Description

Writeup was completed a few weeks ago and stock has moved up slightly from January effect but no change in thesis.

Dorel Industries - $3.50 USD. 32.5M shares. Mkt cap $114M. Net debt $191M (pf net debt ~$125M). Normalized EBITDA ~$95M. Price target $13/sh in 6-8 quarters.

Dorel industries is a consumer products company that has two segments - juvenile and home. Dorel has many leading brands in its two segments. The business is currently facing short term headwinds that are significantly impacting earnings – in my opinion these headwinds will inevitably subside and Dorel will return to its normalized/pre-covid earnings power (or close to it) within 2-8 quarters. Dorel has a two-decade history of defensible EBITDA & unlevered FCF generation (relative to its mkt cap and EV), and I don’t see why the company won’t get back to pre-covid levels.

The below highlights the normalized earnings power of Dorel’s two remaining segments. Note Dorel runs with ~$25-27M in corporate G&A (unallocated below), and ~$27M in annual capex, I also adjust reported EBITDA lower due to IFRS lease accounting.

And ~20-year consolidated highlights below (Sports segment has since been divested).

Ownership – Dorel’s voting shares are controlled by the Schwartz family who founded the company in 1962 and took it public in Canada in 1987 - the company is run by the descendant Schwartz family members today and they own ~20% of the company. Dorel has made over two dozen acquisitions in its history and was at >$2.5B (all figures in USD) in sales before selling its sports division (mainly Schwinn and Cannondale bikes) in late 2021 for $810M or ~10x EBITDA.

Martin Schwartz is the CEO and has led the company since 1992.  Martin co-founded Ridgewood Industries and joined the Company when Dorel purchased Ridgewood in 1987.  Jeffrey Schwartz has been the CFO since 2003.  Alan Schwartz (Executive VP of Operations) was also a co-founder of Ridgewood Industries and joined Dorel in 1987.  Jeffrey Segal (Executive VP of Sales and Marketing) is a brother-in-law of the Schwartz family and was also a co-founder of Ridgewood Industries. 

The owner-operator family has made it quite clear (including explicit earnings call commentary) their intentions for Dorel are to maximize value via sale(s) of the remaining segments either separately or together. They wish to do so when the macro environment is more favorable for a sale. I do have conviction that they will continue to pursue the sale route when the environment normalizes – they executed a great sale of sports, they will soon be in position to sell the remaining segments which should lead to a ~$13+ per share “cashing out” which would provide the family with ~$100M to walk away with – not a bad number to ride off into the sunset with at ages 60s/70s.

Additionally, Dorel does have a long history of paying dividends – so even in the small chance they change course on monetizing I believe they could and would implement a .50-$1 regular annual dividend as soon as 2024, which on today’s share price of $3.50 USD would equate to between a 14.2%-28.5% dividend yield. They also may be savvy enough to eventually do large tenders. 

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Dorel Industries, Inc. engages in the design, manufacture, and distribution of home products. It operates through the Dorel Home and Dorel Juvenile segments. The Dorel Home segment focuses on the design, sourcing, and sale of ready-to-assemble furniture and home furnishings, which includes metal folding furniture, futons, step stools, ladders, and other imported furniture items. The Dorel Juvenile segment manufactures and distributes products such as infant car seats, strollers, high chairs, playpens, swings, developmental toys, and infant health and safety aids. The company was founded by Leo Schwartz in 1962 and is headquartered in Westmount, Canada.

Dorel ranks number two as manufacturer of Ready-to Assemble (“RTA”) furniture in North America. Dorel Home is primarily branded products including: Ameriwood, Altra, System Build, Ridgewood, DHP, Dorel Fine Furniture, Dorel Living, Signature Sleep, Cosmo Living, Novogratz, Little Seeds, Queer Eye, Cosco and Alphason. Dorel Home’s many competitors include Sauder Manufacturing, Southshore Furniture, and Whalen Furniture in the RTA category, Meco in the folding furniture category, Tricam in step stools, Werner in ladders and Zinus in mattresses. Sales are concentrated with Internet retailers, mass merchants, warehouse clubs, home centers and office and electronic superstores. Greater than 2/3^rd of Dorel Home sales are from e-commerce.

