DIT - Amcon distribution co.

[watsa_is_a_randian_hero]

I bought some of this awhile back, but I couldn't get comfortable with the dilution and compensation, so I sold it.

 

Does anyone else have a problem with these issues?

 

In 2010, the top 4 executives took over $6m in total comp vs $8.7m in net income

 

In 2012, it was less, around $3m total comp vs $7.1m in net

 

Market cap per yahoo finance is $48.78m

 

Edit:  I guess I should add that in 2010, Atayan's total comp was about $4.6m of the $6M

 

That was 1 year out out of the 6 or so that he has been here.  They take a longer-term view on awards and they don't occur in that size every year.  Why don't you look at what the performance has been since Atayan took over relative to his compensation rather than just focusing on one year.

[eggbriar]

You bring up a good point eggbriar.  That is my general issue with these micro-caps.  Executive compensation just takes up too much of a small pie.

 

I would also add the declining margins, that is my main issue with the company.  In spite of making acquisitions, and growing, why do profits fall each year?

 

I agree with you, something isn't adding up since profits peaked in 2009

 

 

That was 1 year out out of the 6 or so that he has been here.  They take a longer-term view on awards and they don't occur in that size every year.  Why don't you look at what the performance has been since Atayan took over relative to his compensation rather than just focusing on one year.

 

 

Atayan's gained control in 2009 as his ownership increased from 6.7% to 37.5%.  His big payday followed in 2010, after a big increase in 2009.  Profits peaked in 2009.  The cash flow is impressive and is what initially attracted me to the company.  Those cash flows are lumpy and don't appear to be increasing.  His comp is still high compared to what they were paying out prior to his arrival, with 2012's total comp topped only by 2009 and 2010

[wachtwoord]

Anyone still following this? Same price as 3 years ago but the shares outstanding have increased to 625k and 733k fully diluted (market cap 51M-59.8M respectively). Mostly due to new stock issuing to management (15k shares a year roughly). It's trading below book and seems otherwise an above average business.

 

It seems like 2-3% stock based management compensation will hurt results significantly. Most of the dilution comes from convertible preferred stock but the company has the option to buy back at 112% of face value ($25) but the holders have the option to convert to equity far below the market rate of the stock at any time (~$30). Not sure whether management is allowed to just pay 112% of face value after a holder chooses to convert? Another factor is that Atayan holds a significant portion of the preferred (so he might allow himself to convert; conflict of interest).

 

Thoughts?

[DTEJD1997]

Anyone still following this? Same price as 3 years ago but the shares outstanding have increased to 625k and 733k fully diluted (market cap 51M-59.8M respectively). Mostly due to new stock issuing to management (15k shares a year roughly). It's trading below book and seems otherwise an above average business.

 

It seems like 2-3% stock based management compensation will hurt results significantly. Most of the dilution comes from convertible preferred stock but the company has the option to buy back at 112% of face value ($25) but the holders have the option to convert to equity far below the market rate of the stock at any time (~$30). Not sure whether management is allowed to just pay 112% of face value after a holder chooses to convert? Another factor is that Atayan holds a significant portion of the preferred (so he might allow himself to convert; conflict of interest).

 

Thoughts?

 

I still follow this...I don't currently have a position.

 

I have been toying with the idea of getting back in.  I am intrigued by it's trading significantly below book value.  I also strongly suspect that book value may be somewhat UNDERstated.  I am going to guess that they have some amount of warehouse stuff that is fully depreciated (Shelves, pallet jacks, etc.) but still in use.

 

While I have not been following the dilution & insider compensation...I've been hesitant because as the years pass, they don't seem to make any more money per share.  They also have not hiked the dividend, when they obviously could.  Then you've got the goofy vitamin stores which are in perpetual re-branding/building.

 

Why not sell the vitamin stores, increase the dividend, focus on slowly growing the core brand and building cash flow?

 

Might be worth getting in near 52 week lows, selling near 52 week highs.  Other than a trade, I just don't see a long term hold here.

