During the 1970s, George Clinton and Parliament Funkadelic wrote about the epic battle between Dr. Funkenstein (King of the Funk) and The Nose (Devoid of Funk). In 2002, Dr. Funk (a.k.a. Vince Carter) turned the Roswell Rayguns from zeroes to heroes in his Nike
But if you've got the funk (small f), Chattem
Apparently, a lot of us do have funk, as Chattem reported a very good third quarter. Sales grew 12% (slightly higher than expected) with the Icy Hot, Aspercreme, Selsun Blue, Gold Bond, Pamprin, and Bull Frog brands leading the charge. Unfortunately, Dexatrim and pHisoderm are in a funk because of litigation and competition, respectfully. Margins, however, remained firm. Earnings grew 36% as interest payments declined from the previous quarter.
Good so far. But if we want to see what Chattem smells like up close, we can, as Rich Duprey recommends, start by looking at margins and comparing operating cash flow to net income. Let's try that for Chattem:
|Op cash flow||$35.3||$31.5||$4.3||$13.5||NA*|
Gross margins are fairly steady, meaning Chattem is in firm control of the cost of goods sold. Operating margins are also steady, indicating that SG&A costs are under control as well.
Worth noting, though, is that about one-third of Chattem's sales are from Wal-Mart
But let's get further into Chattem's goods by looking at return on invested capital, or ROIC. As Fool contributor Chris Mallon pointed out, stock returns tend to correlate with ROIC movements.
|Cost of capital||8%||8%|
Chattem earns a decent ROIC, higher than the 8% estimate I made for cost of capital. For the curious, that estimate is a simple weighted average of Chattem's 8.9% overall long-term debt rate (but because of the tax benefits of debt, this equates to a 6% after-tax debt cost -- that's the number I used in my computations) and a ballparked 15% cost of equity.
When ROIC exceeds the cost of capital, value is being added in the business. A quick look at Chattem's stock chart indicates that corresponding value was added in the market as well.
Chattem currently trades at $32.70 or 36 times trailing 12 months' earnings. A few months ago, analysts considered Chattem fairly valued at $35, or 19 times 2005 estimated earnings of $1.87 per share. However, if ROIC continues to increase, Chattem could be worth a deeper look.
Fool contributor David Meier has P-Funk in his MP3 player. And although he is an athlete, he has never had athlete's foot. He owns shares of Nike but of no other company mentioned.