Stephan Co ($SPCO) — Initiation (1/17/20)

Ticker: SPCO Market Cap: $7.6m Valuation: 10x PE Category: Long-Term

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A checklist of things I (still) like about this stock:

  • Cheap at 10x PE (~$0.18-0.19 per share)
  • Earnings = cash flow (approximately)
  • Consistent earnings (albeit flat) over the past 4 years
  • Great balance sheet with no debt and ~6% of market cap in cash
  • Almost no capex needed to run this business (less than $50k aggregate spent past 4 years!)
  • Return on invested capital is amazing… this is a business generating ~$600k in cash flow on some ~$1.1m invested capital
  • Cost saving initiative likely to improve earnings in 2020+
  • $17m in NOLs = minimal taxes on income for many years into the future
  • Insider ownership — this is an unusual company in that it has historically been board-run for the past 5 years with no true CEO/CFO

Backstory

This is a stock I’ve owned for years after the company announced in 2015 they would sell off owned real estate, earnings would be close to $0.20 per share, and the company would start paying $0.15/share in dividends each year.

At the time, this was nearly a $1 stock which was essentially a 5x PE multiple and 15% dividend yield.

Things have played out almost exactly that way with stable earnings each year in the $0.15-0.20 per share range with most of that getting paid out in dividends. But the company recently made an announcement regarding a complete 180 in capital allocation:

Approximately five years ago, the Board decided to payout a substantial percentage of our EBITDA/cash flow in the form of dividends given that we did not contemplate investing in acquisitions at that time. In the last two years, we have acquired three businesses/brands at attractive valuations (MD in 2017, Barbermate in 2018 and StixFix in 2019). We are actively pursuing acquisition opportunities, including substantially larger businesses/brands than the aforementioned deals we have already closed. While we believe that our level of cash flows will benefit substantially as we consolidate our three locations into one and realize the associated expense and inventory efficiencies, we believe that the time has come to shift our capital allocation away from regular dividends to a more opportunistic approach focusing on acquisitions, share buybacks and potentially special dividends. We believe that our acquisition efforts will remain disciplined and our analyses suggest that our recent acquisitions have been attractive returns on the capital invested. We believe our new capital allocation policy will help us to drive value creation for shareholders over the long term.

It now seems highly likely that the company will bite off one or more acquisitions in the near future and some could potentially be large ones.

What’s the business again?

I’ll let the company explain what they do:

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Stephan is a distributor of barbering products. You can get a sense for what they sell by checking out their websites: Williamsport Bowman and Morris Flamingo. Clippers, trimmers, scissors, brushes, hair dryers, shaving cream, etc.

Dividend is gone, now what?

Here we are, I’ve received $0.60/share in dividends and this is a $1.90 stock. So why continue owning this illiquid company without the fat dividend yield?

(1) First is the stable earnings and cash flow…

Some investors prefer compounding earnings and revenue growth (I like those things too, not always willing to pay for them), but I value stability. Despite earnings going nowhere for years, the board opted to return almost all of those earnings which made for a nice return during that period.

Granted, this is a small company and things can change quickly, revenue and earnings have been very stable since the turnaround concluded in 2015. Cash should pile up on the balance sheet in short order.

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(2) Next are the cost cuts in action

A 10% workforce reduction is not insignificant. The Q3 earnings report indicated we’d have to wait until the annual report to see what kind of benefit Stephan will see from the cost cuts but I’m guessing it could be a decent amount. Let’s say it’s only 5% of SG&A = $110k per year saved or ~$0.02-0.03 per share in earnings.

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(3) Next up are the acquisitions…

In the past 2.5 years, Stephan has acquired 3 businesses for a total of $321k (not much relative to the $7.6m market cap but still fairly active).

The tone from the capital allocation change seems to indicate that more interesting deals are popping up and the company wants to leave financial flexibility to explore them.

Stephan currently has $450k in cash on hand which isn’t much but this is a business that should rake in some $600k each year and debt financing is probably an option as well. It’s possible they are considering acquisitions that could add anywhere from $1m in revenue to $4-5m in revenue… I would imagine deals of this size would be at fairly attractive multiples and with NOLs, Stephan will not be a cash tax-payer for some time.

(4) Lastly the Sources & Uses of cash analysis…

This is an exercise I like to do with every stock I own or look at…

Cumulatively, from 2016-3Q19, Stephan Co generated $2.4m in cash and spent the majority of it on dividends $2.1m while making a few acquisitions and some buybacks.

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The cost savings mentioned earlier should help the company get back to earnings = cash flow. Again, this shows me a business where cash accumulates quickly and historically has been used wisely.

What to do now?

I’m inclined to hold this stock. At $2, I think the price is probably fair (it’s likely worth between $2 and $2.40 as-is) but with earnings and cash flow that should add 7-10% each year. I trust the board to deploy cash in a smart manner so I’ll watch to see what and when they decide to acquire something.

I would probably add more if this drifted toward the $1.50 mark and look to sell around $3 (unless things change). This is a large holding of mine and has served me well for years… Insiders own a ton of stock and my guess is they’ll pull the right levers to make this work. Plus, this stock tends not to move in-line with the general market which is something I like.