CCA Industires CAW
December 08, 2004 - 9:26pm EST by
hack731
2004 2005
Price: 11.24 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 80 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

CCA Industries is a “healthy”, growing business trading at ten times earnings, net of cash and investments. Unlike many VIC ideas which are hairy, CCA is a cheap name without “hair”, even though it is in the business of hair removal (among other things).

ABOUT THE BUSINESS

Formed in 1983, the company develops and markets health, beauty and cosmetics products. Because the company outsources 100% of its manufacturing, CCA can be considered a product development and marketing company.

Importantly, the company has grown through internal growth, with revenue CAGR of 11% over the last five years and EPS CAGR of 54% over the last four years. The company has a history of introducing one new product line or entering a new product category about every two years. It launched Sudden Change in 1989, Plus+White in 1990, an extension of Plus+White in 1992, Wash ‘n Curl in 1994, Bikini Zone in 1998 and Scar Zone and Mega-T recently. The company has grown SKUs from 20 in 1999 to about 80 in 2004. It now offers products in six categories: Tooth Whitening, Skin Care, Nail Care, Hair Removal, Diet Supplements and Other (fragrances, hair care, sun care).

The only acquisition we’re aware of is when the company acquired the exclusive rights from Allegheny Phamacal to market products under the Nutra Hair and Hair-Off Brands in 1986. Today, those licensed products represent about 10% of sales, which means that internal growth represents about 90% of sales.

In a market with larger competitors, the company has found a successful, growing niche. As evidence of its strong competitive position, the company has gross margin of 60-70%, operating margin above 15% and ROIC above 15%.

The long-term underpinnings of the company’s market appear quite solid, with favorable demographic trends. The cosmetics industry is large and growing, with $3.4 B in sales in 2002 expected to grow at a rate of 8.5% to $5.1 B in 2007 in the U.S., according to the Freedonia Group. The 50+ segment of the population is expected to grow at a 2.5% rate from 2000-2010 (versus overall population growth of about 1%). This segment will likely continue to increase its discretionary spending on personal care products.

Overall, the U.S. market for health and beauty products generally is estimated at $45 billion, according to Euromonitor. Alternative channel (e.g. department stores, direct marketers, health food stores and mail order) consist of $19 B, 43% of total. Food/Drug/Mass Market (FDM) is $26 B, or 57% of the total. Of FDM, supermarkets are $7.9 B (31%); drug chains are $6.8 B (27%) and mass merchants are $10.8 B (42%).

CCA primarily sells into the FDM channel, especially mass merchants and drug chains. In F03, Wal-Mart represented 35% of net sales, followed by Rite Aid, CVS, Eckerd and Albertson (at 8%, 7%, 6% and 4%, respectively). Sales to each of these five companies has increased from 2001-2003 as a % of net sales. For example, Wal-Mart has grown to 34% of net sales in F03 from 28% of net sales in F01. CCA sells products to approximately 450 accounts (most of which have numerous outlets). Only 2% of sales are international. Management indicated that it could organically expand its revenue by at least 25% by rounding out its product portfolio with existing accounts.

PRODUCT SEGMENTS

The product segments of the company are as follows:

1999 2004E 5-Yr CAGR
Tooth whitening $14.1 m $16.1 m 2.7%
Skin care $7.6 m $11.4 m 8.5%
Nail care $3.1 m $7.2 m 18.3%
Hair removal $7.3 m $9.5 m 5.3%
Diet supplements $2.4 m $15.0 m 44.3%
Other $3.4 m $4.4 m 5.2%
TOTAL $37.9 m $63.6 m 10.9%
Source: Company reports, Seidler estimates

Tooth Whitening. Six products under Plus+White brand, including four whitening toothpastes and two specialty whitening products. Crest and Colgate control 80% of the market in drug stores. Despite increased competition recently, the industry segment is growing overall and CCA’s niche products (including formulations that target coffee drinkers, smokers and tea drinkers) and its new Booster product could help the company maintain its sales in this segment in F05.

Skin care. Products include Sudden Change and ScarZone brands. The company has brand extensions toward antioxidant protection of the skin, with a green tea skin care line that could provide upside in F05. A Denise Austin skin care product is expected to be launched in early F05.

Nail care. Products include NutraNail. Sales could be flat in F04 and grow in F05.

Hair removal. Products include Hair-Off and Bikini Zone, both of which are top ten products in non-blade hair removal products. Sales should continue to grow modestly in F04 and F05.

Dietary supplements. Products include (non-ephedra based) weight loss supplements under Mega-T Green Tea and Mega-G Grapefruit brands. Mega-T is a top moving product in the diet category in the mass market channel (excluding Wal-Mart). Segment could have $15 m in sales in F04 and $20 m in sales in F05.

Other. Products include Wash & Curl. The product generated about $19 m in sales in the late-90s when hair curling was more popular, and then fell to under $1 million in sales. This product is being reintroduced, which could positively impact results in F05.

Overall, we expect sales to increase 10+% and EPS to increase to around $1 in F05, including the effect of the company’s recent purchase of shares.

VALUATION

Price (12/8/04): $11.2
O/S 7.1 m
Market Cap $80 m

Cash $2.7 m
Short-term Investments $3.5 m
Marketable securities $10.1 m
Total cash and investments $16.3
Repurchase of 500k shares $4.5 m
Total cash and investments after repurchase $11.8 m

Note: Marketable securities consist of corporate obligations ($5.6 m), government obligations ($3.4 m) and preferred stock ($1.2 m).

