Sunday, July 15, 2007

New Frontier Media: 6% Yield Attractive

New Frontier Media is in the adult entertainment media business. They have three different segments that provide products for that market. First, they have a Pay TV Group which distributes adult TV to cable and satellite companies through pay-per-view and video-on-demand. This is the biggest segment and a majority of the revenues come from the Pay TV Group. They also have the Film Product Group which produces original adult themed movies and is a sales agency that helps independent filmmakers license their product; they were acquired in February of 2006. Their third segment is the Internet Group which distributes adult content through the internet.

They recently had earnings in early June and missed analyst estimates and that sent the stock down. The big contributor to the earnings drop was an increase of 43% in operating expenses. Organic revenue growth, not taking into account the Film Production Group acquisition, was negative compared to the same quarter last year.

Industry

Their primary competitor in the Adult Entertainment TV industry is Playboy and to a minor degree Hustler and Playgirl. They do face competition from other sorts of erotic material such as adult video/dvd rentals, adult books and magazines, telephone adult chat lines and other adult oriented services. Kagan Research LLC predicts that the adult pay-per-view and video on demand market will grow to $1.4 billion in 2014, the last recorded figure for this was 2004 when it was $761 million.

The adult entertainment industry on the internet is ultra competitive and websites are constantly competing with each other for new members. The Film group competes with other adult video producers like Girls Gone Wild and Jerry Springer Uncensored. The sales agency competes with other similar companies.

Company

There has been a very positive development in the TV segment in that Playboy is struggling with their adult entertainment TV and that could create a big opportunity for New Frontier Media to increase their penetration to more households. The big advantage that their TV has over Playboy’s is that they offer a wide variety of adult content from a lot of different independent producers, they do not use their own movies, this gives their TV channels an edge over Playboy’s. Their TV channels are the market leaders in adult oriented TV.

Their revenues have been growing at a very slow rate as of late; they actually had negative organic growth in Fiscal 2006, this is a concern. Their revenue growth rate over the past 4 years has been just under 8%. They have growth initiatives for this year such as their launch of a video-on-demand service for a New York City cable TV operator that has 3.1 million basic cable subscribers.

Valuation

NOOF is currently trading at a trailing price/earnings ratio of 16.93 and a forward price/earnings ratio for Fiscal 2009 of 13.79. They have $26 million of cash and cash equivalents and no debt. They pay a hefty dividend of 50 cents a year, which is a yield of about 6%, and it is sustainable due to the strength of their free cash flows. If just to assume that NOOF is a never ending stream of $.50 yearly payments, the stock is worth about $10 at today’s interest rates. Their cash flow from operations has been higher than their Net Income for each of the past 3 years, that shows the quality of their earnings and the strength of their cash flows. About 7% of the company is owned by insiders. Their ROE has not been exceptional with a 5 year average of 10.9%. NOOF was a top 25 magic formula stock for companies over $100m on 7/15/2007.

Technicals

NOOF had a significant run up in 2003 and most recently it has been trading in a range between $6 and $10 a share. It has been holding support at $8.5 for all of 2007. Volume recently has been relatively low. It has been in a down trend since around the start of 2007 and that has been carrying the stock down. The P/E ratio is in the middle of its trading range over the past 3.5 years.



Conclusion

I think at the P/E NOOF is trading, it is close to fair value since the growth prospects they are offering are not too exciting. However, during a recessionary environment, NOOF would be a great holding because of the stability and the 6% dividend it offers.

Disclosure: I don’t have a position in NOOF.

Thursday, July 12, 2007

Domino's: Not as Attractive as it Looks (DPZ)

Domino’s is the largest pizza operator in the U.S. All of their domestic stores and most of their international stores do not offer a dine-in option so their stores are very small and lean. That gives them a cost advantage compared to other pizza delivery operations that have dine-in sections. They have two basic operations in the U.S. where they make money, first the franchises that sell the pizza, and second the domestic distribution center which manufactures dough and distributes food. Domino’s has their own fleet of tractors and trailers to help them distribute the food to their franchises. Purchasing food from the domestic distribution centers is voluntary, but almost all Franchises purchase food from the domestic distribution centers anyway. This helps create cohesiveness.

