Prada with Peanut Butter

What do Costco and Carrie Bradshaw have in common? Fendi.

High end designer merchandise has been popping up in the unlikeliest of places. In the past one had to go treasure hunting in discount retailers such as TJ Maxx and Ross for a great luxury find that did not break the bank. These would mainly be discounted items from previous seasons. But now you can find high end merchandise alongside your groceries and cleaning supplies. Target has been collaborating with designers such as Isaac Mizrahi, Prabal Gurung and Missoni. Similarly you can run into Prada and Fendi at Costco. Kohl’s has been selling Vera Wang and Juicy Couture for a while. But is this really a good strategy for these brands? Or is luxury for less, less luxury?

What Works? A sales platform like Costco for instance, gives a designer brand exposure to the company’s 71.2 million cardholders. The average household income of a Costco customer is approximately $96000[1]. For Target customers the median household income is $64,000. Some of these people may not have purchased a full priced high end item from a designer or department store, but may be willing to try it at a lower price point during their usual shopping trip at a mass retailer. So these stores are a gateway to a large, untapped market of higher volumes (although usually lower price points) for the luxury brand. Also for some shoppers exposure to an accessible version of a luxury brand may be the initial hook that pulls them into the world of high end merchandise.

What Hurts? There are two ways in which the move to reach the masses could backfire for some makers of luxury merchandise and lead to a dilution of their brand. Firstly, if they produce lower quality versions (to match the lower price) of their full line merchandise specifically for sale at mass retailers it could hurt the overall reputation of the brand and actually lead customers away.

Secondly, for many people buying a high end item is not just about paying a higher price for great quality. It is also about acquiring a status symbol. If Prada was sold at the same store as peanut butter, that may dampen the “posh factor” for some loyal customers of the brand.

Is it worth it? Among many other factors the success of this strategy depends upon the price and income elasticity of the product being sold. And that depends on the type of product in question.

Luxury goods like high end designer merchandise are defined as products whose demand increases more than proportionately as income increases. But their relationship to movements in price can be interesting.

Usually luxury goods are price elastic, so a change in price leads to a more than proportionate change in demand for the product. Price elasticity can be defined as the percentage change in the volume of a good demanded with a one percentage change in its price, everything else equal. Let’s assume that a luxury handbag is highly price elastic. So for example, a one percentage price cut leads to a ten percentage increase in its sales. In such a case selling more handbags for a reduced price may lead to higher total revenue for the seller. Taking their merchandise to the mass market at a lower price point may be a good bet.

Alternatively, if sales of an item do not respond as greatly to price changes, then selling fewer but more expensive units would generate greater revenue and could be the better way to go. This price indifference could occur in instances where there is a great degree of brand loyalty, or the price of the item is a tiny proportion of the buyer’s budget.

This is just a small piece of a much larger cost benefit analysis that any luxury brand would need to do before making the decision. In the meantime, there are more options in the market for shoppers!

Costco: Is it in your shopping cart?

The over sized shopping carts and super sized merchandise of Costco (COST) is familiar to most Americans and even some customers overseas. As a members only warehouse it provides a diverse selection of merchandise to its customers at a discounted price. While the loaded shopping carts and long checkout lines at the warehouses suggest that people have bought into Costco’s idea of quality at a reasonable price, but does the bargain end inside the store?  Or are the company’s shares a good value for money for the long term investor? The following is my view of Costco’s growth potential and valuation.

Business Model:  The Company operates over 550 warehouses in the United States and Canada. It also has a smaller, but growing, footprint in the United Kingdom, Mexico, Japan, Korea, Taiwan, Australia and Spain.  While targeted towards small business owners, the warehouses also meet the needs of households with their selection of groceries, home supplies, furniture, furnishings, pharmacy and even gasoline. The business is built on the principle of providing cost savings to customers by sourcing merchandise directly from manufacturers and shortening the distribution channel. In addition the warehouses have shorter hours, minimal aesthetic displays and limited number of active SKUs to reduce labor costs and increase efficiencies.

Growth:  Costco’s two main sources of revenue are sales and membership fees. Since 2009 both have expanded over 10% annually on a compounded annual growth rate basis. Food and sundries (such as candy, alcohol, cleaning supplies, etc.) contribute the largest share in revenue. The company operates with tight margins and needs to maintain its fast inventory turnover along with growing its membership base. Its in-house brand, Kirkland Signature, generates a higher margin and could be a useful income source if it continues to grow as a proportion of sales. 

