I first learned about investing from my dad. He taught me about stocks and encouraged me and my siblings to buy Hershey chocolate, shop at Home Depot, and drink Pepsi -- all companies in which our family owned shares. While at the time I was happy just to drink a Pepsi (a real treat back then), I quickly realized that my dad was teaching me the first of many investment lessons to come.
So, for one of his Christmas gifts this year, I thought I would return the favor and give my dad a stock idea that he might not normally consider. On last week's edition of The Motley Fool's podcast, Taking Stock, I mentioned that I'm looking at Topps (NASDAQ:TOPP), the maker of baseball cards and Bazooka bubble gum, as a potential small-cap investing idea. I doubt that my dad would have found this $300 million-market-cap stock through his daily stock research -- although he is a pretty bright guy, so I wouldn't put it past him, either. In fact, although many people are probably familiar with Topps' cards and candy, I'll bet many investors don't realize that it's a publicly traded company.
I've known about Topps ever since I was fielding ground balls as a Little League shortstop. But I started looking at the stock only after it popped up on a screen I had built to identify stocks that have fallen by more than 25% this year. So I poked around through the company's financials and listened to management's September conference call. I soon realized that there may be more to this story than just Bazooka Joe and Mickey Mantle cards.
From a cursory view, there's nothing too exciting about Topps -- other than cool new Ring Pops, that is. Last year, the company generated $296 million in revenue and $12 million in operating earnings, for an operating margin of only 4%, versus margins of 20% for Tootsie Roll Industries (NYSE:TR) and Wrigley (NYSE:WWY). Revenues have been flat for the past few years, while both operating and net income have fallen substantially. That's not too reassuring. But don't worry, Dad, I found some facts that may excite you.
- The company, of course, has a few very well-known brands, including Topps trading cards, Bazooka Joe, and Ring Pops. While the card market is pretty stagnant, Topps, according to its recent investor call, has been able to grow market share. It is now one of only two companies, along with Upper Deck, licensed to manufacture Major League Baseball cards. Bazooka bubble gum is still savored by baseball teams and thousands of kids around the country. And Ring Pops remain a very popular low-priced candy. Management needs to figure out a way to bring out the value of these brands. Which takes me to fact No. 2 .
- Management is now focused on (and compensated according to) growing operating profits. As I mentioned above, Topps' operating margins are far below the industry averages. In its September conference call, the CEO (who owns almost 7% of the stock) and the president/COO outlined a new focus on improving operating margins for both the entertainment (cards, stickers, and games) and confectionery businesses. Through a companywide reorganization, management hopes to save $2.5 million annually going forward. While this will initially add only a few tenths of a percent to operating margins, it's a step in the right direction.
- After falling 25% this year, the stock currently sells at 1.4 times book value and at 2.1 times tangible book value (backing out goodwill). Tootsie Roll trades at around double these ratios (2.6 and 4.7, respectively).
- The company has no debt, only $12 million of operating leases, and almost $100 million of cash and short-term investments. And in September, the company announced that it plans to repurchase up to 500,000 shares of its own stock for each of the next four fiscal quarters.
- Private Capital Management, the value-focused investment firm based in Naples, Fla., owns 25% of the outstanding Topps shares. PCM has recently been in the news for encouragingKnight Ridder (NYSE:KRI) to put itself up for sale. Although PCM has been a net seller of Topps stock over the past year, the firm may still act as a catalyst for change, since its investment in Topps has gone nowhere for a number of years.
These five points are at least encouraging, but are they enough for me or my dad to buy the stock? Well, certainly not without first checking the risks, of which there are at least a few.
- Operating units don't turn around overnight. Topps' operating margins have been moving in the wrong direction, from 11.4% in 2002 to just 4% last year. Margins over the past 12 months were even worse at 1.1%, thanks to higher advertising and salary costs. The reorganization will cost $2.4 million this fiscal year, and exiting its Internet operation, thePit.com, will cost $5 million in the third quarter, but investors can hope that these changes will jump-start the company's performance in fiscal 2007.
- Management failed to secure a buyer for its candy business and ended the search this fall, and that's one primary reason the stock is down nearly 30% since September. This event actually does concern me a bit. Apparently, potential buyers didn't find a lot of incremental value in the confectionery business. Thus, Topps is left holding on to a business it doesn't really want. I'm hoping that the reorganization can improve the business enough that maybe Topps can sell the candy business at a good price in the future.
- It's possible that PCM or some other large institutional shareholders may grow impatient with Topps' mediocre stock performance and start aggressively selling shares. If PCM wanted out of its 10-plus-million shares, it could hurt the stock price significantly, at least in the short term.
So where does this leave us? Should Dad buy this stock? Assuming that Topps won't trade below its tangible book value per share, the low point for the stock is $3.57, about half of where it trades today. Ouch! That sounds steep. But I don't see the stock getting that low. In fact, it seems that over the past 10 years, the stock has never traded below 1.8 times its tangible book value or 1.1 times its book value. As of August, book value was $5.42. While we can't say for sure, I think we're protected at least a little on the downside.
Topps is not the kind of company that will grow earnings by 20% for the next five years. Get over it. In Topps, rather, one would be buying beaten-down shares of a small-cap company looking to improve its operating results and turn around its fortunes. It may not happen right away, but the fact that the company trades near the low end of its historical price-to-book-value ratios at least encourages me to watch the stock and do more research.
So, will my dad buy Topps? I don't know, but I'm pretty sure our next few conversations will include the fortunes of this small cap. Now I'd better go and pick up a few pieces of Bazooka for my brothers and a Ring Pop for my sister.
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Andy Cross is still hurting from taking too many fly balls off his noggin. He is a co-host of The Motley Fool's new podcast, "Taking Stock." At the time of publication, he owned shares of PepsiCo and Home Depot. The Fool has a disclosure policy.
