Dryclean USA (DCU) is another micro-cap company worth it’s market cap, and trading at a ridiculous enterprise value. With earnings that have grown from $300k in 2001 to $600k in 2008, peaking at around $900k in 2007, DCU might seem fairly priced around $7 million. The earnings yield in the last twelve months is 10%. However, if we consider that this company has $5.3 million of cash, we're left with an enterprise value of $1.7 million. The underlying business is therefore yielding a 40% return to investors.
DCU primarily distributes commercial and industrial laundry and dry cleaning equipment including a proprietary line of dry cleaning machines (98% of revenue). They also have a small dry clean franchise and store development business (2% of revenue). Until this past quarter, DCU also operated a broker that matched buyers and sellers of laundromat and dry clean businesses, but this operation was discontinued. In the first three quarters of 2009, DCU has undergone some major changes in sales mix that aren’t apparent on the surface. 9-month revenues have increased by 20%, but this is the result of commercial laundry equipment sales increasing 75.9%, compared to a reduction of 57.4% in dry cleaning equipment, 40.7% for boiler sales, and 2% for spare parts. To a small degree, this have a negative impact on margins as it’s moved the mix away from DCU’s proprietary products. But otherwise, it’s hard to predict what the long-term effect of this will be, if anything. At the moment it’s really just something to be aware of.
Earnings have been positive at least since 2001. Cash flow has been more volatile, occasionally turning negative, but on average it’s approximated earnings. So it doesn’t seem like this company would really need to keep much cash on the balance sheet, especially if they made better use of their unused revolving credit agreement, which expires on October 30, 2009, but is likely to be renewed. As a function of short-term assets, cash has grown from 5% in 2001 to 36% of assets in 2008, peaking at 48% in 2007. Again it doesn’t seem as though this company needs as much cash as it has. The question of whether or not it will be returned to shareholders, or kept on the balance sheet as working capital, is a little more difficult to answer. Between 2004-2008, DCU maintained a dividend payout rate (on FCF) between 50-100%. However, dividends in 2009 have been cancelled. One possible reason for this is that management is concerned about the future and doesn’t want to risk jeopardizing a strong balance sheet. The other possible explanation is that management is more optimistic about opportunities for reinvestment in the business.
One reason to be optimistic about the opportunity for incremental reinvestment is that RoA, RoE, and after-tax RoIC measures have all steadily improved from 2001-2007, from 3.8%, 6.2%, and 8.4%, to 9.1%, 14.0%, 41.1% respectively. These metrics dropped to 5.4%, 9.1%, and 19.0% in 2008, but are back up LTM. Even if we include half the cash balance as working capital, RoIC improved from 8.1% to 19.7% in 2007, and it’s at 16.1% LTM. Only a fraction of DCU assets are long-term, so it isn’t very likely that they will have large CapEx. But the cash should more than allow DCU to expand working capital if sales volume warrants it. We should see some evidence of management’s expectations for growth when the K is released this month. In 2008, DCU employed 33 workers, 13 in sales and 3 in service. If we see these numbers grow in 2009, it should be a strong indication that DCU is optimistic about top-line growth. For reference, LTM revenue is up 13.2% over the prior twelve months. If employment hasn’t increased, investors will just have to be satisfied knowing that DCU has a strong financial position and the means to eventually resume a large dividend.
At the present $1/share, DCU is fairly priced regardless of capital structure. LTM EPS is $0.10/share, against an average since 2001 of 9 cents and a peak of 13. EV/after-tax EBIT is 2.4x, compared to an average of 11.4x since 2001.
I modeled the company out to 2013 based on 3 variables: discount rate, dividend rate, and how much cash we can assume is excess. Sales growth is modeled as a natural function of last years assets (minus some portion of cash), creating revenue growth of just over 8%/year (compared to a CAGR of 5.3%). However, EPS growth is only 6%/year (compared to a CAGR of 9.9%) because revenue from fees is modeled as a flat $800k/year. My base case is a 15% discount rate, 30% dividend payout rate, and 50% of cash is taken out as separate from the business. In this scenario, I’m getting a present value of $1.20/share. These assumptions are conservative considering how much cash has grown compared to other assets and what the historical dividend rate has been. If I decrease the discount rate to 10%, shares are worth $1.49. If I increase the cash take-out to 100%, the shares are worth $1.52. And if I increase the dividend payout rate to 60%, the shares are worth $1.24. So there’s obviously considerable room for upside. Management could unlock a significant portion of this value simply by paying out the unnecessary cash in a one-time dividend.
Again the key factors are: cash/share $0.75, EPS of about $0.10, and no severe revenue declines in 2008 or LTM. The risk tradeoff is really only illiquidity. Nowhere in this analysis do I take into account the possible effects of further operating improvements that would show up in the RoA, RoE, or RoIC metrics which have all been steadily improving over time. It would be impossible to take a large position in this company, but a small position should yield nice returns uncorrelated with the market.
Disclosure: I own shares in this company. Again, this is the most micro of all micro-caps, and it's extremely illiquid. I don't even understand why a company this small is publicly traded. Even with my tiny account, it's taken me about a week to build a position. Please be careful if you decide to buy as there are special risks... and be patient.