ELDO - Eldorado Artesian Springs Inc

[Guest Schwab711]

Summary

• Pure-Play water bottler trading at 5x pre-tax operating income.

• Low-Cost producer in bottled water industry (implies brand power) with COGs of 25% of revenue (peers between 48% and 75%).

• Acquisition target in consolidating water bottling industry due to comparative advantage in operating margins.

• Current conservative fair value of ~$3 per share, implies ELDO has a margin of safety of 70%+ (FV/P ~ 4x!).

 

ELDO is one of a limited few 'pure-play' water bottling companies with Crystal Rock (NYSEMKT:CRVP) being the other pure water bottling company that we will as a peer comparison. I'm sure there must be other small water bottlers trading OTC (there are no pure water bottlers on the major exchanges), however I am not aware of any others. There are, of course, the big household names whose water bottling businesses representing a minor portion of overall revenue and little to no financial information released about their operations. ELDO's competitive advantage comes from the "artesian water" designation as ELDO's water source, an aquifer 8,000 feet below Eldorado Springs, Colorado, where it must pass through 500-foot thick layer of clay and sandstone to reach one of nine wells leading in to their water bottling factory. The water is untreated, leaving a natural taste judged to be the2nd best tasting water in the world (for the 3rd time)! The international competitors Poland Springs (OTCPK:NSRGY) (which has faced allegations of not originating from a spring!), Dasani (NYSE:KO), Evian (OTCQX:DANOY), and Aquafina (NYSE:PEP), among others. Local competition in the greater Denver, CO area used to be discussed in annual reports as recently as 2007 and 2008 but both companies have seen market shares drop drastically and neither are currently mentioned as competition (with just the international giants mentioned). The water bottling business has been in a long-term secular growth pattern for nearly two decades with legislation unable to stop the growing real and perceived threat to the safety of local water reservoirs nation-wide. The nation-wide health movement has seen younger generations use bottled water for a greater percentage of their daily water intake as compared to older generations. Bottled water has been growing by 5% - 10% annually and the industry is in constant consolidation as the major beverage companies continue to prioritize the water bottling businesses due to margins that can compete with carbonated soda. You can see from the table below how fractured the water bottling industry is the U.S. and the market shares of the dominate bottlers.

 

A direct comparison of ELDO (annual report) and CRVP (annual report) is instructive as long as an investor considers the differences in the business models for each company. CRVP gets ~41% of their revenue from bottled water with non-water sources providing a significant percentage of their revenue (coffee and snacks being the largest non-water revenue generators). Non-water products have much lower margins which is why ELDO represents a superior investment opportunity. ELDO receives 50% of their revenue from their delivery business and 50% from retail outlets (with water representing greater than 95% of their overall revenue). The delivery segment has a 55%/45% split between home and business customers, respectively, which shows their effectiveness in advertising and represents the largest potential growth driver for the company. Cost of Goods as a percentage of revenue highlights the main benefit of ELDO with COGs of 25.2% vs CRVP's ~48%. For CRVP, SG&A is 45.4% vs. 33.0% for ELDO (at ~1/7th the revenue of CRVP). This has led to operating margins for ELDO of 9.4% vs. 3.9% for CRVP. Even though this relative advantage in operating efficiency seems impressive, ELDO's single bottling plant seems to be well-below operating capacity and incremental revenue above current levels will likely see 30% - 35% operating income margins. ELDO also implemented a new CRM system, taking the full $225,000 investment in 2013, even though the software will likely be used for many years. This means that operating income was actually $1.2mm (after backing out the $100k tax benefit from their investment). ELDO is trading at just 5x pre-tax operating income with a history of sales growth that is accelerating and an industry predicted to experience secular growth. Assuming 0% future growth, fair value of ELDO is likely $2.00. Assuming 10% future growth and30% incremental operating income margins, FY15 revenue would be $12.3mm and operating income would be $1.6mm with net income of $1.05mm = $0.17 EPS. I believe ELDO should conservatively trade at 10x operating income which implies a market cap of $16mm or $2.67 a share. As a result of the high fixed cost business model and recent water bottling plant investment, ELDO is currently experiencing depreciation greater than capital expenses resulting in FCF greater than net income for the intermediate term. In the past, ELDO has used FCF to invest in their delivery business, advertising, and protecting their water sources from drought with a 20% investment in FRICO. FRICO is a type of company known as a "Mutual Ditch Company" which stores water at the Marshall reservoir that is released on demand to supplement ELDOs Augmentation Plan.