[wachtwoord]

Mind that it's not significantly below book value. Fully diluted it has a market cap of 59.8M versus equity (including convertible preferreds) of  64.3M for a book value of 0.93.

 

Being very liberal by assuming the company would redeem all the preferreds at 112% premium to face value we can use undiluted share count (but this excludes share compensation) and this would mean market cap of 51M and book value of 64.3-4.4=59.9 for a book value of 0.85.

 

So the discount is not so significant I think. They do have an above average ROIC, so that combined with it trading below book made me consider it. I'm just hesitant because of the equity compensation of the board and am looking for input.

 

BTW: They did pay a special $0.28 dividend in January (on top of the regular $0.18 quarterly) and initiated a ~$4M buy back plan (significant part of market cap at current prices) .

[watsa_is_a_randian_hero]

I still own it.  My average cost basis is 62.33 after dividends, most was purchased in 2012 though I added in 2014 in high 70's. 

 

Capital structure is not simple...they have had convertible preferreds outstanding for a long time, so you can't just look at common.  On a diluted basis share count is down because of repurchases of the preferreds & common. 

 

If you look at the multiples on CORE (same industry, larger), this should be worth $200+.  That said I think Core is overvalued and this is undervalued.  My FV is roughly ~105 right now.  In 2013 I thought FV was roughly 90, so I do think value is being added.  Most of their cash flow has gone towards paying down debt and repurchasing stock.

[watsa_is_a_randian_hero]

BTW, I've talked to Atayan about the preferred in 2012. 

 

I cant remember exactly why I was questioning him about the preferred.  I seem to remember it being a bit of a conflict of interest.  On the one hand, he owns preferred.  On the other, from a corporate perspective, it would be really good to buyback because of the dilution.

 

I think there is a clause in the preferred that the company can force them to convert.  I think I was asking why wouldnt they do this now, and just end the need to pay the preferred dividends?  I say *I think that was the question* because I cant exactly remember the details and my notes aren't that detailed.  While I dont exactly know what my question was, I do have his response written down: His response I wrote was that "basically the converts could just take their liquidation preference [rather than convert], forcing the company to come up with cash, and having implications for the credit agreements".  Additionally, he noted that he thought the preferred stock would trade below its current conversion value because of the liquidity in the underlying common is low.  At the time, I think they had just repurchased some below market for $54. 

[wachtwoord]

BTW, I've talked to Atayan about the preferred in 2012. 

 

I cant remember exactly why I was questioning him about the preferred.  I seem to remember it being a bit of a conflict of interest.  On the one hand, he owns preferred.  On the other, from a corporate perspective, it would be really good to buyback because of the dilution.

 

I think there is a clause in the preferred that the company can force them to convert.  I think I was asking why wouldnt they do this now, and just end the need to pay the preferred dividends?  I say *I think that was the question* because I cant exactly remember the details and my notes aren't that detailed.  While I dont exactly know what my question was, I do have his response written down: His response I wrote was that "basically the converts could just take their liquidation preference [rather than convert], forcing the company to come up with cash, and having implications for the credit agreements".  Additionally, he noted that he thought the preferred stock would trade below its current conversion value because of the liquidity in the underlying common is low.  At the time, I think they had just repurchased some below market for $54.

 

This is the section about this: https://www.marketvis.io/stock/dit/financial/fy-2015/note/convertiblepreferredstockdisclosuretextblock

 

The Series A Convertible Preferred Stock ("Series A") and Series B Convertible Preferred Stock ("Series B"), (collectively, the "Preferred Stock"), are convertible at any time by the holders into a number of shares of AMCON common stock equal to the number of preferred shares being converted multiplied by a fraction equal to $25.00 divided by the conversion price. The conversion prices for the Preferred Stock are subject to customary adjustments in the event of stock splits, stock dividends, and certain other distributions on the Common Stock. Cumulative dividends for the Preferred Stock are payable in arrears, when, and if declared by the Board of Directors, on March 31, June 30, September 30 and December 31 of each year.

 

With conversion price per share $30.31 for class A and $24.65 for class B.

