Adam Sues, author of Value Uncovered, has provided a guest post on AMCON Distributing Co. (AMEX:DIT). Adam describes himself thus:
I’ve always enjoyed reading about the stock market and started studying in earnest in 2007 right before the whole financial world crashed. I sold a few positions at a loss (a mistake) but managed to pick up some great names at bargain prices. Over the past two years, I’ve started to study the principles of value investing and special situations, molding my philosophy after famous investors like Warren Buffett and Benjamin Graham.
Here’s his take on DIT:
AMCON Distributing (DIT)
AMCON Distributing Company (DIT) is just the type of business upon which many value investors focus: a micro-cap stock in a boring industry that the market has largely ignored.
With a market cap of only $33M, AMCON is incredibly producing almost $1B in sales, an outstanding number for such a small company.
DIT has been around since 1986, and is currently the 8th largest convenience store distributor in the United States.
The company currently operates 4,200 retail outlets, consisting of grocery stores, liquor stores, tobacco shops, and convenience stores across the Central and Rocky Mountain region of the country, selling over 14,000 different products.
The company’s products would be familiar to any normal citizen who has spent time in a corner store – cigarettes, tobacco products, candy, groceries, paper products, and frozen foods, among others.
Stores are serviced by 5 large distribution hubs totaling approx. 487,000 square feet, and are stocked by major suppliers including Phillip Morris, RJ Reynolds, and Proctor & Gamble.
Retail – Health Foods
The second business segment consists of retail health food stores operating under the name Chamberlin’s Market & Café and Akin’s Natural Foods Market. These stores focus on high-quality, organic, & specialty foods. Both store brands have been around since 1935, with 13 stores between them. Overall, AMCON has exposure to two completely different segments of the market – low-end, commodity type distribution and high-end organic food purchases.
While distribution still makes up for the vast majority of revenues, the retail health food concept is sweeping across the country and could provide a future engine for company growth (just witness the explosion of organic food advertisements and sustainable food awareness campaigns over the past few years).
The company has enjoyed record financial performance over the past two years under the leadership of its Chairman & CEO – Christopher H. Atayan. AMCON is a remarkable turnaround story.
AMCON’s industry is highly competitive and low margin business. Gross margins have averaged 7.3% over the past 10 years, with little variance. Net margins are very tight, averaging 0.2%, although the trend has been increasing.
Breaking down the business segments, margins on the retail side are much better, with gross margins in the 42% range compared to 6.1% on the wholesale side. Despite the wide range of products, the company is heavily dependent on the sale of cigarettes. In 2009, approx. 71% of company revenue came from sales of these products, although only 27% of gross profits.
Sales growth has been steady, but slow, at approx. 3% per year. The company has been able to raise revenue due to price increases, new store openings, and strategic acquisitions.
Most recently, the company owned a new retail store in Oklahoma and expanded its distribution network by purchasing the assets of another distributor:
“On October 30, 2009, the Company acquired the convenience store distribution assets of Discount Distributors from its parent Harps Food Stores, Inc. (“Harps”). Discount Distributors is a wholesale distributor to convenience stores in Arkansas, Oklahoma, and Missouri with annual sales of approximately $59.8 million”
Improved Financial Health:
AMCON is the type of business that turns over a ton of inventory (almost 25x per year). Combine this fact with a low margin business, and the company must fund most of their operations through debt financing – there is little cash on the balance sheet.
Management has taken steps to improve the financial health of the business. Long-term debt has shrunk from $58.2m in 2005 to 27.7M last year. At the same time, shareholder equity has increased from $-0.2M to $23.8M.
Interest coverage has increased to 9.5, putting the company on much better financial footing.
Since the arrival of Mr. Atayan, the company’s current CEO and Chairman, AMCON has undergone an amazing turnaround. A few years ago, AMCON was in rough shape:
“The business had negative availability of $2 million on its bank lines, it was being sued in four separate jurisdictions, it was being delisted by the American Stock Exchange, it was behind on taxes, it was losing business, and it was more than $65 million in debt.”
The company sold off non-essential businesses and turned two consecutive record years in 2008 and 2009.
Insiders own 44.1% of outstanding shares, including 37.5% by the CEO and Chairman, Christopher Atayan. Mr. Atayan bought out the company’s original founder, William Wright, purchasing over 200k shares last year.
The company re-instituted a cash dividend in 2008, and has more than doubled the quarterly payment to $0.18 during one of the toughest economic times in recent memory.
Last year, AMCON’s board also announced a share repurchase program for up to 50,000 shares, or 9% of outstanding.
Although the company has worked to diversify its business, it still relies heavily on the distribution of cigarettes. Cigarette sale and distribution is a highly regulated affair, and overall use has declined due to social stigma and education on the health risks of smoking.
In June 2009, the FDA was granted even greater powers for regulating the sale and distribution of cigarettes. The agency almost immediately banned the sale of certain flavored cigarettes, and then substantially increased the federal excise tax on cigarette sales.
Increased prices put continued pressure on sales – to date, AMCON has been able to pass along the higher prices to its customers but it remains a big risk for the company.
The company is part of a very competitive industry, and the low profit margins do not leave much room for error. An inventory miscalculation or fuel price increase could severely impact the business.
AMCON currently depends on a $55M credit agreement with Bank of America. Average borrowings for last year were $31.2M – the company obviously depends on this line of credit.
The current agreement matures in June 2011, and the outcome of that negotiation will have a substantial impact to the business.
On the retail side, the company’s retail stores face intense competition not only from stand alone health stores, but also major grocery chains who are trying to capitalize on the health movement as well.
DIT is a micro-cap stock, with a market cap of approx. $34M. The stock is also very illiquid and suffers from a tiny float. The company only has 577k share outstanding – with the high levels of insider ownership, float is only 350k.
According to Lowfloat.com, DIT is actually one of the top 3 lowest float stocks trading on any of the major exchanges.
Average 3 month volume is only 1000 shares so picking up large blocks of shares is difficult. Many institutions will pass on the stock because of these challenges, allowing individual investors to benefit.
The stock touched a low of $14 back in November 2008, before shooting upwards to $78 in December 2009 – not a bad return for one year.
Current P/E ratio sits at 4.8 – higher than 2008 (2.4) but lower than 2006/2007 (6.2), the first two years of the turnaround.
DIT’s 2010 EPS should come in around $15-17 – applying a normal P/E of 6 to these EPS numbers results in a share price of $90-$102.
Through the first three quarters of the company’s fiscal year, revenues, operating income, and FCF are all higher than 2009, setting the company up for another record year.
With regards to buying a significant personal stake in the company, Mr Atayan had this to say:
“This is a significant personal investment for my family and reflects my confidence in the management team of our company and the strong relationships we have with our vendors and customers.”
With this type of conviction – not only his professional livelihood and reputation, but putting his family’s stake behind the words as well – I have no doubt that Atayan is committed to making the company succeed.
Based on recent performance, he is off to a good start.