Here is the Paine Webber report that came out a couple of weeks ago!!!
06:50am EDT 24-Aug-99 PaineWebber (Goll, James J. 212-713-1224) SFP
Salton: Initiating Coverage With A Buy Rating (Part 1 of 2)
Consumer Special Situations PaineWebber
James Goll RESEARCH NOTE
212-713-1224/jgoll@painewebber.com
Andrew Shore, Analyst (212-713-2452) August 24, 1999
Salton, Inc. Rating: Buy
(SFP-$29.94)
Salton: Initiating Coverage With A Buy Rating
KEY POINTS
* Initiating Coverage of Salton with a Buy Rating and a $42 Price Target, based
on the company trading at 12.5x our calendar 2000 EPS estimate of $3.36,
which represents approximately 40% return potential.
* P/E Multiple Expansion Has Been and Should Continue to be Driver for the
Stock. As a result of continued strong operating performance and certain
higher profile corporate strategic actions (recapitalization, public high-
yield offering and a sizeable acquisition), Salton's forward P/E multiple has
increased from approximately 6.0x at year-ago trading levels to its current
level of 8.9x calendar 2000 earnings. This multiple is still well below the
approximate 12.0x to 13.0x average of its peer group, and its expansion
should continue to be a catalyst for this stock.
* Future Earnings Growth Also Part of the Salton Story. Our June 30, 1999 EPS
estimate of $2.16 represents a 190% increase over fiscal 1998 EPS. Going
forward, we are estimating that fiscal 2000 and fiscal 2001 EPS will increase
by 33% and 28%, respectively, over prior year levels.
* Recent Acquisition of Toastmaster Provides Additional Growth Opportunities
through market-leading entry into several new categories and access to the
Toastmaster and Ingraham brand names. Further, by applying Salton's recipe
for profitable growth (i.e., design and innovation to drive the topline and
outsourcing production to improve margins), this acquisition will provide
additional growth for the Salton story.
Key Data Quarterly Earnings Per Share (fiscal year ends June)
52-Wk Range $33-6 1999E 2000E Prev 2001E Eq.Mk
.Cap.(MM) $299 1Q $0.67 $0.84
Sh.Out.(MM) 10 2Q 0.83 1.11
Float 74% 3Q 0.36 0.44
Inst.Hldgs. 29.3% 4Q 0.30 0.50
Av.Dly.Vol.(K) 620 Year $2.16 $2.89 $3.71
Curr. Div./Yield None/NA FC Cons.: $2.17 $2.84
Sec.Grwth.Rate 25% Revs.(MM): $491 $685 $754
12-mo. Tgt Price $42.00 P/E: 13.9x 10.4x 8.1x
12-mo. Ret. Pot'l 40.3% EBITDA: $71 $99 $117
Convertible? No TEV/EBITDA: 7.9x 5.7x 4.8x
Fiscal 1999 1Q, 2Q and 3Q results shown above are actual results.
INVESTMENT HIGHLIGHTS
LEADING MARKETER AND DESIGNER OF SMALL APPLIANCES
We believe that Salton is an attractive growth leader in the consolidating
housewares industry. With five-year average annual sales growth of 59%, Salton
far outpaces the industry as a whole, which has had average annual growth of
approximately 2.4% over the same time period. From a level of $77 million in
fiscal 1995, Salton grew net revenues to $441 million for the 12 months ended
March 27, 1999. This incremental revenue growth is attributable to:
*Base Product Line Driven Growth - Sales of products in distribution in fiscal
1995 have grown at an approximate 13% average annual rate from $77 million to
approximately $125 million.
*Acquisition Driven Growth - Revenues from acquisitions, including Block China
and Toastmaster, have contributed 13% of incremental revenues.
*New Product Driven Growth - Revenues from products introduced subsequent to
fiscal 1995 account for $269 million or 74% of incremental revenues.
At this point, we believe that Salton offers investors an attractive value with
upside potential from the expansion of its P/E multiple, as it comes into line
with its peer group average and becomes more reflective of Salton's historic
and estimated future earnings growth. Based on our calendar 2000 EPS estimate
of $3.36, Salton is currently trading at an 8.9x P/E multiple versus a 12-13x
average for its peer group.
