Replies to post #18285 on Castle Brands Board (ROX)

[FUNMAN]

A Solid Quarter And A Cheaper Price Makes Castle Brands A Little Bit Interesting

Click here to see all of the charts and graphs:

https://seekingalpha.com/article/4125428-solid-quarter-cheaper-price-makes-castle-brands-little-bit-interesting?app=1&auth_param=7kokn:1d0r90q:7f51bf9bbcaa90d51f502722424d9a7f&uprof=45

Nov. 16, 2017 9:43 AM ET

Summary

* ROX has pulled back some 50% from early June highs - but even just above $1, the stock isn't necessarily cheap.

* But Q3 results were solid, with Jefferson's and Gosling's leading the way.

* I still have some concerns about the asset base here - Castle doesn't have full ownership of its two flagship brands - and valuation remains an issue.

* Still, that valuation is coming in, and ROX is nearing the $1 level I cited as a buy point in September.

The core problem with Castle Brands (ROX) is that it isn't cheap. It seems like it should be cheap: the stock trades just above $1, and has lost roughly half of its value since early June. But from the standpoint of EV/revenue and, particularly, EV/EBITDA, ROX simply isn't a value stock by any reasonable measure - even 50%+ off the highs.

That said, this is a company that has posted rather solid growth:


And it's a stock whose price has come in quite a bit:


That combination makes ROX intriguing at the moment. I argued in September that I was looking for a price below $1 - and we're not far from that point. Fiscal Q2 (ending September) results look solid - in fact, the first half has shown continued progress, and little to support the pullback in ROX shares.

I still have some concerns, most notably the lack of full ownership of key assets by a company that has made the case for itself as an M&A target. But this is a fun story to watch, and there are some real growth drivers. At a certain point, ROX is just too cheap, and we're getting closer to that point.

A Solid Quarter

ROX shares fell 5% the day after the Q2 report was released - but from here, it looks like a solid, if unspectacular, report. Revenue rose 6.5%, as Castle sales continue their steady upward trend. Gross margin expanded 150 bps, which is good news considering that the fastest-growing product, ginger beer, has a lower margin profile than the rest of the portfolio. Selling expense actually declined year-over-year, by 2%+ per the 10-Q, and G&A deleveraged 10 bps. The combination drove EBIT to nearly quadruple, with EBIT margins expanding 400 bps to 5.5%. Adjusted EBITDA rose 82%, with margins moving to 8.9% from 5.2% the year before.

The profit growth is boosted somewhat by the relatively low base in year-before results - but, still, overall, this looks like a step in the right direction. ROX still is burning cash, in part because it has to hold increasing amounts of bourbon in inventory, but free cash flow burn moderated to just $110K in the quarter, from $1.1 million the year before.

Looking closer, the quarter was still bullish - though perhaps more moderately so, with some minor concerns. This increasingly is a story based on Gosling's ginger beer and Jefferson's whiskey, which combined generated two-thirds of second quarter sales. Whiskey sales overall rose 13% Y/Y in the quarter, showing continued strength in Jefferson's, even considering a roughly 3-point benefit from the Q1 launch of Arran Scotch whiskies (again, per data from the 10-Q). But case data was much weaker: case sales actually fell 4.5%, with just 3% growth in the U.S. Whether that's an issue of timing or shifts to higher-priced products wasn't disclosed.

In ginger beer, revenue grew 21% year-over-year. There was some chatter on Twitter, as I wrote two months ago, that Gosling's had been pulled from Walmart (WMT), whose site listed the product as "out of stock". But the company's recent presentation claimed the product was available in all 4,500 US Walmart stores, and the Q2 revenue increase would seem to put those claims to rest.

That said, the deceleration of growth in Q2 does look a bit concerning. The product was launched at Walmart in March 2017 - toward the end of the company's fiscal Q4. Q1 FY18 revenue in the category grew 60% year-over-year, with case sales up 52%. Those figures decelerated to 21% and 25%, respectively, in the second quarter. Both figures declined sequentially, and though seasonality may come into play there, it's worth noting that Q1 had much tougher comparisons from a growth standpoint.

21% growth is nothing to sneeze at, to be sure, and it's certainly not so weak as to upend the growth case for ginger beer. But - again - this isn't a cheap stock; something like the steady growth shown over the past several quarters already looks priced in, or close. A change in the outlook for ginger beer from a game-changer to a contributor changes the potential upside for ROX as well.

Meanwhile, the rest of the portfolio is struggling. Despite Castle Brands' continued advertising behind the 'Dark 'n Stormy', growth in Gosling's rum has stalled out - and now is moving backward. Revenue fell modestly in FY17, dipped 3.5% in Q1, and then dropped a disappointing 14% year-over-year in Q2. US case sales declined 22%. I wrote after Q1 that anecdotally, it seemed to me that the 'mule' drinks (ie, a Moscow mule made with ginger beer and vodka) were more popular than the Dark 'n Stormy, and first-half results seem to suggest that's the case.