When it comes to sales it is important for the company to grow organically, as well as add new warehouse locations. Same store sales of the company were in negative territory in the aftermath of the financial crisis in 2009, but have recovered admirably since. In comparison to its major direct competitor Walmart’s Sam’s Club, Costco’s comparable store sales performance has been stronger.

Change in Comparable Store Sales*

2013

2012

2011

2010

2009

Sam’s Club

0.4%

3.9%

8.4%

3.7%

-0.8%

Costco

6%

7%

10%

7%

-4%

* Sam’s Club and Costco fiscal years are different.

The company has also been expanding through new stores both domestically (an average of 11 new stores per year in the United States since 2009) as well as internationally. In fact by the end of this month, the company expects to open 3 new warehouses. There is more room for growth in the international markets where the company’s presence is still not as large. Same store sales performance of warehouses overseas has been at par with the United States in the last couple of years, but international markets are more profitable than the domestic market. So there are opportunities to grow both sales and margins in those markets as well.

Treasure Hunt:  An approximation of revenue per square foot also shows that Costco’s generates over $1100 per square foot racing ahead of Sam’s Club over $674 figure. The company has been maintaining this strong performance through large sales volumes and quick inventory turnover supported by its limited yet high quality and fast moving selection of merchandise. Since the company is on the lookout for the best deals, it does not consistently carry the same products that it may have sold before. Anecdotally, while this can be frustrating for some shoppers it also leads many to stock up whenever their favorite product is being sold in the stores. Additionally there can be an element of curiosity pulling people into the stores to discover what new product lines are being sold each time. Similarly the practice of moving products around within the warehouse also may help with putting customers face to face with new items they may not have bought otherwise.

Keeping it Simple:  Another point in favor of Costco is that management understands its market and target customer. The focus is on offering low prices without compromising quality and so it has stayed true to simple warehouse style stocking of items and shorter hours that save on labor costs.

In terms of e commerce, there has not been an overly zealous approach in that area. Online sales are only 3% of total revenue and could be a potential growth area in the future. While management is cognizant of future opportunities/challenges in the ecommerce channel, I think it has wisely kept its focus on the warehouses which are the core of the business at present. Similarly marketing via its newsletter Costco Connection and other activities is limited but targeted.

Employee Satisfaction:  One of the business ethics that Costco follows is that a happy employee leads to a happy customer. It is well known that the company pays an average of $21 per hour to its employees, much higher than its direct competitor Walmart. The company also does well in offering career growth opportunities to its employees since it follows a model of promoting people within the organization, from warehouses to corporate offices. Unsurprisingly, employee turnover rate is low and sales per employee are strong.

 Brand Value:  A harder to monetize yet important metric is what I like to call “brand value”.  In this case I looked at the loyalty that the Costco brand enjoys reflected in its total membership renewal rate which has continued to strengthen, reaching above 90% for U.S. and Canada and above 87% internationally in the last quarter. Among business members the renewal rate is even higher, that is, above 94%. This implies that the company has a stable, growing base of customers that are loyal to the brand as long as it maintains its product quality and pricing.

Valuation:  The shares of the company were trading at $118.64 at the time of writing. This price is above the company’s 100, 50 and 20 day moving averages and just below its resistance ceiling calculated with recent price data. Additionally the peak closing price in the last three months was $119.59, close to the current level at which the stock is trading.  

The current price puts the trailing twelve months price to earnings ratio at 26.55, which at first glance is not inexpensive in my book. Alternatively, the forward P/E is estimated to be around 23.04, which is more reasonable.  Also the trailing 12 month price to sales ratio for Costco is 0.48 which is lower than that of its direct competitors.

Another good forward looking measure to consider would be the price to earnings growth or PEG ratio. Given that the company has seen EPS growth of 9.88% per year compounded annually for the last 5 years we can make some assumptions about future growth. Assuming this growth will continue in the near future and adjusting for dividend yield (since that is another consideration for investors besides earnings growth) the result is a PEG ratio of approximately 2.4. This is on the higher side compared to its direct competitors in the industry.