Over the past three years, Salton's EPS has grown at a compound average annual
rate of 67.5%. This earnings growth is a result of the aforementioned revenue
growth compounded by a nearly eight point expansion in operating margins from
5.1% to 13.0%. Continued topline growth coupled with margin expansion from the
integration of Toastmaster should drive our approximate 30% annual growth
exhibited in our fiscal 2000 and 2001 earnings estimates.
EXCEPTIONAL PORTFOLIO OF BRANDED PRODUCTS
Salton has a broad portfolio of owned or licensed brands that includes George
Foreman Grills, Breadman, The Juiceman, Toastmaster, Maxim, Farberware,
Melitta, Block, Atlantis, Sasaki, Rejuvenique and Ingraham. The company has
recently expanded its licensing program with retailers to sell appliances to
Zellers in Canada under the White-Westinghouse name, in addition to its current
arrangements with Kmart in the U.S. for White-Westinghouse, Sears for the
Kenmore brand and Wal-Mart for the Magic Chef brand. By managing their
proprietary brands, Salton creates value for retailers by helping them to
effectively differentiate themselves from other retailers.
SUCCESSFUL MANUFACTURING OUTSOURCING STRATEGY
Salton outsources the substantial majority of its manufacturing to over 45
unaffiliated manufacturers located in the Far East. It has established a long-
standing network of low-cost suppliers with whom it has forged ties that have
allowed it to develop flexible supply arrangements. These have enabled the
company to minimize the cost of operations in providing its products to
retailers with price points as differentiated as possible according to its
channel marketing concept. This outsourcing strategy affords Salton operating
margins of approximately 15% versus direct competitor margins in the range of
8-12%. This strategy also allows Salton to offer product to retailers at a
price point that afford them equally attractive margins. We expect this
strategy to be a significant advantage as retailers seek to consolidate vendor
rosters.
TOASTMASTER ACQUISITION
The 01/07/99 Toastmaster acquisition provides Salton with the opportunity to
significantly broaden its product line as Toastmaster has leading positions in
the toaster, waffle maker, countertop oven and buffet range/hotplate markets.
With this acquisition, Salton also acquired the valuable Toastmaster and
Ingraham brand names.
Reinvigorating Toastmaster's historically flat topline growth (-3% to +3%) and
improving its breakeven operating margins (versus Salton's 15% margin) play to
Salton's two main strengths: designing innovative and creative new products and
effectively outsourcing manufacturing to low-cost suppliers. Management
anticipates cost-savings of approximately $13.3 million from the elimination of
redundant overhead and the outsourcing of product that was previously
domestically manufactured by Toastmaster. These savings on Toastmaster's
approximate $145 million revenue base would equate to 9.2 percentage points of
margin improvement.
Based on management's past performance of driving revenue growth through
creative and innovative new products, we would expect Toastmaster product line
sales to increase by 7% in fiscal 2000 and by 10-13% in fiscal 2001. Further,
as management shifts a majority of Toastmaster's previously domestically
manufactured products to low-cost out-sources in the Far East, we are
conservatively expecting operating margins on Toastmaster's revenues to improve
to 3% in fiscal 2000 and 8% in fiscal 2001. Longer term, on average, we see no
reason why margins on products under the Toastmaster brand name should not
achieve levels in line with Salton's other products.
Prior to the completion of the Toastmaster integration, comparisons of future
periods to historical periods may be confusing to assess. For example, we are
estimating operating margins to be 12.8% in fiscal 2000 versus our estimate of
13.0% in fiscal 1999. The reason for the decline is the full-year inclusion of
Toastmaster in fiscal 2000 versus six-months in fiscal 1999. Pro forma for the
full year impact of Toastmaster, fiscal 1999 operating margins would have been
approximately 10.6%.
COMPANY OVERVIEW
Founded in 1947, Salton was acquired by current management in 1988 in a
management buyout when the company had net revenues of approximately $8
million. In October 1991, the company concluded an initial public offering of
3.45 million shares (split-adjusted) with net proceeds of approximately $25
million. Through a series of strategic acquisitions, Salton has become a
leading designer, marketer and distributor of a wide range of small household
electrical appliances, tabletop products, clocks, gifts and personal care
appliances.
