In researching stocks that are trading at a discount to their intrinsic value, I read a fair number of blogs and investing forums from time to time.  One of the stocks that was briefly discussed on a forum I frequent caught my attention for a number of reasons, so I decided to write up the stock to get a thorough understanding of the company and its future prospects.  After discussing my critique with another blogger, I’ve decided to reproduce it here.

In going through this valuation, the first thing that should be noted is this is not an investment recommendation of any kind, but just a research article on a particular company and their stock.  As the company discussed in this article is a micro-cap and thinly traded (illiquid), anyone considering a position after performing their own due diligence should make sure that they are comfortable entering into these types of positions.  Also, I haven’t discussed a lot of the terms used in this analysis before on this blog, so stay tuned over the next number of posts where I’ll try to make sense of the numbers and what they mean.

Now on with the show!

Crystal Rock Holdings Inc:

Crystal Rock Holdings Inc (CRVP – AMEX), is engaged primarily in the production and distribution of bottled water, coffee, and other ancillary products.  The company is controlled by the Baker family who together own the majority stake of the common stock.  A quick look at some of the stock’s vital signs are as follows:

• Z-Score:  1.3
• F-Score:  4
• FCF Margin Coefficient of Variation:  0.21
• Ave. 10-year real FCF yield: 19.2% (based on market cap) / 8.7% (based on enterprise value)

Note that in calculating the average 10-year real FCF yield, I adjusted the reported free cash flow in 2010 & 2009 to exclude one time legal settlements of $3.5 million and $3 million respectively (including income tax provisions).

Looking at these numbers, a few things stand out right away; the Z-score is terrible and the company has a lot of debt.  Looking at the balance sheet, due to past acquisitions there is no tangible equity in the business.  The current ratio is okay at a little over 2, but overall, the stock is nowhere near an asset play.

Looking at the cash flow numbers, the FCF margin CoV is very good at 0.21 and they have had over 10 years of positive free cash flows.  Using just the market cap value, the company would seem to be trading at an 19% FCF yield to its average real 10 year free cash flow, but due to the large debt load, this number is misleading.  Using the enterprise value instead of market cap leads to a 9% 10-year average FCF yield which is still somewhat intriguing.  So from a cash flow perspective, the company seems to be worth at least another look assuming that they’re not going to go bankrupt in the near future.

Examining the notes to the financial statements, the debt on the balance sheet is from two sources, a term debt note (and revolving credit facility), and subordinated debt due to the Baker family (from a buyout of Crystal Rock Spring Water Company shareholders in 2000).  Looking at the debt maturities, the company has approximately $2.2 million of debt due in each of the next 4 years.  As the company’s average FCF over the last 10 years is $4.1 million, the debt retirement is covered approximately 2 times.  Out of the last 10 years, the company only failed to generate this amount of real FCF in 2001.  However, given recent acquisitions and the relative stability of the business, the company should be able to continue to retire debt as planned as I would expect FCF generation to at least remain at its historic average.  Furthermore, to help stabilize the interest payments on the debt, the company has entered into a number of interest rate swaps.  Though the first swap actually resulted in a net loss (due to the very low rates experienced from 2008/9 to the present), insuring against the possibility of significantly rising rates is prudent for the company as a rapidly rising interest expense could result in default.  Though there is a large subordinated debt maturation (13 million) in 2015, by that point, the company will have paid off over $9 million in term debt which should let them refinance if needed.  The company has also been paying down debt ahead of schedule from time to time to lessen their debt load ($500,000 in both 2009 & 2010).  After looking at the debt maturities, FCF generation, and interest rate swaps, I am more or less convinced that they shouldn’t go bankrupt in the near future barring extraordinary circumstances.

Given that debt retirement accounts will account for 50% or more of the available FCF over the foreseeable future, and given the financial covenants in place, no dividends can be paid on the common stock.  Other than debt repayment, FCF has been used for small share repurchases from 2006 onwards and for acquisitions.  Looking at the past history of acquisitions, the company has primarily targeted water producers and distributors to grow their geographical area and expand their business. In addition, their coffee distribution business is a compliment to the existing water business as the demand for the two beverages tend to be somewhat counter-cyclical.  Future acquisitions to expand these sides of the business would seem to be the most appropriate investments.  However, the most recent acquisition was an office supply company in order to ‘diversify’ their business.  Though their existing customer relationships with businesses may make it easier to make sales to their existing water and coffee customers, this purchase would seem to move the company out of their area of expertise.  I would rather have seen this cash (essentially from their legal settlement) been used for additional debt repayment or held to fortify the balance sheet.

As the Baker family owns the controlling interest in the company, they should be motivated to ensure that the company remains in compliance with its debt covenants.  Though the Bakers would recover most of their subordinated debt ($13 million) in the event of a bankruptcy, they would lose an equal amount of equity in the company.  They would also lose their income as employees and directors of the company ($320,000 annually) and the operating leases of properties that the company rents from them would be terminated (an additional $700,000).  Furthermore, they have options on 300,000 shares outstanding with a minimum strike price of $1.80.  Based on the above, the Baker family would seem to have incentive to ensure that the company survives and that the stock price increases such that their vested options are in-the-money.

Having gone through the financials, using the average real 10-year real FCF of $0.19 per share and assigning a FCF multiple of 15 while subtracting the net debt position leads to an estimated intrinsic value of the company of somewhere in the $1.50 to $1.75 range.  Given that the stock is trading around $0.86 (and has hovered around $0.70 for much of the last year) it is trading relatively close to a 50% discount to my calculated intrinsic value.  As recently as 2008, the stock traded in the range of the above estimated intrinsic value.

Based on the above, CRVP seems like an interesting earnings value play.  However, other than the obvious difficulties in carrying a large debt load (which seems manageable based on the above discussion), the decision to branch out into office supplies somewhat muddies the future.  Though the company is trading in an attractive range, as the potential profitability of their entry into the office supply business is not known, it is difficult to determine how much of the available free cash flow outside of debt repayments will be required for this venture, and what the returns may be.  If instead, the cash available had been redeployed into their water / coffee businesses, returned to shareholders through buybacks, or used for additional debt repayments, I think the investment case would be a lot stronger.  That being said, if everything works out according to plan, an intrinsic value of between $2.50 to $3.00 (valued only on market cap after significant debt repayment) for this stock within 5 – 10 years seems to be within the range of possibility.

Until next time,
Nathan @ EngineeringIncome.com

Full Disclosure:
No Positions

Disclaimer:
The data and opinions presented above are for educational purposes only and should not be construed as individualized investment advice or as a recommendation to buy or sell the securities in question. The investing methodology outlined on this site assumes that a stock will perform in the future as it has in the past. This is generally not true. It is the responsibility of individuals to perform their own due diligence and/or consult their investment adviser to determine the suitability of any given investment product for their specific situation. For more information, please see my disclaimer.