A point to note is that the company has been continuously adding new warehouses domestically and internationally. Since profitability is higher overseas and major U.S. competitors have a limited presence there, it is a possibility that earnings growth may improve in those markets. Also if the company can continue to increase sales of its higher margin Kirkland Signature brand then that would be another impetus for better earnings.

Overall: Costco is an example of a company that has proven to be a sound business idea combined with good execution.  It has potential to expand its footprint in the United States and overseas and I would look for a price level near the 100-day moving average ($115 – $116) to pick up some stock in the company.

Walgreens: Not Leaving on a Jet Plane

The price of Walgreens (WAG) shares plummeted after the company announced that it had no plans to shift its headquarters overseas as part of its acquisition of Allianz Boots and take advantage of the “inversion loophole”. The company’s management cited reasons like the burden of IRS scrutiny as well as public and media backlash as drivers of the decision. The move may be considered patriotic by some, but did not get the stamp of approval from disappointed shareholders. Wall Street expectation was that Walgreens would follow the footsteps of several other corporations that have acquired companies located in countries with lower corporate tax rates primarily for the benefit of slashing their U.S. tax burden. But Walgreens was not alone in forgoing the overseas tax advantage and retaining its headquarters in the homeland. Agricultural giant Archer Daniels Midland (ADM) also decided to move its headquarters to the Chicago area despite rumors of a possible move overseas associated with its recent purchase of Swiss food ingredient producer Wild Flavors.

While these companies refrained from this lucrative but ethically ambiguous option, there are many others who have leveraged it. A recent article in the Wall Street Journal reports that this has been the chief motivation for approximately 66% of international deals announced this year. Corporations such as pharmaceutical company AbbVie have initiated mergers with foreign counterparts in the recent past that could result in large tax dollar savings. So I have been wondering if this was a smart move or a missed opportunity for Walgreens.

Anyone reading the news will see that this topic is heating up in Washington. President Obama has expressed his resolve to tackle this loophole and prevent U.S. companies from “gaming the system”. Although any substantial executive action may be easier said than done in the near term, the issue is definitely on the radar. So for a business that is estimated to earn a sizeable chunk of its revenue from Medicare and Medicaid program prescription sales, picking a fight with Washington may not be the greatest idea. Since Walgreens is such a universally recognizable brand, there is greater awareness and somewhat higher exposure to backlash from the government and general public compared to other companies that may not have as much direct consumer recognition. So in the case of a possible inversion investigation, large PR costs would likely be piled on top of legal costs.

Additionally inversion deals could lead to greater burden of corporate gains tax on shareholders even without selling any shares when they receive shares of the new corporation. There are ways to mitigate this impact, but it is another case in point that this route may not be an obvious win for shareholders as it appears to be initially.

The debate over whether it is justified for companies to evaluate the option of inversion deals or not, and what would be the optimal way to dissuade them from it, is not likely to be resolved easily. In the case of Walgreens, while the initial shareholder response to the decision was negative as manifest in its stock price decline, for the long term investor the focus should remain on fundamentals and growth.

Going Organic

Walmart recently announced that it was partnering with Wild Oats to sell organic foods in their stores at prices 25% below other organic food brands. If successful this could be a game changer in the organic foods world, typically understood to be a niche market for a premium paying customer. In this regard Walmart has a potential goldmine of untapped customers who shop on a budget and have been keeping away from organic foods due to the cost factor.

The opportunity that lies open before Walmart is a market that currently makes up about 4% of total grocery sales in the United States and is expected to grow to 5% by 2019. The largest components of these sales are produce and dairy. In the case of dairy, the share of organic to total milk sales ratio in the United States has grown from 1.92 in 2006 to 4.38 by 2013. Interestingly during this period, except for the year 2009, there has been a decline each year in total milk sales while sales of organic milk have been increasing. Since around that time consumers were feeling the direct hit of the Great Recession on their personal finances, it may be possible that it led to a cutback in the purchase of higher priced organic milk. However the fact that every other year the consumption of organic dairy has increasing might suggest that the status of organic foods as “luxury” grocery may be changing. And Walmart could benefit by taking it even further in affordability to a growing number of customers who are willing to try it.  In fact Walmart’s own survey indicates that 91% of their customers would be willing to buy organic foods if they were available at more reasonable prices.