 

A summary of financial statements shows ELDO is a strong investment relative to their competitor as well as on an absolute basis. I hope ELDO considers a share buyback plan with their $675k in cash (which could increase by nearly $1mm over the next year) which would allow the company to buy back approximately 10% of the company at current price levels. The main investment metrics point to ELDOs strong cash generating potential with pre-tax ROA of 15%, ROIC of 25%, and ROE of 41.7% for FY2013. Regardless of the valuation method used, ELDOs fair value is at least $2.00 currently with continued sales growth and multiple expansion providing catalysts for ELDO to become a rare 10-baggerover time. I recommend buying ELDO up to prices of $2.00 currently (10x 'true' operating income). Regardless of when fair value is realized, I plan to hold my shares for the foreseeable future.

[Guest Schwab711]

Excellent Q1 for ELDO.

 

Operating Income at a $1.2 - $1.4mm run-rate (there is some seasonality to water). AR continues to increase at rate similar to increased revenue likely points to increased number of customers and not difficulty in collecting revenue.

 

Fair Value (at 10x operating income) looks to be solidly between $2.00 and $2.50. Will continue to buy up to $2. For disclosure I own ELDO.

[Shane]

Hi Schwab711 - the stock is closely held by insiders (~67%), do you have any idea of whether or not they would be willing to sell the business?  I am at work, so no time to check their compensation... do they overpay themselves?  It looks like they have done some buybacks in the past, but the long-term trend is a flattish share count (6m shares in 2006 then up to 6.7m and back down to 6.0m today).

 

Also is there opportunity for capacity expansion (If they could ever amass the cash needed)?  I have a feeling this stock will just be eternally stuck where it is without a catalyst.

 

All the best,

Shane

[Guest Schwab711]

- Stock is closely held by 3 founders. 1 of 3 has retired from company (and soon board). It is up in air whether shares will be sold.

- Salaries have been hovering around $100k each for 3 founders for nearly a decade. First major raise came last year (20%) and it was the first (significant one) in over a decade. I don't see future raises coming based on trends. Salaries are quite low, all things considered. Management seems to treat shareholders like partners.

- No buybacks (that I recall). They have a huge authorization for stock compensation (though they barely chip away at it historically, think Coca-Cola - this is only major drawback) and diluted shares increased significantly because of large run-up in stock price from $0.10 to $3 handle. Now that it is back to $1 handle the shares are back to flat.

- Part of my thesis is there shouldn't be a need for additional capacity expansion for some time.

- Catalyst is recent trend of 10%+ annual revenue growth and water that sells at a significant premium price. Any revenue increase leads to large increases in net income (20% NI margins on incremental revenue). Current factory cost $4mm and they currently have $800k in cash with expected $1.3mm by year end. I don't think last statement will be an issue. Who knows about catalysts.

[jouni1]

The water is untreated, leaving a natural taste judged to be the2nd best tasting water in the world (for the 3rd time)!

do you have a source for this? how much higher prices are customers willing to pay for this clay water? sorry if i sound harsh but it seems like the usual penny-stock "we have the best product in the world" pitch.

 

there was a company called royal spring or something that made similiar claims and in the end wasn't that great as an investment iirc. the ticker is RSPG but doesn't seem to be listed anymore.

[Guest Schwab711]

http://finance.yahoo.com/news/eldorado-natural-spring-water-repeats-151500061.html

[jouni1]

seems they're at least a bit promotional in press releases, as they forgot to mention they tied for the second place. i never knew water tasting was such a serious business :D you live you learn.

 

http://www.berkeleysprings.com/water/winners14.htm

[Shane]

Thanks Schwab711.  I'm not sure I fully understand what is going on with the diluted shares, but will look into it on my own.  I appreciate the Idea.  Will let you know if I pull the trigger.

[Packer16]

One comparable is Crystal Rock described in the Investment Ideas here:

 

CRVP - Crystal Rock Holdings 

 

Packer

[Guest Schwab711]

I didn't follow through enough with the CRVP comp (this was supposed to be a longer SA article) but CRVP actually has a vastly different business model (50% revenue from water where the high-margins are). ELDO is 95% (99%?) rev from water. ELDO also attempts to differentiate their water to sell at premium prices as opposed to CRVP selling water as a commodity (where the falling prices of water will likely keep revenue down for some time).

 

In short, ELDO is significantly better business model in my opinion as opposed to CRVP. It's also nice that they are cheaper!

[yadayada]

i don't like that their water is already more expensive then average. If there is some sort of water price war these guys get killed. Especially with that debt. You basicly need to see growth and sustained prices to win on this.