 

So, the company forcing conversion would be stupid as it's in the interest of the preferred holder. They can convert one share of class A pref to ~0.82 shares and one of class B into 1.01 common share. The company can buy the prefs back for 112% of liquidation value which is 1.12*$25=$28 per pref. Way cheaper than buying back prefs "below market" at $54.

 

I have the strong feeling Atayan is helping himself to the cookie jar. Am I missing something?

[watsa_is_a_randian_hero]

If the company ever tried to exercise its redemption rights, the holders would just convert before any redemption was executed.

 

So the dilution will occur regardless...My point to him is that if the dilution is going to occur regardless, why not force it to occur immediately?  Because paying the dividend on the common is cheaper then paying the dividend on the preferreds.

 

Thats where his response was that it was a liquidity risk if they tried to do that, because if all the preferreds opt to request liquidation preferrence rather than convert, the company wouldnt have the cash to pay them.

[wachtwoord]

If the company ever tried to exercise its redemption rights, the holders would just convert before any redemption was executed.

 

So the dilution will occur regardless...My point to him is that if the dilution is going to occur regardless, why not force it to occur immediately?  Because paying the dividend on the common is cheaper then paying the dividend on the preferreds.

 

Thats where his response was that it was a liquidity risk if they tried to do that, because if all the preferreds opt to request liquidation preferrence rather than convert, the company wouldnt have the cash to pay them.

 

But holders of the prefs won't opt for liquidation. And if they do that means buying back shares for $25-$30! You can borrow money at quite a crazy rate for that still to be profitable.

 

And can holders quickly convert if the company opted for redemption? That seems silly. Anyway, if you assume the holders are stupid enough to opt for liquidation over conversion then they could very easily also forget to ask for conversion when you attempt to redeem the prefs ...

 

EDIT:

 

Anyway, the above is part of my worry. The other part is the ~2%-3% annual dilution due to equity compensation. Will this continue in the future? What is your opinion? (the dilution is significant enough for me to consider not investing).

[watsa_is_a_randian_hero]

Atayan's argument wasnt that the holders were stupid (the holders are himself and other board members).  It was that they may opt for liquidation preference (cash) over a large illiquid block of shares (that were trading near $60 at the time of my discussion).  As a matter of corporate finance, they can't announce a redemption without also having a clear source of funds to fund the entire redemption, even if it is unlikely that they will actually need to redeem based on market prices.

 

Your argument on the conversion I dont think is valid.  The steps would be (1) company announces a mandatory redemption that will be executed on a certain date, and (2) the preferred holders would then convert prior to that date. 

 

Because these are going to be converting either way, I look at them as currently costing the company roughly $195k per year, which is roughly $0.27 per common share per year.  Its concerning, but not a huge concern.  Also, they have bought some of them back over years at prices representing discounts to the then as-convertible market value. 

 

The price difference between market and liquidation preference has grown since then, and the company has paid down its debt and has a stronger balance sheet, so I think that argument is less valid today.  Perhaps its worth reaching out to Atayan again and pressing him on this?  Or submitting a shareholder resolution for an annual meeting.

 

My view on it is that overall Atayan has done a pretty good job here.  The company was near bankrupt when he took it over.  He has done a fairly good job allocating capital in other areas.  While I thought his explanation on this in 2012 was suspect (and less valid today), no management is perfect and overall I think they've done a good job and overall this isn't that big of a deal. 

[wachtwoord]

Thanks for the additional insights, I appreciate your input. I am asking these questions because there's a lot I do like :)

 

To close this off do you have an opinion on the yearly 2-3% dilution due to share based compensation (roughly 15k shares a year)?

 

This reduces a 12% book value growth to 8.7-9.8% (and maybe 12% is too liberal here. 10% becomes 6.8-7.8%). The effect of that on intrinsic value is sgnificant right? Do you work with the adjusted values?

[Guest Schwab711]

I think the effects of share comp will be more impactful then a simple subtraction indicates. 100% of share dilution is compounded while some % < 100% of earnings (BV growth) compound.