The ~$825M in 2022 revenue will likely slide/reset slightly lower in 2023 in a recessionary environment, this would be similar to how Dorel home performed around the GFC (note Dorel home still generated respectable operating margins for the most part through the GFC). Given we have a long history of Dorel home I think that paints a good picture for what normalized earnings should look like more or less, pre-covid this was a 9-9.5% EBITDA margin business at the segment level. I like to be conservative and say the normalized earnings power for the home segment is 250bp lower EBITDA margins for 6.5-7% EBITDA margins on ~$825M in revenue – for $58M in segment true EBITDA. The risks here are potential overcapacity/oversupply in the RTA furniture industry or a deep recession. Thankfully, I believe much of the supply chain availability and freight blowout concerns are in the rearview. The current problems are over inventory hitting GMs and potential for a more severe recession – I think inventories will normalize in the relatively near future.  I believe the industry is acting fairly rational (everybody sees the telegraphed headwinds) and we will return to a more normalized environment in the RTA furniture business in 2H23 or early 24. Dorel and others have ridden the wave of Wayfair and ecom which has provided nice growth for their businesses in recent years (and I don’t think this will go away medium to long term).

So I do believe the segment will navigate the headwinds and eventually return to a conservative normalized segment earnings power of $825M and $58M in true segment EBITDA. While this may not be a sexy high growth asset for an acquirer, I do believe there will be interested parties bc this is a decent consumer product business and the #2 player in RTA with a long history of solid cash flow. There should be material synergies in many aspects of the business. Potential buyers include Haworth, Sauder, other RTA companies of size, or private equity. I do not see this business going for less than 4.25x segment EBITDA or $250M, this would be 0.3x normalized sales – that is very attractive for an acquirer and the number could be higher but let’s be conservative.

Juvenile – The Maxi-Cosi, Safety 1st and Tiny Love brands are sold globally in most of Dorel Juvenile’s markets. Other brands such as Bébé Confort, Cosco, Mother’s Choice and Infanti are strong regional brands and Dorel Juvenile is able to address all price points with its range of brands and products. I believe most of these juvenile brands are very solid.

Dorel juvenile has a moat given the barriers to entry in this category where trust is a huge factor. Other top players consist of Graco by Newell Brands, Evenflo Company Inc. (a subsidiary of Goodbaby International Holdings Limited), Uppababy, Chicco and Britax. Newell has historically achieved double digit overall operating margins, I estimate that Newell’s baby division has operating margins in line with the wholeco at ~10-12%. Newell Baby is in NWL’s Learning & Development segment along with Writing, the Learning & Development segment has high teens to 20% operating margins.

Dorel Juvenile’s sales were hardly impacted during the GFC as baby products are non-discretionary, Dorel Juvenile tends to benefit from trading down in a bad macro as well.

In a takeout of juvenile the potential synergies could include – cut corporate functions, slim finance and accounting, only keep top salespeople, buying power with suppliers, manufacturing and distribution synergies, gross margin optimization, lots of IP, durable and proven brands (that fill out good, better, best), and it would give you more power/leverage with large retailers.

We also have a long history of dorel juvenile which is a helpful frame of reference for normalized earnings power – it looks like pre covid segment EBITDA margins were ~7-8% (including the Toys R us babys R us hit). I would assume the juvy segment is a normalized $900M+ in revenue and 8% EBITDA margin business or $72M normalized for the segment. I believe this juvy will fetch at least 0.4x revenue and 5x segment EBITDA, or $360M – I believe this is quite conservative and that is further backed up by precedent transactions. There should be significant synergies for a strategic acquirer, they would also capture many valuable market leading brands.

