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SLGD Writeup

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collinmcb   Wednesday, 12/21/16 11:18:32 AM
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SLGD Writeup

Scott’s Liquid Gold, ticker SLGD, is a $16 million market cap provider of skin & hair care products and household wood care products. The company completed a transformative acquisition at the end of June and the market does not yet appreciate the new earnings power of the business. I expect SLGD to generate $0.30 of EPS and $0.40/share of FCF over the next twelve months. Peers trade over 20x P/E; using a lower 12x P/E, SLGD’s fair value is $3.60/share, providing significant upside potential from the current $1.39 price.


Business Description

• SLGD has two reporting segments

o Skin and Hair Care (80% of sales) which includes Batiste dry shampoo, Prell, Denorex, Zincon, Alpha Hydrox, Diabetic Cream, and Montange Jeunesse.

o Household (20% of sales) which includes Scott’s Liquid Gold wood care, floor care, and cleaning & dusting products.

• SLGD shares trade at $1.39 with 12.03mm shares outstanding, resulting in a $16mm market. The business has $4mm of debt and $2mm of cash for an enterprise value of $18mm.


Long Thesis

• High Quality Business. SLGD is a high quality business that generates a 45% ROIC with growing revenue (28% revenue growth) and rising margins. Management owns over 25% of shares and is well-aligned with shareholders.

• Transformative Acquisition Creates Opportunity. SLGD completed a transformative acquisition of three shampoo brands (Prell, Denorex, and Zincon) from a family owner for $9 million funded with cash and debt (no new shares issued). The company was poorly run and had elevated costs under prior management. When SLGD acquired the brands, they did not bring over a single employee which drives strong operating margin and FCF generation. SLGD generated fully taxed EPS of $0.05 and FCF of $0.09/share in 3Q, resulting in a $0.20 EPS and $0.36 FCF/share run-rate.

• Cost Synergies to Drive Further Earnings Growth. The acquired brands currently outsource manufacturing to a 3rd party, but SLGD plans to move manufacturing in-house to their Colorado plant over the next 12 months which will improve gross margins and drive EPS higher from 3Q levels. I estimate gross margin will improve from 41% to 50% by the end of 2017 which drives EPS from $0.05 in 3Q16 to $0.10 in 3Q17 or a $0.40 run-rate.

• Attractive Valuation. Peer consumer products companies such as PG, CHD, CLX, and EPC trade for 22x P/E; even small consumer products companies such as AMNF trade for 17x P/E because of the stable earnings power, high ROIC, and strong FCF generation. With the acquisition of Prell, Denorex, and Zincon, SLGD reduces its reliance on Batiste distribution (agreement with CHD) which will likely cause the multiple to expand from SLGD’s own historical 12-16x fully taxed P/E.

• Beneficiary of Corporate Tax Reform. SLGD pays a full 40% tax rate, so stands to significantly benefit from potential tax reform to 15-25% rate under the new administration. At a 20% tax rate, SLGD’s EPS rises from $0.30 to $0.40, further increasing fair value.

• Future Growth Potential. Future growth will come from organic growth of existing products and acquisition of additional brands with the $5mm of FCF the business will throw off.


Catalysts
• 03/30/17 – SLGD reports 2016 earnings. Expect 4Q16 revenue of $10mm, 35% y/y growth, and $0.06 EPS, 150% y/y growth
• 05/16/17 – SLGD reports 1Q17 earnings. Expect revenue of $10.4mm, 35% y/y growth and $0.07 EPS, 100% y/y growth
• Potential tax reform which lowers SLGD’s tax rate from 40% toward the 15-25% range contemplated by the new administration


Risks
• Potential integration risks when SLGD in-houses manufacturing
• Costs increase more than expected resulting in less margin expansion
• Competition from new products impacts sales growth


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