[wachtwoord]

I think the effects of share comp will be more impactful then a simple subtraction indicates. 100% of share dilution is compounded while some % < 100% of earnings (BV growth) compound.

 

Correct. To make this more appearent I showed examples. At 2% dilution book value growth of 12% is 9.8% effectively, and 10% book value growth is 7.8%.

 

What I'm struggling with here is how to incorporate this into my IV calculations. Shall I just assume the dilution will continue? (I'll go reread the latest annual reports to see if I missed clues on this). The effect will be quite significant.

 

What do you (Watsa, or anyone with an opinion) use for book value growth in your IV estimation process?

[watsa_is_a_randian_hero]

This has become more impact-ful over time.  In 2011 the GAAP value of share based compensation was approximately 11.7% of EBT before share based compensation (ie, it cost DIT 11.7% of EBT).  In 2015 it was 10.9%.  So this is roughly flat, they are paying out the same amount, but margins have declined. 

[watsa_is_a_randian_hero]

As an update to this: Atayan converted all his preferred in the last quarter.  Should save the company $ going forward. 

[HowMuchValue]

I use this company as an example of when incentives are broken for management. In 2011 the CEO Christopher Atayan earned $1.6M when DIT earned $15.6M in Operating Income. With Christopher Atayan at the helm of the company, reinvesting the majority of the company's profits, the Operating Income of DIT is $10.9M in 2016, a 30% reduction. What has happened to the CEO Compensation? It has been raised from $1.6M in 2011 to $2.1M in 2016. Ridiculous.

[Grossbaum]

Some updated thoughts on Amcon - Financials and Summary PDF with exhibits attached.

 

TTM

$15.6m Wholesale distribution segment operating income (includes $1.6m interest expense)

$(2.9)m Retail Grocery segment operating loss

$(5.9)m Corporate Overhead

$6.8m Operating Income

$(1.7)m Tax at 25%

$5.1m Net Income

 

$43m Market Capitalization (@ $74/sh)

$61m Capital Employed

$61m Book Value

$56m Tangible Book Value

 

 

Valuation

The current price is roughly 8.4x TTM earnings. Excluding the $2.9m operating loss at the retail grocery segment (I believe management will not endure sustained losses in this segment) the Company’s earnings would be about about $7.2m on a trailing basis, which would equate to ~6.0x Normalized P/E. The current market cap is ~2.8x the wholesale segments operating earnings. An acquirer of Amcon might be focused on this wholesale segment operating income amount, since the acquirer would not have to pay most of the ~$6m in corporate overhead expenses if it purchased the Wholesale business.

 

I think in a private market transaction, the Wholesale business could reasonably fetch 7x operating income, or about $110m, plus perhaps $5m from owned real estate (net of debt). Assuming no value for the retail operations (maybe it should be negative), that would equate to a private market value of $115m, or ~$199/share. A sale would be a high case scenario, and not likely in my opinion.

 

More likely, the Company will continue operating as a public company. With my estimation of normalized earnings at $7.1m (excludes retail losses) and a 11x multiple, Amcon would have a market cap of ~$78m, or about $135/share.

 

There will be upside or downside based the attractiveness of acquisitions going forward.

 

Sustainability of earnings

In my judgement the Wholesale business will, at worst, maintain it’s earning power going forward. It is one of the largest convenience store distributors in the nation, and provides an essential service. I would bet on very modest growth in earnings over time in the wholesale business. I do not think earnings are declining secularly. This is a fiercely competitive business, and my judgement may prove wrong. The Retail grocery segment is extremely competitive as well. I believe if management cannot generate profits in the Retail grocery segment over time, they will get out of the business - this may or may not prove to be true as well.

 

Consolidation

This industry has experienced significant consolidation over the years, and I believe this trend will continue. I think companies with scale have an advantage, and it will be harder for smaller companies in the industry to compete. Here are a few examples of the consolidation that has taken place. Coremark (the 2nd largest convenience store distributor) purchased Farner-Bocken (the 6th largest) in 2017. In July of 2018 Imperial Trading Co (the ~8th largest) acquired Abraham & Sons (the 10th largest) and is now the 5th largest convenience store distributor. In April of this year Performance Food Group purchased Eby-Brown (the 3rd largest convenience store distributor). In January, Amcon agreed to purchase a minority interest in Team Sledd, a West Virginia based wholesale distributor with ~$600m in sales.