Subordinated Debentures $0.5 m

Net cash $11.3 m
Net cash per share $1.6 per share

F05 (Nov.) EPS $0.97
P/E, cash adjusted 9.9x forward earnings net of cash
Earnings yield 10%

BV per share $3.6 per share
TBV per share $3.5 per share

The company has steadily improved earnings over the last few years:

Year EPS
F00 (Nov): ($0.09)
F01: $0.26
F02: $0.40
F03: $0.68
F04E: $0.78E
F05E: $0.97E

We would estimate the intrinsic value of CCA based on its current earnings power value. We should note that over the last three fiscal years, D&A (average of $364k) has roughly approximated capex (average of $344k), so earnings are a good proxy for cash generated by the company.

Industry peers trade at an average of 16.3x forward earnings. Those peers include Chattem, CNS, Church & Dwight, Colgate-Palmolive, Unilever, Procter & Gamble, Helen of Troy, Int’l Flavors & Fragrances, Del Labs, Avon Products, Elizabeth Arden and Alberto-Culver. Applying that multiple to the earnings of CCA of $0.97 for F05, we arrive at a $15.8 stock (41% upside) today. Adding back net cash per share ($1.6), we arrive at a $17.4 stock (55% upside) today.

Industry peers trade at an average of 13.1x EV/ trailing EBITDA. In one year, applying the same multiple of F05 EBITDA, we arrive at a price of $18.8 (68% upside) at the end of 2005.

A recent private market transaction underscores how CCA is undervalued. Del Labs is expected to be purchased by Kelso & Company shortly (deal was announced in July 2004) at a valuation of about 17x earnings and 11.5x trailing EBITDA. We would argue that CCA should be valued at least at these multiples based on significantly better operating metrics: operating margin of 10% for Del Labs (versus 15+% for CCA) and EPS growth of 2.5% (versus 10+% for CCA).

Though several of its competitors are larger companies with more resources and brand recognition, we feel that CCA has found a successful niche, as exhibited by its impressive internal growth. As mentioned, the company has gross margin of 60-70%, operating margin above 15% and ROIC above 15%, further examples of a strong competitive position.

POTENTIAL RISK FACTORS

The company has some corporate governance issues, though these issues are arguably not major ones given management’s style and track record. Compensation for management is on the high side: the CEO and Chairman each receive salary and bonus of over $1 million. Six years ago (November 3, 1998), the Board of Directors authorized the repricing of over 400,000 options for management from $2.5 to $0.50 when the stock was trading at $1. The company also has a dual-class ownership structure in which the top two executives own 100% of the Class A shares (enabling them to select four of the seven members of the board of directors). However, management has a conservative management style and an impressive track record in this industry.

The stock trades on the AMEX.

CCA is highly dependent on local and national television advertisements (print and radio are secondary) to promote its brands. The stock fell from $9 to $7 in early August 2004 when the company increased its advertising spend by $1 million in the face of “overwhelming campaigns by two of the country’s largest consumer products companies”, which has “created enormous competition in all categories.” Despite competing with larger companies, CCA has a successful advertising program, especially relative to its niche peers (as the cosmetics industry is large and varied). For example, CCA brings in over $5 in net sales per dollar of advertising, versus about $3 for Chattem and CNS.

Wal-Mart mandates a 5% decline per year in supplier prices for standardized products, such as toothpastes, nail care. Wal-Mart is CCA’s largest distribution channel, and its products fall into the “standardized products” category. However, margins have expanded in recent years despite increased customer concentration with companies like Wal-Mart because CCA is aggressive in reducing product costs. Also, note that the company benefits from a considerable days supplier float (as days receivable is about sixty days above days payables).

CATALYSTS

Importantly, the company has a history of returning capital to stakeholders. In F01, the company paid $1.5 m on debt and purchased $71k in stock. In F02, the company purchased $106k in stock. In F03, the company paid dividends of $371k. Recently, the company declared a $0.14 dividend (payable on June 1, 2004) and a $0.07 dividend (payable on December 1, 2004). On June 17, 2004, the company declared a 2% stock dividend, payable on December 1, 2004. On October 4, 2004, the company also purchased 500,000 shares in a private transaction from its two founders for $9 per share. We are hopeful that the company will continue to make smart use of its cash. Importantly, we expect that the company will only consider acquisitions that are EPS accretive. The company’s parameters for a potential acquisition include a valuation less than 1.5x sales, gross margin of 65-70%, operating margin of 10-15%, outsourced manufacturing and existing relationships with key distributors.

In addition to these actions with its cash, the company is gradually undergoing a management transition from Berman and Edell to the two sons of Edell, Dunnan and Drew (who have a combined 47 years of experience with the company). Dunnan Edell was promoted to President in November 2003, and Drew Edell is Senior VP. The retirement of Berman and Edell may increase the probability that the company is sold (especially in an industry that is consolidating), given that the two are planning their estates.

Importantly, management team are significant owners of the stock: Chairman Ira Berman (72) owns 675,052 (8.9%), and CEO David Edell (71) owns 676,475 (8.9%). As a group, management owns roughly 30% of the company. The management team, including President Dunnan Edell (48) and Vice President Drew Edell (46), have been with the company for over twenty years.

Catalyst

Stock currently trades at a low multiple of earnings
Company continues its history of returning capital to stakeholders
Continued solid internal growth in sales and earnings
Expanding product portfolio to existing accounts
Potential acquisition candidate in a consolidating industry
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