financial stake in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.
