CODI - Compass Diversified: Bag Up To 8% Yield On This Private Equity-Like Firm

2023-12-08 08:05:00 ET

Summary

• Compass Diversified offers investors access and transparency to the private equity industry.
• CODI has a track record of respectable total returns and invests in growth stage companies that provide cash flow and capital appreciation potential.
• The upcoming sale of Marucci will generate significant gains for CODI, which can be used to pay down debt and support its distribution.
• Investors who want more income safety over the common shares may want to consider the Preferred C Stock currently yielding over 8%.

Private equity is a segment that remains out of reach for most investors, given high capital requirements for entry. Yet, there are a handful of publicly-traded entities in this space that offer investors both access and transparency to this often opaque industry.

This brings me to Compass Diversified ( CODI ), which I last covered here back in January of 2021. While CODI hasn’t given much in the way of price return (rising by just 3% since my last piece), it’s total returns that matter for dividend payers like CODI.

In this regard, CODI has given a 19.5% total return including distributions, and this sits slightly below the 20.6% rise in the S&P 500 ( SPY ) over the same timeframe. In this article, I provide an update and discuss what makes CODI a good choice for income and potentially strong total returns, so let’s get started!

(Note: CODI issues a Schedule K-1)

Why CODI?

Compass Diversified is an externally-managed investment firm that owns a diverse collection of portfolio companies in the middle-market space across North America. This gives investors to participate in a private equity-like business by investing in growth stage companies that give both cash flow and capital appreciation potential.

CODI was founded in 1998 and became public in 2006. CODI has produced respectable total returns over the past 10 years, despite not having exposure to tech-fueled stocks that throw off little to no dividends like that of the S&P 500. As shown below, CODI’s total return has more or less tracked that of the SPY over the past decade, with a 134% total return compared to the 157% of SPY.

CODI’s strategy is to opportunistically seek opportunities in sectors with management expertise, and then partner with the management teams to sustainably build businesses for the long-term. This includes businesses with branded and niche industrial verticals, with which CODI has 25 years of experience in investment management.

At present, CODI has $3.2 billion of invested capital across 15 subsidiary companies in niche industrial, branded consumer and healthcare. Its portfolio companies generated $2.2 billion and $446 million in combined revenue and adjusted EBITDA, respectively, over the trailing 12 months. CODI has seen a successful track record of successful portfolio exits (Liberty Safe and Advanced Circuits) while investing in high growth companies with 21% to 61% revenue growth in recent years, as shown below.

Meanwhile, CODI reported strong results in its last reported third quarter, driven by continued outperformance in Lugano, a luxury jewelry company with a high value and loyal clientele, and the majority of CODI’s other companies are performing above expectations. Moreover, management announced the exit of its Marucci investment, a sports equipment manufacturer that CODI acquired in 2020. CODI intends to sell Marucci to Fox Factory Holding Corp. (another former investment of CODI) for $572 million. CODI spent $200 million to acquire Marucci plus another $70 million in bolt-on acquisitions, and will thereby realize a sizable $302 million gain on this sale.

Risks to CODI include the fact that its companies will experience downturns due to both micro and macroeconomic factors. This is reflected by net sales being down by 1% on a consolidated basis to $570 million during Q3. This was driven by outperformance at Lugano and Marucci partially offsetting lower sales at BOA due to inventory destocking in the footwear industry, and lower sales at Velocity Outdoor after COVID-driven gains from consumer recreational activities last year. Potential for a hard landing in the economy pose additional risks for CODI’s portfolio companies in 2024. It’s worth noting, however, that CODI’s companies have seen pricing power, as reflected by adjusted EBITDA being up by 13% YoY to $104 million during Q3.

Another potential headwind is higher interest rates, but that won’t affect CODI in the near-term as it has no significant debt maturities until 2027, and has net borrowing capacity of $486 million under its revolving credit facility. With the aforementioned significant realized gains from its upcoming sale of Marucci, I don’t see CODI needing to tap its revolving credit facility. Plus, CODI is modestly leveraged with a debt to total capital ratio of 63.5%, and I would expect for the leverage ratio to trend down since it doesn’t take into account future gains from the Marucci sale.

Looking ahead, I would expect for fourth quarter results to be more or less in line with that of Q3, as inventory de-stocking is expected to continue. However, management expects the economic resilience of its underlying businesses to come through in 2024, as inventory oversupply issues this year are put in the rear view mirror.

CODI’s $0.25 quarterly distribution rate equates to a 4.8% yield at the current price of $20.71. It's worth noting that CODI did cut the quarterly distribution from $0.36 starting in 2022, but that was only after it paid a special $0.88 special distribution in August of 2021. While the TTM distribution of $72.1 million exceeds the operating cash flow of $68.6 million by 5%, investors should understand the lumpy nature of cash flows due to the private equity-like nature of CODI’s business model. Plus, CODI will have ample funds to cover the 5% shortfall after the aforementioned sale of Marucci.

Lastly, I see value in CODI at the current price of $20.71 with an EV/EBITDA of 10.6, sitting towards the low end of its 3-year range, as shown below. Sell side analysts have a ‘Buy’ rating on the stock with an average price target of $27.67 , and Seeking Alpha’s Quant Rating System has a ‘Strong Buy’ rating with a score of 4.53 on a scale from 1 to 5.

Those investors who prefer higher income safety may want to consider CODI’s Preferred Series C stock ( CODI.PR.C ). This stock currently yields 8.1% and at the current price of $24.40, trades at a 2.4% discount to its $25 par value. This preferred issue also cannot be called until 1/30/2025 at the earliest, and potentially may not be called on the call date should interest rates remain elevated at present levels. This series is also cumulative, which means that missed distributions must be made up at some point unless if CODI goes bankrupt. As such, CODI.PR.C is a worthwhile option for more conservative income investors.

Investor Takeaway

CODI is a private equity-like company with experienced management and a track record of successful investments. Its portfolio companies have seen strong underlying profitability, despite some headwinds in the last quarter. The upcoming sale of Marucci will generate significant gains for CODI, which it can use to pay down debt and more than support its distribution. With the common shares offering a 4.8% distribution yield and potential for capital gains and the Preferred Shares offering a higher yield and safety, income investors have two options to profit from this name. As such I maintain a 'Buy' rating on both CODI and CODI.PR.C.

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