In January 1999, the company completed its largest acquisition to date,
Toastmaster, Inc., for aggregate cash consideration of $111 million. The
company reported net revenues of $441.0 million for the twelve months ended
March 27, 1999. Pro forma for the Toastmaster acquisition, comparable twelve-
month revenues would have been approximately $561 million. As shown below,
Salton's Kitchen and Home Appliance category is its largest contributor.
REVENUE BY PRODUCT LINE
NEW PRODUCT DEVELOPMENT
Among the attributes that set Salton apart from its competition are the ability
of its in-house design and engineering departments to develop new products and
enhance existing products in ways that satisfy a wide range of consumers. With
74% of its historic growth driven by new product introductions, we believe that
this capability, coupled with the company's brand building strategy will
continue to achieve excellent topline growth in the future.
The company's most successful new product introduction to date has been the
George Foreman Grill. We are estimating that this product will nearly double
its fiscal 1998 level and contribute approximately $175 million, or 30% of pro
forma fiscal 1999 revenues. Although we are not expecting this sizzling growth
to continue, Salton will benefit in fiscal 2000 and beyond from the broadening
of its George Foreman line to include a new rotisserie product and a cookware
line.
Also in fiscal 2000, Salton is launching a unique facial toning system under
the Rejuvenique brand name, and with the support of Linda Evans. This product
has achieved the highest levels of acceptance in marketing studies of any new
product launched by the company. Management has stated that if all pre-orders
on this product were filled, incremental revenues would reach $200 million.
Given manufacturing capacity issues, and more importantly, our uncertainty of
the long-term acceptance of this unique product, we have assumed incremental
revenues of $20-25 million from this product in our fiscal 2000 estimates.
Other new product launches or product line extensions include a line of coffee
preparation products under the Melitta brand name, a Toastmaster countertop
toaster oven with a removal inner-liner, the Marilyn Monroe personal care
product line, the Sasaki line of dinnerware and crystal giftware, and the
Advantage 2000, a database Internet module for use in the kitchen.
MULTI-CHANNEL DISTRIBUTION STRATEGY
The company maintains a diversified base of distribution channels. Salton
distributes through mass merchandisers, department stores, infomercials, TV
direct shopping, mail order catalogs and catalog showrooms. The company
expects to continue selling its products through infomercials and its Internet
website. These alternative channels provide Salton with additional product
sales, direct contact with consumers and increased brand awareness which, in
turn, assist in stimulating retail demand.
KMART AND OTHER TRADE AGREEMENTS
In January 1997, a five- to seven-year purchase agreement to exclusively supply
product under the White-Westinghouse brand was signed with Kmart Corporation.
Thus far, Kmart's purchases have exceeded minimum annual requirements. During
the nine months ended March 27, 1999, Kmart accounted for approximately $53.4
million, or 14% of Salton's net revenues. During fiscal 1998, Kmart purchased
$58.9 million of products from Salton, which accounted for approximately 19% of
net revenues.
Salton has similar exclusive partnership agreements with several other retail
customers. These include Sears with the Kenmore brand, Target / Nutritionist,
Wal-Mart / Magic Chef and QVC with the cook's essentials brand.
VALUATION
In line with its financial performance and certain higher profile business
decisions, Salton's stock performance has gained considerable momentum, from a
base of $9.50 to its current level of $29.94 per share. Despite this three-
fold increase, we still believe the stock continues to offer significant upside
over the next 12 months. On August 23, Salton's stock closed at $29.94 per
share, 13.9x and 10.4x our $2.16 and $2.89 fiscal 1999 and fiscal 2000 diluted
EPS estimates, respectively. This equates to 11.5x and 8.9x our calendar 1999
and calendar 2000 diluted EPS estimates of $2.61 and $3.36 per share,
respectively. These calendar multiples represent an approximate 23% and 29%
discount to the calendar 1999 and 2000 EPS multiples, respectively, of our
composite peer group.
