Price: C$10.70 (2/15/2012)
Recently a reader sent me an email asking for my opinion on a stock they were looking at. The company is Danier Leather a Canadian retailer. The company has retail locations located in malls and power centers which are large outdoor malls. Danier is a vertically integrated leather company meaning they don't just sell leather apparel they also design and manufacture it. They source their leather from China and then manufacture their designs domestically.
Before I dive into the weeds I want to make a small investment case for Danier Leather:
-Trading slightly above NCAV
-55% of market cap in cash
-EV/EBIT of 2.16
-EV/FCF of 11.02
-ROE of 12%
Asset value examined
I recently overhauled my net-net template to something that I think will be easier to read and contain more information. Danier is a perfect company to trial the template on:
There are two columns, the first shows the balance sheet values for different assets. The second column shows a discounted value of that asset. Both columns have a per share breakdown as well.
So as you can see with Danier they have an NCAV of $9.06 a share, and a discounted NCAV of $6.08 per share. Most of the company's assets are in cash and inventory which isn't surprising given they are a retailer. It might seem strange that they don't have a large account receivable balance but this makes sense. When a customer comes into a store they pay on the spot, the company shouldn't be waiting for a payment from customers at all.
The item that stuck out to me when reviewing the balance sheet was that there was a relatively small balance of fixed assets. Knowing that most locations are in malls I figured Danier doesn't own any retails space. So I searched the annual report for operating leases and voila an off balance sheet contingency.
Adding back the operating leases discounted to the present squarely knocks Danier out of the net-net category. If they were to liquidate they could still contractually be on the hook for those leases, and the minimum lease amount is more than cash on hand eliminating that buffer.
Fortunately for the reader who asked about Danier all is not lost. Even though Danier isn't a solid net-net it's not really a problem, the company has no plans to liquidate and in fact they have something most net-net's don't have, a decent business.
The operating business
The company has had a nice run of profitability outside of a small loss in 2009 which is a bit surprising because Canada only had a mild recession as a result of missing the housing bubble. Some people argue that Canada is in a housing bubble now, but based on Danier's earnings it doesn't appear like too many people are borrowing on their homes to purchase leather goods.
The company has a nice summary in their annual report of the past few years results:
The key takeaway for me is that results aren't consistent but they've been profitable four out of the last five years. The second key point is that shares outstanding has been declining at a pretty rapid pace, almost 30% fewer shares in 2011 than in 2007.
The next thing I did was to steal an idea from Richard Beddard at Interactive Investor Blog (a must read if you don't already). He likes to show the growth in book value by breaking out tangible assets, intangible assets and cumulative dividends. Danier doesn't pay a dividend so I decided to do two charts, one showing assets on a gross basis, and the second showing assets on a per share basis. The second chart is what shareholders get as a result of buybacks, a steadily increasing book value per share.
Assets per Share
The last thing I looked at was the return on invested capital. I get questions about this all the time so I want to explain my calculation. I take free cash flow divided by equity minus cash plus debt and operating leases. So let me explain a bit, I use free cash flow because this is a realized return above what the company needs to operate. This eliminates companies that eat up a dollar generating a dollar even if on a net income or EBIT basis returns look great there's nothing left over for shareholders. Secondly I add in operating leases because this is an intangible asset the company needs for their business. If Danier didn't have their leases they wouldn't have a place to sell their apparel.
In computing this for Danier I ended up with a 3.56% ROIC. Here is the calculation:
Putting it all together
So what we have is a retailer that has a solid balance sheet operating leases not withstanding. They have a stable sales history and a pretty good track record of profitability recently. The company's free cash flow has fluctuated over the years with inventory build ups and draw downs. When free cash is flush the company's used it to buy back shares which have increased the book value for shareholders.
I like to invest in businesses that have an absolute margin of safety which is something I'm not seeing with Danier. The balance sheet at first appears to provide it but once all liabilities are considered the margin disappears. The company is undeniably cheap trading below book, with a low P/E and EV/EBIT multiple.
Danier doesn't jump out to me as a fat pitch stock. The stock is cheap, but there are a lot of cheap stocks out there. The question to ask "Is Danier cheap due to it's business or something external?" I don't know the answer. I also recognized I'm biased because leather doesn't seem to be in style in the US, which means nothing for Canada and a Canadian retailer. This is probably the type of stock for someone who likes to build a portfolio of low EV/EBITDA, EV/EBIT or P/CF stocks would own and do well with.
Talk to Nate about Danier Leather
Disclosure: No position