Vodka sales continued a multi-year negative trend (they're down well more than half from FY12 peaks) with a 15% drop. Tequila revenue rose 23%, but off a small base, and YTD performance remains basically flat. Liqueurs are staying steady, generating about 11% of revenue in the first half and growing 3% Y/Y, including 0.7% in Q2. A three-year streak of declines in sales in that category should end in FY18, but it's not as if liqueurs are going to be a growth driver, given their current share of overall revenue and the lack of 'sizzle' in that category. Q2 shows that ROX increasingly is a Jefferson's and ginger beer story, for better or for worse.

Is It Enough?

So the question remains: are those two products enough? One big sticking point on that front is that Castle doesn't actually own either product - at least in whole. ROX actually owns 80.1% of a "strategic global export venture" with the Gosling family. Castle doesn't even manufacture the beer; it's made by Polar, who also has limited distribution rights in the Northeast U.S., per the 10-K.

At Jefferson's, Castle now owns 25% of Copperhead Distillery Company, which houses the Jefferson's visitor center; the product is bottled on a contract basis.

There's a cost to that setup in terms of valuation. In the September presentation, ROX once again made the M&A case for itself:

That EV/revenue figure is down to just under 2.8x on a trailing twelve-month basis, which would seem to suggest a potential takeout at $2+ based on that metric.

But a dollar of revenue from a strategic export venture, or a brand bottled on a contract basis used aged stock purchased elsewhere, isn't the same as a dollar from a wholly-owned distillery. There are margin impacts to the current setup at Castle Brands, and for a company like Diageo (DEO) with a nearly $100 billion enterprise value, 19.9% noncontrolling interests and a 25% stake in a Kentucky brewing outfit actually be could negatives, not positives, simply due to the added complexity of such a deal compared to the relatively modest value-add of ROX overall. (If Castle is worth double to DEO what it's worth right now, the boost to DEO's market cap is about 0.25%.)

I'm not dismissing the M&A case entirely - but it's foolish to rely on it as the only exit, given Castle Brands' tiny size and somewhat awkward ownership profile. To be a compelling investment, ROX needs to show consistent profitability as a standalone - and the good news is that it's getting there. I'd expect the company to have a solid shot at positive free cash flow in Q3. Adjusted EBITDA is up 73% through the first six months. And the two-thirds of sales coming from Jefferson's and ginger beer is growing, and should grow for the foreseeable future.

But, again, ROX isn't cheap. On a trailing twelve-month basis, using the fully diluted share count (including options, but not the convertible debt), the enterprise value here is in the range of $225 million. Trailing EV/EBITDA is 36x - double the peer comparisons ROX itself cites above. I'd expect that multiple to drop into the high 20s by the end of FY18, assuming continued strength in the second half. From there, however, ginger beer's blowout Q1 (and the Walmart launch) has to be lapped, and there's a case that as a result revenue growth and margin expansion should moderate. A 28x multiple for decent growth isn't exactly a screaming bargain.

Even coming back toward $1, ROX looks interesting - but not particularly compelling from a fundamental standpoint. The M&A case is imperfect for a number of reasons. There's still 20%+ of revenue that's declining over the past 3-4 quarters, if not longer. The company isn't generating cash, yet, and isn't notably cheap on an EV/revenue or EV/EBITDA basis.

Whiskey and ginger beer do drive some optimism, and there's a case to simply tuck ROX away for a few years, letting the current trend run and hoping that one morning a buyout offer comes flashing across the screen. I'm closer to buying that case - but a still-high valuation and falling knife concerns leave me on the sidelines, at least for now. There's a lot to like about Castle Brands - but there's enough to concern around the edges to argue that it still needs a sub-$1 price, or a stronger Q3, to get excited about it.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

[FUNMAN]

Goslings Sport is with Goslings Rum. - As the weather gets colder, there's nothing better than some Goslings Rum to warm you up.

https://www.facebook.com/search/top/?q=goslings%20sport


It sure seems like Goslings is everywhere.

[FUNMAN]

Knappogue Castle Irish Whiskey - Thanks to everyone who came to visit us at our booth (and Caroline and Jon for their presentations) at WhiskyFest New York last night!

https://www.facebook.com/knappoguewhiskey/photos/a.1659038067643390.1073741830.1635035136710350/1942125149334679/?type=3&theater

[FUNMAN]

Need a little something for dessert on #Thanksgiving? Celtic Honey liqueur matches pies, cakes & other sweets and tastes great IN pecan pie!

Need a little something for dessert on #Thanksgiving? Celtic Honey liqueur matches pies, cakes & other sweets and tastes great IN pecan pie! pic.twitter.com/PHkmqS5lcl

— Irish to the Core (@Irish2Core) November 20, 2017

[FUNMAN]

Gosling's Invitational - Gosling's Rum & Bermuda Tourism Authority

https://nepga.bluegolf.com/bluegolf/nepga17/event/nepga1728/index.htm

[FUNMAN]

Watch - Jefferson's Limited Release Holiday Oak Cup -

Spreading Holiday CHEERS, Jefferson's style! #JeffersonsBourbon #cheers #HappyHolidays pic.twitter.com/OyT1zgbJ0R

— Jefferson's Bourbon (@JeffsBourbon) November 28, 2017

[FUNMAN]

Kentucky Artisan Distillery - Can't be giving us any people food, Bulking season


https://www.facebook.com/KentuckyArtisanDistillery/photos/a.764963843583253.1073741827.764941116918859/1633495143396781/?type=3&theater