 

Comparable Transaction

Based on Amcon’s recent purchase of a minority interest in Team Sledd it looks like the Company is more likely to be a buyer than seller, but it still makes sense to compare recent transactions in the industry to estimate a private market value for Amcon. Farner-Bocken had revenue of about $1.4b when Coremark purchased the company in 2017. Coremark paid about $176m for Farner-Bocken. Farner-Bocken had about 1,000 employees and operated primarily in the midwest. Amcon’s revenue is fiscal 2019 was $1.4b and the Company has a little over 900 employees.

 

I don’t have any details on whether the 2 company’s operating margins are comparable or not. Given the similar niche of the convenience store wholesale distribution industry both companies participate in, perhaps it’s fair to assume that operating margins for the 2 companies would be fairly comparable. In which case, Amcon may be worth 4.3x its current market capitalization to a buyer of the business ($176m Farner Bocken valuation / $41m Amcon’s market cap). A purchase price of $176m for Amcon would be about 10x the operating income of the Wholesale business.

 

A more thorough analysis might include the net inventory owned by each of the companies - Amcon has about ~$42m of “owned inventory” as of 12/31/19; (gross inventory less credit facility working capital borrowings) - as well as net real estate owned. (Still looking for more details for both the Farner-Bocken and Eby-Brown transactions).

 

Share Repurchases

Current shares outstanding are ~577,000. Management owns ~378,000 shares. That leaves the float at about 199,000 shares. In the last 2 years Amcon has repurchased about 150,000 shares - an aggressive pace. The average price paid for each share was $101.34. That is about 35% higher than the current share price.

 

Owned Real Estate

It’s worth noting that Amcon owns 4 distribution facilities that have taxable value of ~$8.3m. There are real estate loans outstanding of about $2.3m, with 3 facilities used as collateral.

 

Risks

• 
  Management gets a lot of the economics of the business via salaries. The top 3 executives had total compensation of about $3.0m in 2019, or about 25% of operating income (before their compensation). Management compensation may grow faster than operating income going forward.
  
• About ~14k RSU are awarded to management annually, equal to about 2.4% of the company each year (using 577k share count)
  
• Potential take under in some form. Management controls the company. Perhaps they will buyout minority shareholders at an unattractive price.
  
• The Company could delist - it has disclosed that it has had less than 300 shareholders of record since the 2017 10-K. It would be unfortunate if the Company delisted and stopped providing financial and business disclosures. The delisting would likely lower demand for the stock and hurt the stock price.
  
• Sustained or growing losses in the Retail Grocery business. Currently at $2.1m of annual losses. Perhaps losses will increase going forward.
  
• Decline in profitability of the Wholesale distribution businesses. Perhaps the competitiveness of the industry erodes margins and/or revenues
  
• Average return on capital employed - capital reinvested into the business will not earn phenomenal returns
  
• Only way to potentially generate a strong return on retained earnings is to acquire a company at an attractive price relative to its contribution to earnings; although the risk to that is the management makes a poor acquisition and destroys value
  
• Value trap - no significant M&A occurs over the next few years, and the shares continue to trade at low multiples and below private market value
  
• Perhaps not a risk, per se, but DIT is not a very liquid stock and it may be difficult to build a sizeable position without affecting the price.
  

 

Another note regarding the credit facility. I have excluded the credit facility in an EV calculation, as it is used to finance inventory. I think about it the same way as auto dealers for instance - as they use floorplan financing to fund their car inventory. I don’t include the floorplan financing in auto dealer EV calculations, and I believe it is appropriate to exclude the inventory based Credit Facility from Amcon’s EV calculation as well.

