In my last article, I explained how the combination of a small market cap, a slightly boring industry, and an understandable business aligns the planets in favor of the individual investor. I tossed out two names last week, and this week I'm back with fresh ideas.
But unlike the first two, these companies employ Pac-Man-style acquisition tactics to combat the slow growth inherent in their industries. That may worry some people at first.
Acquisitions, like relationships, don't tend to work when the premise is that of a rescue mission: The stereotypical bad acquisition would begin with a power-hungry CEO expanding into an unrelated industry and gaming on a turnaround to boot. By contrast, the companies below are picky eaters, buying solid brands and staying focused.
As Rich Duprey reported last month, K2
But it's a bet I'm tempted to make, given that as an avid outdoorsman I have a love affair with many of K2's products. Besides small-but-well-known makers such as Marmot, Ex Officio, and Dana Design, K2's stable includes a wealth of leading brands beyond its own K2-branded stuff. I'll rattle off some names: Volkl/Marker ski products, Ride/Liquid/Morrow/5150 snowboards, Tubbs and Atlas snowshoes, Brass Eagle paintball markers (don't you dare call them guns), Rawlings and Worth team sports equipment, Shakespeare/Ugly Stick fishing poles, and Stearns life jackets.
The idea behind acquiring industry-leading names is simple: Top brands have already done the hard part -- earned the right to precious shelf space. Shelf space, K2 feels, will become an increasingly important denominator of success in the future, at least in the event of further sports retail consolidation via the likes of The Sports Authority
Here's how K2's 2003 revenues break down, although future years should see higher Action Sports figures thanks to the 2004 Volkl/Marker ski acquisition.
2003 K2 Revenue
But what it really comes down to is future earnings and cash flow. Although analyst-expected annualized five-year earnings growth is 15%, the deciding long-term factor will be how fast all these acquisitions accrete, as K2 claims they will, to earnings. But for now, operating cash flow seemed a little less affected by acquisition-related one-timers than earnings, so it might be better to look at:
|Operating Cash Flow||$32,668,000||$21,264,000||$15,633,000|
|Operating Cash Flow per share||$1.14||$1.18||$0.87|
K2 would be quick to tell you that the timing and magnitude of 2003's acquisitions and related share issuances make their per-share numbers poor harbingers of the future. While I agree, the dilemma pretty much sums up the major concern with investing in acquirers: We know the "real" numbers will be better, but by how much and when?
Nobody (not even the crack analysts responsible for our Hidden Gems newsletter) can tell you for sure when that will happen, so the only thing to do is wait and keep the faith that K2's management is on the money with its claims of pending near-term accretion.
Moreover, through its many acquisitions, Jarden aims to leverage operating and distribution efficiencies. For example, its pending acquisition of the Bicycle/Bee/Aviator/Hoyle playing-card group stands to provide additional entree into the convenience store and European sales channels. Given that 98% of their sales are on this continent, European expansion -- they think their FoodSaver will do especially well there -- is a fantastic wild card.
Though space won't permit listing all my model assumptions, I ran a discounted cash flow analysis on Jarden with some round-number discount rates. I used 10% as my median discount rate and analyst-estimated 13.5% earnings growth over the next five years, tapering down to 4% stable growth (in both earnings and free cash flows to equity). Jarden is currently in the mid-$30s, so according to this particular model, it's almost certainly undervalued.
Jarden DCF Valuation Matrix
|Value per share||$80.25||$52.22||$38.32|
With stable companies such as Wal-Mart
|EV/Free Cash Flow||13.2||12.4||7.1||5.5|
|Earnings/Mkt value equity||7.9%||9.1%||13.4%||1.4%|
In spite of my adjustments, it was hard to get meaningful numbers for 2001. Regardless, the trend is clear: The still-good numbers are reflecting more recognized value in the company. But for an improving company such as Jarden, such additional value may be well-deserved. I'd need ROIC figures, which Jarden's acquisition-style growth prevents me from accurately ascertaining, to determine that for sure, though.
You take it from here
Both K2 and Jarden, as well as the stocks I previously highlighted -- corn processor Gruma and home-goods retailer Tuesday Morning -- have things that would be wise to investigate further. Actually, that's the idea behind these picks; companies that are at the same time promising and straightforward, providing ideal starting points for further research. If you're looking to round out your arsenal with stocks you can act upon today, I'd start with Tom Gardner's Hidden Gems newsletter. It can't hurt to take a peek. A trial is free.