Usually there is some kind of negative news or just a negative cloud surrounding a stock to make it a Magic Formula Stock, but Domino’s is unique in that it just completed a recapitalization plan that included a $13.50 special dividend. Well, the special dividend was just completed, the stock price dropped and now it’s just trading for $18.73 compared to over $30 per share before the dividend.

But before I go any further, I have to clear this up. I ran the screen for top 25 stocks with a market cap over $100m and DPZ was on it, but it should not be because the screener is not taking the new post-recapitalization $1.7 billion of debt into account because the recapitalization closed in the 2nd quarter. The last available quarterly statements do not take this into account. The Pre-Tax Earnings Yield should actually be about 7%. Here is the calculation involved:

EBIT last 4 quarters = $199.2 million
Enterprise Value = $1.7 billion in debt + $1.2 billion in market value
Pre-Tax Earnings Yield = 6.9%

Industry

The pizza U.S. quick service restaurant industry is very competitive. Domino’s main competitors domestically are Pizza Hut, Papa John’s and other local pizza restaurants. Internationally they compete with Pizza Hut and other local restaurants. Domestically, they are the #1 pizza delivery company with a market share of 19% based on dollar value. This is a very stable industry, it is growing at the rate of inflation, maybe a bit higher.

One issue I see with the pizza industry in general is that it does not follow any of the major trends happening inside the country, I don’t know about the rest of the world. People are becoming more health conscious and that will ultimately hurt the pizza industry. Basically, pizza goes against one of the major trends sweeping across the country.

Company

Domino’s has been making pizza for a while, almost half a century. In 1998 Bain Capital acquired a 93% stake in the company and in 2004 it went public, probably so Bain Capital can cash out of their big investment. They have economies of scale for their food manufacturing unit for their retail stores because of their big market presence which gives them a cost advantage over smaller competitors. They are very unique in their treatment of franchises because a majority of the time person has to work/train in the Domino’s system for some time before he/she is allowed to become a sole operator of a Franchise. They promote entrepreneurship inside their franchisees.

Domino’s Pizza is a strong brand being one of the most known consumer brands in the world. They spend a lot of money on advertising, over the past 5 years they have invested an estimated of $1.4 billion in the United States. Domino’s also has marketing affiliations with NASCAR and Coca-Cola.

They plan on growing through the growth of their store count. Additional stores will not cost a lot of money due to the size of the stores and the distribution system available. Domino’s has been struggling with their domestic stores same store sales growth, they were negative in 2006 and just in the past quarter they were negative as well. Their domestic distribution system and their international operations have been the two growing areas of the company.

Something to keep in mind, they are currently defendants in a couple of lawsuits all accusing them of bad working conditions in regards to breaks and meal time.

Valuation

One major factor that bothers me about Domino’s is their debt load, which is $1.7 billion, over half of the company is financed by debt. Their P/E earnings ratios look good at 13.58 for the trailing twelve months and 14.64 for fiscal year 2008. 2.9% of the company is owned by insiders. They have an attractive dividend yield of 2.6%. Domino’s is a great cash generator, cash flow from operations for the past 3 years has been higher than Net Income.

One great part of Domino’s is that they do a great job managing their working capital. Historically, they have had very little or negative working capital. This is because they receive their receivables a lot faster than they have to pay their payables.

Papa John’s (PZZA) is trading at a Earnings Yields of over 10% compared to Domino’s of almost 7%. Their cash flow from operations(ttm)/enterprise value is 22.3%. Domino’s cash flow from operations(ttm)/enterprise value is 9.7%. Analysts expect PZZA to grow their earnings a bit faster than DPZ in 2008 compared to 2007 earnings expectations.

Conclusion

There is a whole list of issues I have with Domino’s:

1) Their huge debt load
2) They are not a “real” top 25 magic formula stock
3) The lawsuits they are facing in regard to working conditions
4) They are facing the health trend head-on
5) Their pizza is not that good
6) They are overvalued compared to Papa John’s (PZZA)

I would not be a buyer of DPZ.

Disclosure: I don’t have a position in DPZ.