But the question is whether the reduction of this price premium by Walmart will pose a threat to the Natural foods stores that have so far been out of reach for a majority of customers. The typical customer who shops at such stores is already willingly paying a higher price not only for their grocery, but also for the ambiance, the healthy cuisine in-store restaurants, and so on. So natural food stores can probably keep this group of customers even if Walmart offers a more competitive price. However, it is the potential “converts” who are not buying organic foods at present but would try it at a more reasonable price that could open up a still largely untapped market with great growth potential.

 

Ceco Environmental: Three Takeaways from the Q4 Conference Call

Ceco Environmental (CECE) is a global air pollution control company that I have evaluated in the past as a potential investment opportunity. In its recent released Q4 2013 earnings report the company beat expectations with an EPS of $0.26, but missed revenue expectations. This was despite the fact that its revenue expanded over 100 percent year over year, mainly on account of acquisitions, and gross profit was up 50% from last year. But to me the highlights of earnings release were in the following three themes that indicate the future direction of the company.

Acquire and Integrate: In my last article on Ceco I had written in detail about the business and management’s strategy relating to acquisitions. Total revenue in 2013 was $197 million compared with $135 million primarily due to the acquisition of new businesses. In order for an acquisition to be successful it is crucial for the integration of the new asset with the existing operations to be seamless. In this regard the company has been successful so far in smoothly integrating the recent acquired MetPro and realizing $9 million of synergies from it. Management has consolidated 3 manufacturing facilities and office buildings, selling the Met Pro facility and moving ahead on the path of realizing synergistic value from the integration. Recent acquisitions have opened up new revenue sources, contributed to an increase in bookings as well as more recurring business opportunities. Another example of the effective management of the integration process has been that operating margins improved with MetPro under the Ceco umbrella, and the company was also able to achieve 19% SGA including MetPro, despite it having run on higher SGA before.

Grow Overseas: The Company currently has about $3 billion of installed capacity worldwide and there is an opportunity to grow recurring revenue from this source since currently it counts for only about a third of the business. It is looking to expand operations in China both as a market and manufacturing source. In fact, it was indicated that there could be a potential acquisition as part of a manufacturing expansion initiative in China in the near future. While the company has operations in countries like India, China, Canada and Latin America, a large proportion of the business is still in the United States. So there is still room for expansion of its business internationally. Moreover in developing countries environmental/pollution control regulations and laws are likely to grow and create opportunities for the company.

OneCeco Initiative: Most of the revenue growth reported in the quarter was from acquisitions and organic growth was not robust during the period. But one of the company’s initiatives highlighted in the earnings call could also be instrumental in moving the dial on this. The OneCeco sales initiative is a tool to consolidate all air pollution control products and technologies and use this powerhouse to gain more market share and grow margins. The company is tracking its sales performance closely under this OneCeco “segment” and management expects that only 50% of the gains from this initiative have been realized yet. The initiative has already resulted in the creation of over 150 new RFQs and led to over a dozen new air pollution control projects. I think this could be an astute way to blend, bundle and leverage economies of scale for the benefit of Ceco as well as its customers.

Why I am currently Neutral on Blucora

Blucora (BCOR) has been in the news for all the wrong reasons lately. First, the company was hit with accusations of possible policy violations which resulted in the stock tanking. A couple of days later the company released their fourth quarter earnings beating both revenue and EPS expectations, but lowered guidance for the next quarter. Management revealed that Google, their largest search partner and contributor of the lion’s share of their search revenue, had renewed their partnership but only partially.

The last time I wrote about the company in October 2013, I had analyzed its growth potential based on recent performance and acquisitions. In the same article I noted concerns regarding its relative inexperience in the mobile space and heavy dependence on Google, but overall it still appeared to be a good growth opportunity. Recently, in the light of events mentioned above I decided to take a more cautious “hold” approach towards the company. This was because these events brought into sharper focus for me the importance of the following –

  1. Blucora’s dependence on Google
  2. Need for better information on the company’s future strategy

Dependence on Google

While I have no way of knowing about the accuracy of any of the accusations raised against the Company, it does make one thing very clear. Even the suggestion of a doubt on the future of the Blucora-Google partnership can wreak havoc on the stock. For context, the Search segment of the company’s business is about 75% of their revenue and Google alone accounts for nearly 85-90% of it. So at least at present, Blucora’s success is closely intertwined with its relationship to the search giant.

