Motley Fool Hidden Gems "Tiny Gem" designee Lakeland Industries (NASDAQ:LAKE) took a dive last week, falling in the wake of an earnings report that Wall Street deemed all wet.
The safety-first clothier, maker of everything from lab smocks to chemical protection suits, reported that its Q1 earnings declined 15% year over year to $0.29 per share despite a modest 6% rise in sales. Gross margins held firm at 24%, and gross profits grew in line with sales at 6%. However, operating margins declined abruptly, falling from 10% to 8%.
According to the press release, sales were held down by two main factors: first, a slowdown in the need for special protective gear sold to the refining industry and used in the maintenance of refining plants -- maintenance that's been delayed in an attempt to keep our cars filled to the brim with affordable gasoline -- and second, weak sales caused by competitor/supplier DuPont (NYSE:DD) introducing a new line of Tyvek clothing and dumping its obsolete products on the market, thereby depressing sales. Lakeland is hoping to see sales revive this year, but it predicts that real earnings growth will not be seen until Q4 2006 and Q1 2007.
Inventories
For several quarters now, I've been monitoring Lakeland's inventory, since that looks to be either the company's Achilles' heel, or its secret sauce -- sometimes both at once. If you recall our April Foolish Forecast on the company, I mentioned that Lakeland had been stocking up on raw materials while the price was right and anticipated strong margin expansion going forward as it sold finished goods for higher profits.
Obviously, that didn't happen this quarter. And to be honest, I'm wondering whether it ever will. Although Lakeland highlighted a 14% sequential buildup in raw materials this quarter compared with the last one, and a significant drawdown of finished goods, the year-over-year picture looks a lot different. From that point of view, Lakeland shows 6% sales growth, a 25% rise in finished goods (meaning products aren't selling), a 25% drop in work-in-progress (suggesting Lakeland knows they aren't selling and so isn't making more), and an 87% jump in raw materials (meaning Lakeland is still stocking up on raw materials).
Lakeland's explanation for all the above is that the government is still sitting on its hands about distributing funds to the states to purchase clothing designed to protect against SARS, avian flu, or similar potential pandemics. Meanwhile, DuPont offered Lakeland a "very nice, handsome discount" if Lakeland would take some extra Tyvek off its hands. CEO Chris Ryan summed up the deal thusly: "[DuPont] offered us a deal we couldn't refuse, and we didn't." Result: The raw-materials inventories continue to pile up.
Considering all of the above, cautious investors should probably sit on the sidelines for a few quarters and wait to see whether Lakeland's promised sales and earnings growth reappears on cue nine months from now. More adventurous Fools might want to take the CEO at his word, trust that the raw materials will be put to good use and produce a bumper crop of profits as promised next year, and buy on the current weakness.
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Fool contributor Rich Smith does not own shares of any company named above. He's feeling a bit adventurous, though, liked what he heard in the conference call, and just might buy some Lakeland soon -- but per the Fool's disclosure policy , no sooner than 10 days from now.