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Dorel’s overall geographical revenue mix is approximately: 67% US, 8% Canada, 15% Europe, 6.5% LATAM, 2% Asia Pacific, and 1.5% Africa & Middle East.

Dorel does have concentration with Walmart at roughly a quarter of company sales – but Dorel has had a multidecade relationship with WMT that doesn’t seem to have had hiccups. In juvenile, essentially every sizeable player has similar customer concentration.

Short term headwinds and cash

In the last few months Dorel has been caught with its tail between its legs. Dorel has been facing too much inventory in the channel leading retailers to order less, which is leading Dorel to discount to move inventory, all the while Dorel has faced rising input costs (freight, product costs) so it has inventory at high costs that it is having to discount to clear. But input costs are declining, and the inventory channel will clear – meaning in the future Dorel’s costs of its products won’t be so high and inventories will normalize leading to margin normalization. Notably, gross margins have been hit hard lately but Dorel has a multi decade history of GM’s staying in the 22-23% range along with fairly strong EBITDA and unlevered FCF (relative to mkt cap and EV) – I don’t see a credible case for why Dorel GMs and EBITDA margins are structurally impaired and won’t get back to historical levels. Dorel has faced some FX headwinds recently, but these don’t concern me as Dorel is 3/4^th North America and its juvenile business has more non-NA exposure but demand should be relatively steady, Dorel juvenile has gained share recently and benefits from trading down in a recession.

Dorel had a bad Q3, and they said Q4 won’t be much better. Dorel generated a $14.5M EBITDA loss, they did say they expect the business/margins to start to normalize in 2023, and Dorel has typically held their own in recessions. They also SLB’d a property for $34M subsequent to the quarter end, I believe they have at least another $40M in RE they could tap for cash as well if needed.

Counting the proceeds from the recent RE sale, Dorel would have ended Q3 with $57M in cash and $248M in debt via its ABL, for $191M in net debt. The good news is that Dorel refinanced its ABL a year or so ago and it essentially has no financial covenants – and Dorel has another $100M in availability on it that they could tap (and no maturity until 2026). Dorel management describes their inventory as being $60M+ too high here at $462M and they are focused on working this down – I believe they can work it down meaningfully in coming quarters and likely get all of that $60M+ back to cash by the second half of 2023, plus they can sell some real estate and unlock another $40M.

So while $191M in net debt looks bad on a business that probably generates breakeven EBITDA in Q4 (while they are trying to clear high priced inventory at a discount), they should be EBITDA positive in early 2023 and they should be cash flowing positive now or very soon as they are focused on reducing their inventory balance. The RE optionality provides a nice margin of safety, no covenants so the bank can’t call the debt, and if we look forward 12 months net debt should be in the $125M or better range and that’s against ~$95M in normalized EBITDA at Dorel.  Insiders own 20% so they are aligned and want to get to the $13+ fair value – I don’t see how it could be in their interest if they try something funky like voluntarily file, bankrupt and gamble the company they’ve grinded tooth and nail to build for 3 decades – but if they did there would be some interesting claims that should have a lot of value (including probably equity value). I think there is less than a 10% chance that a restructuring (rights offering or other) will occur. IMO the only plausible risk to the investment from here is a very bad prolonged recession coupled with Dorel acting very complacent about cutting costs.

I do wish Dorel came out with a larger and more coherent cost cutting plan, it doesn’t seem like they have committed to a large one yet. Maybe they believe the environment is looking better in coming months, plus with the cash they can get from current and future inventory reduction/RE/availability on ABL – they apparently believe more drastic actions aren’t needed at this stage – the management team has been running this business for more than three decades and has navigated a multitude of environments.

What is the business worth?