It helps that the company announced in its earnings call last week that Google had renewed its partnership with them until 2017 in the desktop search area.  However the renewal did not extend to the mobile and tablet space. The immediate implication is the financial headwind, reflected in lowered guidance. The long run implication is the possibility of a further break in the alliance with Google in the future. Since the Android OS has the largest market share in the mobile market globally, it also implies that Google is the search engine of choice in that medium. So the end of Blucora’s mobile/tablet agreement with Google is a blow to the company.

But to put this into perspective, mobile is a relatively small driver of the company’s search revenue at present. Management stated that about 85% of the search traffic from Google comes over desktop, which is still covered under their renewed agreement. Alternatively, on the mobile front the company has other liaisons like Yahoo that will continue to power their searches. Also the mobile/tablet market still has a lot of unchartered territory; so the company could potentially carve a niche for itself in that space. Management mentioned plans during the recent earnings call to explore search and non-search solutions like text, video, etc. But there is still not enough clarity around the company’s plans for mobile growth. In my last article as well I had concerns about the Search segment’s lagged development in this field.  But with this latest development with the Google partnership, this issue has become more relevant.

 

Needed Clarity on Long Term Strategy

In the recent past the company has made a move to diversify its revenue streams through the acquisitions of the DDIY tax business TaxAct and the ecommerce business Monoprice. Both segments have been performing fairly well, although ecommerce sales were softer than expected in the fourth quarter. Overall the ecommerce segment generated revenue of $39.7 million in the fourth quarter with order growth of about 10%. TaxAct revenue grew at about 75% year over year while recording a loss, in line with expectations, due to seasonality in the tax business. It is expected to track guidance in the 2014 tax season.

At present these two acquired segments combined comprise only about 25% of the company’s total revenue. They are also very different from the company’s core search business. But while they may not be obvious synergistic acquisitions, they may turn out to be useful diversification tools that the company needs. One advantage is that they open up the growing DDIY tax and ecommerce market to the company that could potentially grow into a larger proportion of sales in the future. In fact, if the company has more future acquisitions planned that are executed and integrated successfully, then this may be a way to reduce the heavy dependence on search and Google. But again, the long term strategy on acquisitions and vision of what the company wants to evolve into, is not very clear at the moment.

Conclusion

At present Google is certainly the mammoth in the search landscape. So in the near future at least, the success of Blucora’s search segment is tied closely to its partnership with Google. Currently I am comfortable with a more cautious approach of having a neutral position towards the company. I would like to wait and watch how it operates in the mobile world without Google, and get more information on what plans it has in the future of building a business that is not overwhelmingly dependent upon one partner.

 

The week ahead in economic news…

  • Tuesday
    • Case-Shiller home price index December data is scheduled for release on Tuesday.  Although lagged by nearly two months, a noticeable slowdown would support other housing indicators.
    • Consumer Confidence February results are also expected to release on Tuesday.  Consensus expectations point toward an index value around 80 on par with January.  Continued sluggishness in the job market could push the consumer confidence numbers to come in below expectations.
  • Wednesday
    • New home sales January results are expected to release, and expectations are for slightly lower numbers compared with December.  With the decline in existing home sales, new home sales could come in below expectations as winter weather and low inventory more than likely hampered sales in January.
  • Thursday
    • Weekly Jobless numbers will be released which will provide further insight into February’s employment picture.
    • Durable goods orders for January could shed some additional insight on the state of the economy.  After a noticeable 4.3% decline in December, orders are expected to decline a further 2.5% in January.
    • Markets will be closely watching Janet Yellen’s testimony at the Senate for any additional insights into the Fed’s monetary policy.
  •   Friday
    • Q4 GDP revision release and expectations are for a downward revision of 2.4% compared to an initial release of 3.2%.
    • Chicago PMI for February is expected to come in at 56.0, down from 59.6 recoded in January.
    • The release of January pending home sales should provide some insight into home sales in February.  The 8.7% decline observed in December brought the index to the lowest level observed since Oct-2011.

Chipotle Mexican Grill: the Good, the Bad and the Unknown

As a frequent customer of Chipotle Mexican Grill (CMG) I have been happy with the quality of food, promptness of service and reasonableness of price that I have experienced. Given that its revenue has expanded in the last five years at a compounded annual growth rate of almost 21%, there are many others that share that feeling. The company has risen as a leader in the “fast casual” industry, intelligently filling the gap that existed between less healthy fast food options and healthier but more expensive sit down restaurants.  My own experience as a customer and Chipotle’s incredible growth story has prompted me to don my investor hat and try to evaluate if buying the company’s stock would be as satisfying as buying its delicious food.