[Packer16]

I wouldn't focus on the margin differences as much due to the operational leverage from having similar delivery routes for the water and the other low margin goods.  I would want ELDO to deliver more stuff to customers even if the average margin is lower because the incremental margin is higher.  These guys are competing in a low-end of market dominated by giants (consumer bottled water) and competing with distributors in the water delivery business.  The other companies in a similar position in the beverage business are guys like Leading Brands (LBIX) and Cott (COT).  There have been some pretty big wipe-outs in this space historically (look at Amcon's history for example of this as it almost destroyed Amcon).  Another potential issue is the company is controlled by 3 insiders.  If you read the proxy they state no need for a comp committee???  They have not paid themselves very much (which is good) but do you have any background on them.  How is ELDO in a better position than either LBIX or COT who in COT's case is larger, priced about the same and is not controlled by a few insiders?

 

Packer 

[Shane]

It is a tiny little company, I'm not that alarmed that they say they don't need a comp committee... I would look at what they pay themselves historically more than anything.  ELDO is selling at about .55 P/S while COTT is selling at 1.3x P/S... pretty drastic difference in valuation looking at a higher level.  On P/E they aren't similarly priced either... According to bloomberg (COT P/E almost 21x forward earnings).  What were you referring to here Packer16?

[Packer16]

I use EV/EBITDA as that is how the beverage companies are priced.  For ELDO it is 5.9x for COT 6.9x.  Given the differences in the companies, I don't see ELDO as that mispriced vis a via COT.  Earnings has all kinds of things that make comparability difficult (write-offs, etc.).

 

Packer

[yadayada]

The reason most beverage companies deserve a premium is because of mindshare I think. They are large so they can afford to spend the most on marketing. This is a tiny company, plus it sells water, not beer or fruit juice or something. I don't think they get the same kind of loyalty. The large amount of debt makes it kind of risky. If you see price wars with water like you did several years back, this company will get murdered.

[yadayada]

what are the switching costs? I think if a larger beverage company would come in and spend 20-30 million$ they could do serious damage to this company. Why is this company different then the other ones that were wiped out?

 

For example the large beverage companies had pricing wars a few years back with bottled water. And those were large established brands backed by a lot of marketing. Prices were slashed by 1/3 of current prices ELDO charges. Why can't this happen here? You don't see those pricing wars with beer or with soda really. I think you overestimate the taste aspect.

 

Usually when I buy water I don't really look at brand. I can barely taste the difference anyway. Except maybe for very cheap brands that taste bad.

 

Just because they charged high prices for a few years does not mean it can last.

[yadayada]

There are certain reasons why beverages get brand power and pricing power. I don't see that here. This might be an anomaly. That is my point. Brand power is largely irrational and a function of marketing. If a large company throws some marketing dollars in Colorado's way this company could be wiped out or get in trouble. People paying up this much for this water is basicly stupid and irrational, so that is why you need a lot of marketing to keep them irrational and to keep up those positive associations with your products. And in some sort of crisis, the first thing they will stop spending money on is expensive water.

 

So for this investment to work you need to see growing revenue, no decrease in price. And then you maybe double or triple. If something goes wrong you can lose a lot due to their debt load. Does not look like attractive risk/return ratio.

 

http://online.wsj.com/news/articles/SB125167502443470973

 

 

[yadayada]

Larger companies would benefit from scale, so they stand to gain making more then just a million. I am not saying this will happen. But it can happen. Just because it did not happen does not mean it can't happen. im sure the other companies that were wiped out looked great when they were still growing. Untill they got wiped out...

 

You have to know the businessmodel of these beverage companies. Usually marketing is pretty important to brand power. So small players are at a structural disadvantage.

 

And as an investment, it does not look that cheap.

1. you need growth for this to work out. Im not sure how likely that is given that this company does not offer a good value proposition. Even the most amazing tasting water does not deserve a price premium this big to most rational people. So that seems like a gamble. Reminds me of that tv show that switched around very expensive wine to cheap supermarket wine in a wine tasting with all these prententious wine tasters. They did not notice the difference. I don't like investments where people need to be very irrational about a product to work out.

 

2. there is a lot of debt. So that means risk, and all FCF going into repaying debt. So on a EV/FCF basis it is not that cheap given the risks. A business with shaky long term prospects trading at a 10x EV/FCF multiple (if you assume they can 1 million next year). Or trading at a current 16x EV/FCF multiple.

 

And if something goes wrong, there is no liquidity and you are married to this thing.

