TUESDAY, JANUARY 27, 2009 Barrons - WEEKDAY TRADER
By NAUREEN S. MALIK
Investment firm Compass Diversified can buy solid businesses at a discount thanks to its cash hoard. And its stock is cheap.
THE CREDIT-LENDING AND private-equity spigot has been welded shut for a vast number of companies seeking financing to survive and grow.
But Compass Diversified Holdings (ticker: CODI), an investment firm with loads of cash on hand, is taking advantage of this environment.
At a Glance: Compass Diversified Holdings (CODI)
Stock Price: $10.33 52-Wk High: $14.99 52-Wk Low: $7.52 Market Cap: $325.6 million Est. 2009 EPS $1.31 2009 P/E: 7.4x Est. Long-Term EPS Growth: * 10% Est. ('10/'09) EPS Growth: 27% Revenue (trailing 12 months): $1.4 billion Dividend Yield: 14.3% Chief Executive Officer: I. Joseph Massoud Headquarters: Westport, Conn.
* Based on analyst estimates looking ahead three to five years. Sources: Thomson Reuters, Barron's OnlineCompass buys midsize companies with strong cash flow and leading positions in their niche markets. It currently has majority equity ownership in six companies, ranging from temporary-staffing agency CBS Personnel Holdings to hospital-bed maker Anodyne Medical Device.
Trading at $10.33, Compass shares are down 31% since last February's highs, tumbling amid the broader U.S. financial meltdown. Certainly, investors should be cautious treading here: As a small-cap company with thin trading volume, Compass is a highly speculative play.
Growth will likely be damped this year, but Compass is well equipped to weather this economic storm. It is flush with more than $400 million in available cash and untapped credit as it scours the U.S. for its next investments.
This cash also ensures that Compass will continue to pay out its dividend -- currently yielding a whopping 14% -- even if cash flow from its portfolio of companies comes in short due to economic pressures.
The stock looks cheap at 0.7 times its estimated book value of $15.21 and a dividend yielding more than five times the benchmark 10-year Treasury.
Historically, its normal yield has been around 8%-9%, notes Stifel Nicolaus analyst Greg Mason.
Compass' operating structure is widely misunderstood. It is frequently lumped in with so-called business development corporations (BDCs) and private-equity firms.
American Capital (ACAS) and other BDCs have to pay out 90% of their income to shareholders and make mainly debt investments in hundreds of companies.
Generally, both private-equity firms and BDCs have relied on third-party credit providers for the funds used to make acquisitions.
But Compass has its own cash and an established credit line for funding its purchases. The company retains a significant portion of its cash flow for investments. It also has a small, actively managed portfolio of five to eight companies at any time.
Compass shares have held up relatively well compared to shares of American Capital and private-equity firm Blackstone Group (BX), which are down 80%-90% since their early 2008 highs.
In the near term, news of an acquisition plus proof that the company can "continue to show their ability to generate enough cash flow for distribution" could push Compass shares higher, says SMH Capital analyst Will Hamilton.
Hamilton rates Compass at a Buy, mainly because the company has "a very strong management team that we give a lot of credit for in terms of their ability to identify attractive companies while also being very disciplined in how much they pay [for them]."
An acquisition would immediately boost cash flow.
Compass' portfolio is pretty transparent unlike BDCs because it reports financials for each company quarterly.
Compass' team, led by Chief Executive Officer Joe Massoud, is focused on growing market share for each niche business, along with cutting costs. Acquired companies retain their management teams.
"We don't have a whole lot of leverage, only about $60 million net debt. We don't have real amortization issues, but we have real liquidity," he says. "This is the time to take advantage of less-capitalized competitors."
Better market positions will ultimately "mean more cash flow" when the economy starts to recover, he adds.
The biggest contributor to Compass' fortunes is CBS Personnel, making up 40% of earnings before interest, taxes, depreciation and amortization (Ebitda). CBS derives 95% of its revenues from temp placements of low-to-midskilled industrial, clerical, technical, health-care and other niche workers.
This is the reason that Compass often trades in tandem with staffing pure plays such as Robert Half International (RHI), notes Mason of Stifel Nicolaus.
Morgan Keegan analyst Robert Dodd estimates cash flow can fall 12% at CBS in 2009 due to bleak employment numbers. But even with a "pretty steep" decline, Compass will be able to cover its dividend thanks to stability in other less-economically sensitive businesses.
Advanced Circuits, which provides universities and researchers with circuit boards, generates 21% of Compass' Ebitda. The rest comes from Fox Factory, the maker of suspension for biking enthusiasts; low-end furniture from American Furniture; Halo Branded Solutions, a leading distributor of customized promotional products; and Anodyne.
Massoud doesn't expect to sell off any of these companies until 2011 at the earliest. He is shopping around for companies nearing cyclical bottoms and some potential medical-device companies.
Compass is also hearing from potential sellers who balked less than six months ago, adds Massoud.
Meanwhile, Janney Montgomery Scott analyst John Rogers estimates that Compass can generate a compound annual earnings growth rate of 10%-15%.
Cash flow could come in less than the dividend this year, but Rogers says, "we are in trough year." His price target of $15 implies a 42% upside to the stock price and total returns of close to 60% over the next 12-18 months.
So while Compass stock has clearly lost its way, the secure dividend and focused management team could help it find due north again.