The Good

1.       Simple Concepts: Chipotle has built a business and a reputation by focusing on a few basic ingredients and serving dishes that are based on permutations and combinations of those. This makes it easier for the company to focus on improving the quality of these ingredients. It has done so by moving towards more organic, sustainably grown or raised, non GMO, lower carb raw materials.

In terms of service as well, having few simple ingredients is very helpful in keeping speed and service levels high in their assembly line style setup of made to order meals.

Every so often the company does expand its offerings to cater to a wider range of customer tastes and preferences. Some examples are sofritas or tofu for vegetarians or salad and burrito bowls for the carb conscious. But overall it has stayed true to using a few building blocks to build many different structures.

2.       Strong Financials: Chipotle has been continuing along a path of robust financial growth for the last several years. After the company reported its solid Q4 2013 performance recently the stock soared 12% at opening the next day. The fourth quarter was another strong quarter for the company with revenue growth of nearly 21% and comparable restaurant sales growth of approximately 9% on a year ago basis. Operating margins for restaurants increased by a 100 basis points year over year, while earnings per share increased nearly 30% over prior year to $2.53 in the fourth quarter.

Historically, between 2009 and 2013 the company’s revenue grew at a compounded annual growth rate of nearly 21% and diluted earnings per share grew at about 28% over the same period.  The company ended the year 2013 with over $323 million in cash and cash equivalents and 185 more restaurants under its belt. Another attractive factor is that it has virtually no long term debt and total cash per share of $18.64. While the company does not pay cash dividends, reinvestment of cash into the business can compensate the stock holders by providing future returns.

3.       Room for Expansion: The Company has been growing its culinary empire in three main ways; new restaurant openings, organic growth and international growth. As of year ended 2013 it operated 1572 restaurants in 40 states in the U.S., 7 in Canada and 9 in Europe. So there is still plenty of room for both domestic and international expansion. An instance is that the first Chipotle location opened up in Reno only earlier this month.

Additionally expanding its frontier overseas could be instrumental for the company in maintaining the pace of growth that it needs to justify its price. In the last quarter of 2013 the company opened up a total of 56 new restaurants and plans to open a total of 185-190 locations in 2014. Included in this growth are the company’s ventures into Asian fast casual through its ShopHouse restaurants in the D.C. and L.A. areas, as well as, Pizza Locale, its experiment with pizza, in Denver. If it is successful in taking the ideas and culture that has helped make Chipotle a trailblazer in the industry and applying them to these new types of cuisines, then it could be a great way for the company to branch out and grow. It is also investing in a more enhanced marketing plan using digital media, food and music festivals to increase its reach to potential customers.

The Bad

1.       Valuation Multiple: The least attractive thing about Chipotle for me right now is its valuation. From a Price to Earnings perspective it is valued at over 50 times earnings. This puts immense pressure on the company to deliver stellar financial results quarter after quarter and maintain strong sales growth rates, which can be challenging. For instance, 2013 revenue growth over prior year was about 18%, which while strong, was a little below growth rates from the previous few years. If this does prove to be a trend of plateauing growth, and the company is not able to accelerate with help from expansion into new markets and cuisines, then a multiple of this level will become very hard to justify. Also with such rapid growth and lots of public exposure, the company has to not only perform well but beat a lot of high expectations continuously to maintain growth in its stock price, and justify the high valuation.

 

2.       Comparable and New Restaurant Sales: Drilling down into comparable restaurant sales, the company gave guidance of low to mid-single digit growth in 2014 mainly because of tough 2013 comps. This organic growth is important for the company as there are higher margins associated with it. Also, as noted in their 10-K filing, in the past the stock price has slid down when the company experienced slowing comparable sales. While the company is skilled in maximizing efficiency and productivity from each of its restaurants through strategies like its assembly line setup, placement of best employees during peak hours, etc., there is a peak beyond which it is not possible to increase productivity. For example, the record so far has been 300 customers served at a location in one hour. While impressive, this is neither the average, nor easy to maintain and exceed.