We have derived a $40-44 12-month price target range based on applying a 12.0x
to 13.0x multiple to our $3.36 EPS estimate for calendar 2000. We have arrived
at this multiple range by looking at two different benchmarks: first, by
looking at the composite mean multiple of our entire composite peer group.
Second, by taking an approximate 15-20% discount to the 15.7 mean of the large-
cap companies (FO, HAS, MAT, NWL) within our peer group.
RISKS
Salton relies on its George Foreman Grills, The Juiceman and Breadman product
lines as these accounted for approximately 57% and 62% of revenues for the nine
months ended March 27, 1999 and fiscal 1998, respectively. As such, any
adverse sales growth trends in these products would negatively impact the
company's near-term performance. Likewise, failure to effectively integrate
Toastmaster and achieve the expected $13.3 million of cost savings would have
an adverse effect on the company achieving our EPS estimates. Further, as
Salton continues to participate in the consolidation of the housewares
industry, acquisitions could have a near-term negative dilutive effect on EPS.
Other new product launches or product line extensions include a line of coffee
preparation products under the Melitta brand name, a Toastmaster countertop
toaster oven with a removal inner-liner, the Marilyn Monroe personal care
product line, the Sasaki line of dinnerware and crystal giftware, and the
Advantage 2000, a database Internet module for use in the kitchen.
MULTI-CHANNEL DISTRIBUTION STRATEGY
The company maintains a diversified base of distribution channels. Salton
distributes through mass merchandisers, department stores, infomercials, TV
direct shopping, mail order catalogs and catalog showrooms. The company
expects to continue selling its products through infomercials and its Internet
website. These alternative channels provide Salton with additional product
sales, direct contact with consumers and increased brand awareness which, in
turn, assist in stimulating retail demand.
KMART AND OTHER TRADE AGREEMENTS
In January 1997, a five- to seven-year purchase agreement to exclusively supply
product under the White-Westinghouse brand was signed with Kmart Corporation.
Thus far, Kmart's purchases have exceeded minimum annual requirements. During
the nine months ended March 27, 1999, Kmart accounted for approximately $53.4
million, or 14% of Salton's net revenues. During fiscal 1998, Kmart purchased
$58.9 million of products from Salton, which accounted for approximately 19% of
net revenues.
Salton has similar exclusive partnership agreements with several other retail
customers. These include Sears with the Kenmore brand, Target / Nutritionist,
Wal-Mart / Magic Chef and QVC with the cook's essentials brand.
VALUATION
In line with its financial performance and certain higher profile business
decisions, Salton's stock performance has gained considerable momentum, from a
base of $9.50 to its current level of $29.94 per share. Despite this three-
fold increase, we still believe the stock continues to offer significant upside
over the next 12 months. On August 23, Salton's stock closed at $29.94 per
share, 13.9x and 10.4x our $2.16 and $2.89 fiscal 1999 and fiscal 2000 diluted
EPS estimates, respectively. This equates to 11.5x and 8.9x our calendar 1999
and calendar 2000 diluted EPS estimates of $2.61 and $3.36 per share,
respectively. These calendar multiples represent an approximate 23% and 29%
discount to the calendar 1999 and 2000 EPS multiples, respectively, of our
composite peer group.
We have derived a $40-44 12-month price target range based on applying a 12.0x
to 13.0x multiple to our $3.36 EPS estimate for calendar 2000. We have arrived
at this multiple range by looking at two different benchmarks: first, by
looking at the composite mean multiple of our entire composite peer group.
Second, by taking an approximate 15-20% discount to the 15.7 mean of the large-
cap companies (FO, HAS, MAT, NWL) within our peer group.
RISKS
Salton relies on its George Foreman Grills, The Juiceman and Breadman product
lines as these accounted for approximately 57% and 62% of revenues for the nine
months ended March 27, 1999 and fiscal 1998, respectively. As such, any
adverse sales growth trends in these products would negatively impact the
company's near-term performance. Likewise, failure to effectively integrate
Toastmaster and achieve the expected $13.3 million of cost savings would have
an adverse effect on the company achieving our EPS estimates. Further, as
Salton continues to participate in the consolidation of the housewares
industry, acquisitions could have a near-term negative dilutive effect on EPS.
Scott |