 

Summary

The thesis boils down to 1) the judgement that management will not endure sustaining losses in the retail grocery business 2) an conservative multiple for the rest of the business would be 11x earnings. Based on these assumptions the stock would trade about 80% above current prices. An additional assumption is that any M&A related activity would be favorable to the shareholders of Amcon because of management’s ability to allocate capital effectively.

Amcon_Distributing_Summary_

DIT_Financials.pdf

[DTEJD1997]

I think the most likely scenario for DIT is that they keep plodding on.  Some years they will make more money than others.

 

One problem is that so much of their revenue comes from tobacco.  Long term, that is in secular decline.

 

I am surprised at the amount of loss at the vitamin shops.  Those things should be sold off with a service agreement for a couple/few years.  Get $1 or $2 million for it, a 3 year service agreement, and be done with it.

 

Once that is done, look for small bolt an acquisitions...work on cash flow, reduce debt, increase the dividend.  Just simply block & tackle.

 

Perhaps a larger player will take them out?  Maybe? but then management loses their jobs.  I would put this probability at about 10% a year.

 

I don't think management would do a take under.  If they are going to do a buyout, it is almost certainly going to have to be close to book value. Maybe they shave a few dollars off it, say offer $100 if book is $110.  Why would they put up that much capital to earn a mediocre return? They get plenty of $$$$ from their salaries and keeping everything chugging along.  I also think they would get too much static from shareholders.

 

I think there are two ways to play this if you are so inclined:

 

1). buy at/close to 52 week lows, harvest the dividend, sell when it is close to a 52 week high.

 

2). There might be a shakeup/write down from sale/disposition of the vitamin shops and/or the acquisition of smaller distributors.  This could lead to a write down or disruption in price or trading.  If you've got a good model and are solid in your assumptions, this could also be an opportunistic buying time?

 

 

[Spekulatius]

We looked at this in another message board 10 years ago - it was trading around the same price back then. Looks like profits have been essentially flat. This is almost a picture perfect value trap.

[Grossbaum]

Here is a quick update on thoughts, TTM numbers, and current valuation (Amcon reported Fiscal Q1 yesterday).

 

There seems to be strength in the Wholesale Distribution business. TTM operating income is $19.4m (before interest expense).

 

It is good to see loses from the Retail Grocery business moderating somewhat, as last quarters operating loss was ($0.1)m and TTM operating loss is $(0.8)m

 

 

$61m Market Capitalization (@ $111/sh)

$11m Value of Team Sledd Investments

$50m Enterprise Value

 

TTM

$17.8m Wholesale Distribution Operating Income (includes $1.6m of interest expense)

$(0.8)m Retail Grocery Operating loss

$(6.5)m Corporate Overhead

$10.5m Operating Income

$(2.6)m Tax at 25%

$7.9m Net Income

 

$14.31 earnings per share

 

EV/E 6.3x

EV/E 6.0x (ex retail losses)

 

EV/EBIT 4.8x

 

It will be interesting to see where the operating profits for each division goes from here.

 

I'm a bit surprised by the higher level of profitability in the trailing year from the Wholesale Distribution business. (Operating income +13% on a TTM basis yoy).

 

Also, it is still my opinion that management will not tolerate ongoing losses in the Retail Grocery business. Losses have moderated a bit as of late, but it will be interesting to see what the future holds.

 

The total return for the stock in the last year has been about 63% ($111 price + $5.28 dividends), but with increased earnings in the Wholesale Distribution business and reduced losses in the Retail Grocery business, the valuation (in terms of multiple of free cash flow) still seems fairly low.

 

At 10x EBIT and including $10.7m for Team Sledd investments and $4.0m for real estate, the total value would be about $120m, or $215/share.

 

Perhaps profitability will wane from here, as has happened in years past. Both businesses operate in extremely competitive industries.

 

 

 

Management now owns over 70.6% of shares outstanding, leaving the value of the public float at about $17.8m (@ $111/sh). As the public float decreases, I wonder if it makes it more likely that the Company's structure as a public company changes. I don't know what Atayan's long term ambitions or motivations are.