As far as new restaurants are concerned, the company has a lot of opportunity to grow in domestic and international markets as I wrote above. This is also the main source of sales growth for the company. But the guidance for 2014 indicates between 180-195 planned restaurant openings in 2014. In the years 2013 and 2012 the number of new restaurants opened were 185 and 183 respectively. So the rate at which new restaurants are added has not been accelerating in the last few years.

Additionally, the company does not franchise. This helps with maintaining consistency of product and service but can be a limiting factor on growth.

 

3.       Brand Dilution: The Company has undoubtedly done well so far, establishing itself in the fast casual healthy Mexican food business. By extension it should be able to apply the same panache to its new Asian and pizza ventures. But there are also chances that by wearing too many hats the company may not only fail to succeed in the new initiatives, but also lose focus on its core business and take a hit to its reputation.

Another issue for the company is upward price pressures on its food ingredients in 2013, that are expected to continue in 2014 as well. Pressures such as these pose a difficult situation for the company since its USP is selling healthy, high quality food at a reasonable price. The tradeoff between potentially raising menu prices versus abandoning some of the company’s organic, non GMO food initiatives could impact the image of the company.

 

The Unknown

Conclusion: Will Chipotle Mexican Foods stock keep going from strength to strength, or will it have a hard time justifying the high P/E multiple it is trading at presently, remains to be seen. Powered by continued financial strength and a business that has given new meaning to “fast food”, Chipotle stock has been soaring. Between its last closing price and the same day a year ago, it has grown over 76%. While there are many factors that could propel its growth in the future, I think that at the moment the valuation puts it out of my comfort zone. It may continue to perform well but I think it might be a challenge to keep growth continually at the same pace, or ahead, of expectations.

Acme United Corporation – Value in Simplicity

Some companies slip under the radar for investors simply because what they offer is not exciting or groundbreaking. Yet, they may be solid, well-managed businesses that are good value for money. I think Acme United Corporation (ACU) is one such company. Its strong fundamentals, reasonable valuation, tactical acquisitions, strategic partnerships and pool of intellectual property, make this low profile business interesting.

Business: Through it brands Westcott, Clauss, Camillus, Physician’s care and Pac Kit, the company sells cutting and measuring tools and safety supplies for a variety of uses in homes, offices, industries, hospitals and schools. Typical products of the company include scissors, knives, sharpeners, paper trimmers, medical cutting instruments, measuring instruments, first aid kits and the like. It employs 171 full time employees and operates in the United States, Asia, Canada and Europe through wholesale and retail distributors, hardware stores, office supply stores and so on. In 2012 it generated revenues of $84.4 million with 80 percent of its total sales attributed to the U.S. segment (which includes Asia), and 10% each to Europe and Canada. Its import sales to the U.S. from its Asian business have been growing as a percent of total sales from 16% in 2012 to 22% in 2013.

Financial Performance: The Company reported robust growth in Q3 2013 as net sales grew nearly 9% and gross profit expanded by almost 7% year-over-year. The five year annualized revenue growth rate has been nearly 6%. Net income and earnings per share also advanced over 20% and 15% in the same period from a year ago. Net cash from operating activities was at $3 million at year-end September 2013, compared with a negative $1.4 million balance in 2012. The net debt position of the company also improved to $13.2 million by Q3, down about a million dollars from the prior year.

While the U.S. segment sales grew by nearly 10% and sales in Europe witnessed a robust 26% growth, sales in the Canadian segment declined due to weakness in the office products business and losses from some large accounts. However, the U.S. segment was bolstered by improved performance in Camillus knives sales, growth in first aid kits and stronger back to school sales. In the European segment the strong growth was fuelled by increases in mass market retail of knives for kitchen use, new distribution by signing on a large German distributor and expansion into Scandinavia.

The company declared a cash dividend of 8 cents per share in December in line with previous, which has been growing at a five year annualized growth rate of almost 17%.

Valuation Multiples: From a price to earnings ratio perspective, the company trades at a reasonable multiple of 12.44 which is lower than the industry average. The price to book ratio is also below 1.5 while the price to sales is a modest 0.55, which is below the industry average of 1.11 and much below one of its direct competitors, Johnson and Johnson (JNJ).

Tactical Acquisitions: The Company has been making moves to grow and diversify its business through a series of acquisitions and strategic partnerships. In 2011 it acquired Pac-Kit, one of the oldest brands in the first-aid kit business, for $3.4 million. The first-aid kit business has been one of the strong performers for the company and it has since been moving forward in producing hazard protection kits for disaster management.

