2023-07-10 00:44:44 ET
Summary
- Crown Crafts Inc., a manufacturer of infant and juvenile products, has acquired Manhattan Toy for $17 million, funded by a combination of cash and debt.
- The acquisition is expected to contribute $24 million in sales by fiscal 2024 and could add almost $2 million to the bottom line annually when restructuring is completed.
- Despite the increased interest payments, the company appears able to both comfortably pay its dividend and service its debt.
- Our conservative estimates assuming no terminal growth put the fair value of Crown Crafts Inc. shares at $6.50, indicating they likely trade at a modest discount.
Executive Thesis
Crown Crafts Inc ( CRWS ) is a fiscally conservative low to no growth infant and juvenile product manufacturer, with a history of returning large amounts of capital to shareholders. Dividends paid have generally been below free cash flow generation, and when cash gets built up management has been partial to paying special dividends as can be demonstrated below (special dividends in 2013, 2017, and 2020-2022).
Investors may have gotten used to these more generous payments, so the company recently being in the news for acquiring Manhattan Toy for $17 million with a combination of cash and debt may have come as a bit of a shock. After reviewing the details of the deal, I believe it is a good allocation of capital with the potential for future synergies and combined growth opportunities.
Company Overview
Crown Crafts Inc. designs infant and juvenile products, manufactures said products in China, and stores the products in their Compton, California warehouse. These products are then sold primarily to retailers such as Walmart ( WMT ), Amazon ( AMZN ) and Target ( TGT ) with sales proportions visualized below. The company also licenses trademarks from companies such as Disney ( DIS ) to use in their products (ex. think Disney character sheets), and pays royalties on these sales. Approximately 30% of sales prior to the Manhattan Toy acquisition used Disney trademarks and required royalty payments.
Crown Crafts 14th Annual Southwest IDEAS Investor Conference
Prior to the FY 2023 the company had an impressive 10 year track record with an average ROIC of 13%, and a $6.9m average FCF when adjusted for stock based compensation, and operated with no long term debt. This success is attributed to fiscal conservatism, brand name advantages, and consistently being able to design products that are attractive to the consumer.
Manhattan Toy Acquisition
The knee jerk reaction to this kind of company making an acquisition is uneasiness. Investors may be worried that shareholder value is getting destroyed, and they will no longer be able to collect special dividends as cash has disappeared from the balance sheet and acquisition debt needs to be serviced. Additionally, the recent appointment of a new CEO could spook the market further, as the acquisition could signal a change in strategy.
I believe Manhattan Toy is a relatively conservative and strategically beneficial acquisition. First, it is expanding within one of the company's core markets, baby toys. We all dread "diworsification," but that usually happens when management insists on expanding into new markets where they have little experience. I can also see synergies and potential growth opportunities given CRWS's strong relationship with Walmart ( WMT ) and Manhattan Toy's exposure to the European market. CRWS did not previously have significant exposure to Europe with 96% of sales in the US, and Manhattan Toy did not have a Walmart relationship.
Turning to the financials management has offered us, the acquisition costed $17 million funded with cash and debt, with $12.7 million in debt currently on the books with a 6.4% interest rate. This amounts to $800 thousand in interest expense, which appears manageable given the company's historic profitability. It seems the company can both comfortably service its debt and continue to pay its dividend despite the increased debt load, as is demonstrated below:
Manhattan Toy is expected to contribute $24 million in sales by fiscal 2024. Assuming Manhattan Toy margins are similar to the core business at around 7.5%, the acquisition could add almost $2 million to the bottom line given 2024 sales projections. Manhattan Toy also targets a higher income clientele and there will likely be future cost synergies, so margins could be even better once restructuring is completed. Our rough and hopefully conservative estimates give us an approximately 12% yield on purchase price, which should be accretive to shareholder value given the 6.4% current cost of debt.
A Note on the New CEO
The company also appointed a new CEO in 2022, who is an internal hire and served as the CFO since 2008. In the 2022 letter to shareholders, she reassured investors she will be following in the fiscally conservative and shareholder friendly footsteps of previous leadership. This is important, as execution matters most in this kind of business with low to no moat. I am also encouraged by the fact that she has been with the company for so long and has an accounting and finance background.
The key to this success has been our steadfast dedication to the strategy that Randall introduced early in his tenure, managing the Company in a fiscally conservative and sound way with a focus on generating cash flow, controlling expenses, delivering products that are attractive to the marketplace, and never losing sight of our responsibility to provide long-term value for shareholders.
- Olivia Elliott, President and CEO of Crown Crafts Inc.
Valuation
In my valuation modeling I assumed the Manhattan Toy company would not be accretive to shareholder value in FY 2024, but starting in FY 2025 the company would generate $7 million in free cash flow net of stock based compensation, as Manhattan Toy adds an estimated $2 million to the bottom line. I used a 10% discount rate to be conservative, as it is higher than both the 6.4% cost of debt and the approximately 6% dividend payment which can be taken as a proxy for cost of equity. Assuming no growth, total PV can be estimated as approximately $65 million which is demonstrated below. I believe these to be very conservative estimates, indicating approximately 30% upside from the current market price of around $50 million.
Risks
Reliance on A Few Large Companies
CRWS relies heavily on companies like Walmart ( WMT ) as a customer and Disney ( DIS ) to license their trademarks for their products. If relationships sour, or large customers are adversely impacted or go bankrupt, CRWS could quickly lose revenue.
Historically No Growth Business
The company offers a steady dividend and has not grown significantly over the long term. This offers its own risks, and for example the recent sell-off could have been in part due to the "bond like nature" of the stock and the risk free rate increasing made the dividend yield less attractive.
No Moat
The company manufactures and sells baby products which has pretty low barriers to entry and plenty of competition. In this kind of business, above all else execution/efficiency is important and if for some reason management falters market share could be eroded rapidly.
Assumed High Profitability of Manhattan Toy
I am putting a lot of trust in management and assuming Manhattan Toy will have similar margins to the core business in the long term. Other than management asserting the acquisition will be accretive to earnings in FY 2024, I do not have much concrete information on margins or expected profits from the segment. The acquisition may fail to be productive, as many are.
Conclusion
Crown Crafts Inc. is a conservatively financed, shareholder friendly business with a history of rewarding shareholders with high dividends. Manhattan Toy appears to be an appropriate allocation of capital given its synergies with the core business and potential for a 12% annual return on investment using sales projections and assuming similar profit margins to CRWS as a whole. Hopefully, margins and therefore return on investment may be even higher than the core business, as Manhattan Toy has a wealthier target customer. Conservatively, our models indicate shares are worth approximately $6.50, indicating decent upside from current market prices. If synergies and combined growth opportunities are instead able to significantly grow the business over time, CRWS may be worth much more than our conservative projections. I am continuing to hold my shares, and may choose to add more if the price falls much further.
For further details see:
Crown Crafts: Manhattan Toy Acquisition Appears Beneficial For Shareholders