Monday, July 9, 2007

Cherokee's Drop Only Temporary

Cherokee is a company that markets and licenses its brands for apparel, footwear and accessories in the world. They also consult and provide services for companies or anyone looking to add brands for their own line of products. Some of their major brands include Cherokee (which is their best seller), Carole Little and Sideout. The reason they license and not produce on their own is because their mid-priced brands are better suited for larger retailers with economies of scale.

There is an opportunity in this stock because it recently missed analyst earnings expectations and the stock price dropped 25%. A big chunk of the earnings drop can be attributed to a revenue drop of 9% compared to the same quarter of last year, most of the revenue drop can be blamed on the sale of the Mossimo agreement last year, which cut the royalty stream, and the drop in sales of Cherokee products in Target stores.

Industry


The clothing industry is very competitive, although most of the competitors do not have the same business model Cherokee has. Trends can change quickly and it is up to Cherokee’s management and the retailers that they have agreements with to make sure they stay on top of the trends. And it is up to Cherokee’s management, to make sure that the retailers they have agreements with promote their products in their stores. The Cherokee brand, which is mid-priced apparel, competes with the big clothing firms such as Levi Strauss & Co., The Gap, Old Navy and VF Corp. The Sideout brand, which is in the active wear business, competes with companies like Nike and Quiksilver. In the international arena, they also compete with the countries’ local companies.

Company

Cherokee has been around for over 30 years. Their revenues heavily rely on their top two clients, Target in the United States and Tesco in Europe and Asia. Not including the one-time Mossimo gain, the two retailers combined for over 70% of Cherokee’s revenue in fiscal 2007. They run a very lean operation with only 18 employees.

After the price recent drop, there were two significant insider purchases, the CFO Russell Riopelle and a director named Jess Ravich purchased over $600k worth of stock combined. Their track record on purchasing Cherokee shares is good, with an average return of 27% for Ravich and 21% for Riopelle for the following 6 months after a purchase according to www.form4oracle.com. On a side note, insiders own over 16% of the company.

Revenue has been steadily growing over the past 5 years but growth has been slowing, not taking into account the one-time gain. On average, revenue growth has been a little over 7% a year over the same period.

Valuation

CHKE is trading at a trailing price/earnings ratio of 9.81, although that is a little misleading due to the one-time again, and a forward price/earnings ratio of 16.8. They have a very solid balance sheet with no debt and over $22 million in cash. There was rise in Accounts Receivable of over 63% compared to the same period of last year, this is even with revenue dropping. They have a dividend yield of 8% at current prices. Their Cash Flow is very strong, cash flow from operations has been higher than their net income for each of the past 3 years. Return on Equity has ranged from 52.1% to 96.3% over the past 4 years. CHKE was in the top 25 Magic Formula stocks with a market cap of over $100m as of 7/8/2007.

Technicals

CHKE is currently trading below its 3 major moving averages with all of them besides the 200DMA trending down. It just found support at a previous support level of $36 a share. The stock was in a very healthy uptrend before the earnings miss, the long-term trend is neutral, the medium-term trend is down and the short-term trend is up. Volume increased significantly on the way down. The stock mostly never moves quickly so I doubt the stock will run away from here, but if it breaks overhead resistance at $38 a share, this will probably be the last time you see $36 in the near future.



Conclusion

The major obstacles this company is facing is its drop in royalty revenues from Target and the need for new revenue streams. Target is Cherokee’s biggest client and the drop in revenue from Target has not been made up by the gains in Cherokee’s other contracts, but Target is expected to open new stores and that should increase Cherokee’s cut from them. Cherokee’s other biggest client, Tesco, has been growing at a healthy clip and just got Cherokee’s permission to be the sole Cherokee label distributor in new markets in Asia and Eastern Europe.

Although Cherokee will not be a high flier growing its revenue at 15% a year, it would be valid to assume they will continue to grow at their previous growth rate of 7% a year. They have a great business model and their 8% dividend is excellent. Management also actively searches for new brands to acquire. Target’s store expansion and Tesco’s territory expansion should help Cherokee get back to their growing ways.

Disclosure:
I don’t have a position in CHKE.

Wednesday, July 4, 2007

I'm Back

I just arrived back in New York in the wee hours of Tuesday morning, I will hopefully have something tomorrow morning on CHKE. A big thank you to all the readers that kept visiting my page while I did not have any new posts.