In Dorel’s pre covid years (figure 1), revenues were ~$850M in home and ~$915M in juvenile, for a combined ~$1.77B. The segments averaged $76M and $70M in adj EBITDA, for a combined $146M before unallocated corporate G&A of ~$27M today, post G&A this would be $119M in EBITDA on $1.77B revs, or a 6.7% EBITDA margin. EBITDA should be adjusted lower by another ~$37M due to IFRS accounting for leases – meaning historical EBITDA run rate of ~$95M (5.4% EBITDA margin).  Dorel run rate capex is just ~$27M as well.

Again, I don’t see how Dorel doesn’t get back to these approximate figures, and they probably do (on a run rate) in 2024.

In my conservative base case, I use normalized EBITDA of $95M (avg of 2016-2021). Dorel would be worth at least 5.75x EV/EBITDA or $546M less $125M in pf net debt for $421M in equity value across 32.5M shares or ~$13/share. This is just 0.32x EV/sales as well, I would consider this quite low and highly conservative for a consumer products company with many leading brands.

The family is clearly set on maximizing value and harvesting the fruits of their labor via selling the business in a better macro. I am confident there are fairly large run rate cost savings opportunities in each segment for a strategic or a financial – likely at least $20-25M in each segment for a financial and likely $40M+ in each segment for strategics – which would drive those pro forma multiples even lower for an acquirer.

If they don’t immediately go the sale route in 2023 or 2024, I believe they will flip back on the dividend by 2024 (or buybacks) – and a $1/sh dividend should be well covered by FCF, this would put the stock at an absurd 28% dividend yield.

For the current stock price of $3.50 USD to be correct, one must assume normalized EBITDA is ~$45-50M (high 2% EBITDA margin), and Dorel dilutes (unlikely), and doesn’t refocus on a sale, this is a forward EV/Sales of 0.16.

The real bear case would look something like the company needing to raise cash so they do a rights offering for ~15M shares at ~$3.50, this would defeat the debt/leverage concerns but would dilute and leave 47.5M shares. Dorel should later sell for a bear case $425-550M EV which would be $7.20 - $10/sh post dilution. Still not a bad outcome for a bear case. I think it is clear that this would not serve management’s interest so I don’t think they will do this and instead focus on reducing inventory (and selling RE if needed) to get debt down swiftly.

Precedent Transactions in Home and Juvenile Products:

FWIW I count >$700M in acquisitions Dorel has made in its home and juvenile segments from 1998-2014.

Other

Management buyout – Management actually did try this in 2020 when they partnered with Cerberus seeking to MBO at a very slim premium. Dorel couldn’t get enough votes as large shareholders aggressively spoke out against, those shareholders are still in Dorel and some of them have increased their positions. I don’t believe an MBO is a credible risk going forward. I believe the Schwartz family is now doing the Cerberus (or PE) playbook on their own and maximizing value, they made a great sale in 2021 of the sports segment which they sold for $810M (~10x EBITDA) and paid a $12/sh special along with paying down most of the debt. Dorel has been clear they plan on maximizing value via sale(s) of the remaining home and juvenile segments when the macro clears up. They own 20% and could ride off with close to $100M if they monetize at a conservative fair value, the family members are in their 70s and 60s as well. This would be in their best interest, as well as shareholders.

Recent insider buying - Jeffrey Segal (Executive VP of Sales and Marketing), the brother-in-law of the Schwartz family – purchased 50k shares in mid-November at CA$4.88/share.

Dorel is likely a prime tax selling candidate for many given it is down 80% ytd (paid $12 USD special in 2022).

Conclusion

I believe Dorel is an orphaned stock that is extremely mispriced, while short term numbers may not be pretty, Dorel has plenty of liquidity and an improving cash flow outlook plus options to make it through a recession to the inevitable normalized earnings power of ~$95M in EBITDA. While a sale is not needed to win big, it is highly likely to occur within ~2 years and these assets would surely go for multiples of the current stock price.

Catalyst

inventory normalization, light at the end of the tunnel on recession, value maximization plan resumes in a more reasonable macro.