[Guest Schwab711]

Just to add on pricing, ELDO is priced competitively with most other delivery services that use purified tab water. Much of the pricing premium over store bought water is the convenience of having water delivered. Crystal Rock has similar pricing for inferior water.

 

As I mentioned, the business model for water retailing is different than carbonate beverages. There is some overlap but not much. I don't think you fully appreciate ELDO's business model.

 

I understand growth is a large factor in the valuation of the company but that is similar to nearly every investment (any DCF analysis assumes earnings growth - whether realistic or not). I also believe the odds that ELDO continues to grow are relatively strong considering all of the catalysts for growth in their favor (bottled water is popular, perceived health/quality benefits over tap, Denver, CO economy is strong, COGs advantage, ect). Liquidity is a huge concern but this is a well run business with an excellent product, shareholder friendly management and tremendous potential. I'll take my chances. The risk/reward is likely much higher than you are indicating. 

[Guest Schwab711]

Also, on the debt. None of the long-term debt is due until after 2017 I believe. They have $750k in cash and $750k in untapped line of credit. Liquidity at the company is equal to the shareholder equity (~45% of total debt). The business model requires fairly high debt to obtain the large ROE after the break-even point is reached. At which point operating leverage should provide tremendous margins. The debt could likely be turned in to equity given the interest in the company (I'm thinking the founders), but it makes more financial sense to have the debt so the ROC and ROE are as high as they are. Debt/Equity of greater than 2x can be somewhat nerve racking or risky but this is why investing is an art. Consumer staples companies with stable or growing revenue are better served by having large amounts of debt. Again, I think your analysis of ELDO's business model is incomplete given your aversion to the debt levels and the 'pricing wars'. Liquidity is certainly an issue but the debt and pricing of the product are more than manageable in my opinion and the financial statements of the company support this.

[Shane]

http://www.yelp.com/biz/eldorado-natural-spring-water-louisville

http://www.yellowpages.com/louisville-co/mip/eldorado-artesian-springs-inc-455687566

 

Mixed reviews... It seems as if they might have some operational issues.  It does seem clear that people perceive them as a high quality product, but their service is generally poor.  I'm still mulling this one over, would have loved to see more positive feedback.

[Philip Morris IV]

Schwab, with regard to competitive advantage, have you analyzed ELDO in the context of other luxury water brands?

 

I would think the success of Fiji or Evian (now under Dannon/Groupe Danone) would support your thesis, if you can find similarities in business strategy.

 

From what you say, it does seem like a larger competitor would rather acquire ELDO than run it out, but water is outside my CoC.

[jouni1]

yes evian was acquired by danone in the 70's. it was a 110 year old well-established business already by then. i'm not sure business strategies will compare very well.

 

the customer reviews are very disturbing. when selling a luxury product (best water in the world), great customer service is key.

 

hope it works out! just looks like it could be a fad.

[Guest Schwab711]

So whose buying and not telling anyone?  ;)

[noxalley]

This is an interesting idea. I'm going to state my humble ELDO of it so far. And then I have two questions.

 

I agree that brand/reputation is correlated to marketing expenditures. ELDO doesn't spend much on marketing, so any economic profit derived from that is unlikely. Word-of-mouth advertising is less likely to result in significant economic profit, as well, because of its mixed reviews online at yelp and yellowpages.

 

But ELDO does seem to have a unique asset, doesn't it? The water drawn from the aquifer it has access to was rated as high quality a few times. Paying more for high quality water may not have mass appeal (the older generations especially think drinking anything but tap is absurd), but so long as there is a subset of the population that values it, then it should at least have stable pricing power with that subset of the population, which is presumably its established customer base and reflected in the historic data. 

 

Then again, artisan water is a luxury product, and it most likely doesn't produce a big dopamine reaction like Coca-cola does (maybe for a few odd people it does?), so this artisan water is liable to be a purchase that people will defer in the event of an cyclical downturn, as their incomes decline on average. But, then again, the people who buy this kind of water in the first place are obviously not the poorest subset of the population; they would be comparatively resistant to a cyclical downturn. This question is hard to decide without having the backup of hard data in the past.

 

A minor point worth making, I think, is that ELDO doesn't have a worldwide monopoly on high quality water, so it could face competition from afar. But distribution of water would have a low value/weight ratio; therefore, the distribution costs would be somewhat high per unit sold and the local provider would -- all else equal -- have an advantage on that cost item.

 

I do question how faddish artisan water is -- anyone know where I can read about the history of this? I'm sorry if I missed it earlier in the thread, but where can I find the historic data on price comparisons between ELDO and competitors?