This was followed by the acquisition of the C Thru Ruler Company in 2012 for which the company paid $1.47 million for inventory and intellectual property. It produces transparent measuring instruments which has increased the company’s exposure to students, schoolteachers and scrap bookers.

In 2013 the company acquired a new, 340,000 square feet manufacturing and distribution facility in North Carolina for $2.8 million that is meant to consolidate two distribution centers and improve operational efficiency. While the company had duplicate operating costs of two facilities as it upgraded the new purchase, in the long run it provides additional space to expand operations and /or store inventory. After adding in the price of updates to the purchase price the facility will cost the company upwards of $4 million, but has been estimated to have a replacement cost of $13.5 million, potentially making it a bargain buy for the company.

Each subsequent acquisition that the company makes provides it with another step forward towards diversifying its product offering and customer base and creating capacity to fulfil future demand growth. Since it operates in an industry with low barriers to entry, this broader customer base and brand familiarity for customers could be useful to compete.

Innovation and Partnerships:  The business of Acme United may not sound thrilling, but it too calls for product innovation and thoughtful design. Along these lines the company has continued to develop new and improved products like titanium coated non-stick cutting tools for better performance, measuring instruments with non-microbial coating and new disaster survival kits. It continues to invest in R&D and maintains several patents and trademarks that are critical for business preservation and brand recognition.

An innovative marketing strategy has been to partner with survivalist Les Stroud to develop and design survival tools, knives, etc. This adds a touch of adventure and excitement to the business and uses the celebrity survivalist’s reputation to reach out to a new group of customers.

Another astute liaison emerged between Scott’s Miracle Gro and Acme United in 2013 when the two companies entered into a licensing partnership to develop two new types of garden tools, namely, Scotts Air Shoc and Miracle Gro Environline. This provides Scotts the opportunity to expand its repertoire to garden tools, while for Acme it is another avenue to increase sales and become more visible to the established customer base of another retailer.

Seasonality: One of the challenges for the Company is the seasonal nature of its sales, primarily due to timing of back to school sales. It typically performs better in the second and third quarters of the year. However there may be very early indications of some shift in this seasonality in favor of the company. The fourth quarter has benefited from Christmas promotions of Camillus knives and hunting knife sets, while the industrial safety kit business has been boosting growth in each quarter.

Overall: Acme United is a company that has been maintaining strong financial performance, paying dividends to its shareholders and growing its operations domestically and internationally. Its products are easy to understand, and while it faces competitors like Fiskars and Johnson and Johnson, it has a well established reputation in its lines of business.  At the time of writing the stock was trading at $15.30 which was above the 20 and 50 day moving averages and near a simple resistance bound of the past three month’s high points. Given recent performance and strategies for future growth, I think that this low profile company has the potential to be a good value for money.

A Long Wait

We have been hearing for a number of years now about the “tough” job market out there. That is generally true; but the employment situation varies by educational, demographic and even geographic factors, amongst other things. Overall the employment picture has been improving slowly as the economy continues to recover the nearly 8.8 million jobs lost in the last recession. The average duration of unemployment has declined from 38 weeks in December 2012 to 37.1 weeks in December 2013. So people are finding more jobs, and finding them faster than they did a year ago. But things have been less rosy for those that have been looking for jobs the longest. According to data from the Bureau of Labor Statistics (BLS) 53.7% of unemployed persons had been without a job for 15 weeks or more in December 2013. While this was down from 54.4% in the previous year, it is still a large percentage of people that have had to undertake a painfully prolonged job search. From the employer’s perspective a longer period away from gainful employment may imply a depletion of a candidates skill set, reinforcing the cycle of unemployment.

Another poignant feature that surfaces in BLS data from 2012 is that the average duration of unemployment increased with age, being as high as 54.6 weeks for those in the age group of 55 to 64 years. This is despite the fact that the actual unemployment rate has been lower among people in this age group compared to those that are younger. So while those that were older were less likely to be unemployed than their younger counterparts, if they did lose their jobs, it was a long, arduous journey to find work again. A possible explanation could be that with a large pool of unemployed people looking for jobs, employers may have been more likely to hire younger, less experienced employees who may be available at a lower pay.

The jobs situation is improving overall, but it has been an incredibly long, painful journey for many.