Neglected Canadian Success Story
raveninvestment.com
(Updated December 23, 2000)
John Zemanovich
Raven Investment Management Limited
Friday, December 1, 2000 (OAKVILLE) - The safest way to make money in the stock market is to invest in a company that's easy to understand, operates with little or no debt, consistently makes money for its shareholders, has a good, honest management team and is available at a reasonable price.
Such businesses are hard to find yet they do still exist even in today's largely overvalued stock market. One such business is a true Canadian success story with its head office operating out of Calgary. Liquidation World Inc. (LQW/TSE or LIQWF/NASDAQ) is a liquidator of merchandise from bankruptcies, receiverships, closeouts, inventory overruns, buybacks, insurance claims and other distress situations. In other words, they liquidate excess inventories for banks, insurance companies and inventory-laden companies through their 89 locations across North America.
The company's CEO, Dale Gillespie, started Liquidation World back in 1986 ("back when I couldn't sleep with worrying about finding inventory") with 150,000 mechanical pencils. In fact, one of his first insights, which lead to the development of this niche market, was that it's much easier to sell 150,000 mechanical pencils if you can spread them throughout a wide area and a variety of outlets rather than one location. With that insight, Gillespie made sure the business expanded to different geographies. Ever since, Liquidation World has increased their outlets from 1 in 1987 to 89 at time of publishing with 1700 employees. Another side benefit of that insight was that the larger distribution network gave them leverage with their suppliers for better pricing and inventories. Companies looking to rid themselves of inventory need to get rid of it all as soon as possible. Liquidation World's outlets allow them to move large quantities of merchandise and with their strong balance sheet; suppliers are paid in full with cash. The smaller liquidators simply cannot compete. In fact, according to Mr. Gillespie "we have no pure competition." He pointed out that there are a "variety of business segments" in the liquidation industry and Liquidation World has diversified themselves throughout. In fact, Mr. Gillespie added that they are looking to expand to other segments such as the "GOB" (Going Out of Business) part of the liquidation industry. He also pointed out another durable competitive advantage for the company is that "We are the only company in our business operating on both sides of the border". This gives Liquidation World an amazing edge inasmuch as clients can discreetly sell their excess inventories in different markets without alerting competitors or clients. Liquidation World never discloses the source of their goods nor a client's name unless specifically instructed to. This is very important to their suppliers, many of which are Fortune 500 companies, because they need to protect the pricing power of their current inventories.
The company's financials are solid. Sales have increased from less than 800 thousand in 1987 to over 165 million in 2000. In case the math eludes you, that's a growth rate of over 47% compounded. Net earnings for the company have grown from 8 thousand to 6.3 million in 2000. That's a 61% compounded growth rate. From 1987 to 2000, sales growth has averaged 46% and the average return on equity has come in at 17%. All without any long term debt.
Perhaps the most valuable asset the company has that isn't reflected on the balance sheet is their reputation. Mr. Gillespie and Mr. Andrew Searby, the company's CFO, gave detailed examples of instances where Liquidation World's reputation for honesty and integrity have delivered dividends to the company. Mr. Gillespie added with obvious pride "We have a great reputation in our industry."
With goodwill and financials such as these, you would assume a high-tech valuation would be in order for this decidedly non-tech business. Well, for reasons known only to those selling their stock so cheaply, you would be wrong. Believe it or not, Liquidation World is trading at a P/E of only 6.6 times last year's earnings or less than 1 time book value. "We come to work everyday and work very hard at making money," added Mr. Gillespie. "I simply cannot explain that (the share price) to you."
My expectations for 2001 Earnings Per Share (EPS) are 84 cents a share. If Liquidation World were a bond, current market pricing means your investment is yielding a coupon (EPS) of 15% with growth options attached for as long as you hold the bond. Given that the risk of default is unimaginably low (Remember - they have no long term debt) and the business is solid (over 56 consecutive quarters of profit with no losses), the terms of commitment are currently extremely favourable.
In fact, it is so cheap that management has recently announced a share buyback program for 5% of the outstanding shares on the open market and has instituted a shareholder rights plan in order to ward off unfriendly and unfair takeover attempts. (Editor's note: The shareholders rights plan was voted down by shareholders 25/01/2001)
If Liquidation World continues to grow its EPS at a rate of 15%, half it's 14 year average of 36%, the company should be earning approximately $1.49 per share in 2005. If the investor chose to commit for 10 years, the company should be earning approximately $2.99 in 2010.
Thinking in bond terms, your Liquidation World equity/bond should look like the following:
2001 LQW Equity/Bond
Priced at $4.85
Year
Coupon (estimated EPS)
Yield
01
$0.84
17.3%
02
$0.97
20.4%
03
$1.12
23.5%
04
$1.29
26.6%
05
$1.49
30.7%
06
$1.71
35.3%
07
$1.97
40.6%
08
$2.26
46.6%
09
$2.60
53.6%
10
$2.99
61.6%
Year to date, the stock is down over 30% from its high. The trouble began when a US deal went sour. This deal did not turn out well for reasons beyond management's control and it had to be ended prematurely in order to mitigate the damage to the balance sheet. Larger than expected expenses and a temporary slowdown were the results.
Besides being a less than glamorous business, there may be a few reasons for the steep decline in price this year. Mr. Gillespie and Mr. Searby mused that it could be the lack of interest in small cap stocks, the emphasis on momentum investing, a speculative market favouring dotcom and high-tech offerings, or that they have been pegged to the retail industry by investors despite not really being a typical retailer. With all these potentialities, the shares were prone to being sold off.
Despite the market's suspect view, insiders and employees are holding fast to meaningful amounts of the stock. Mr. and Mrs. Gillespie personally own almost 10% of the company and have purchased 100 thousand shares "at an average cost of $5.67" over the past year. Mr. Searby pointed out that he is holding stock with an average cost of approximately $13. "Our employees who become eligible for bonuses and have the option of certificates for Liquidation World merchandise or stocks are opting for stock." Said Mr. Gillespie. "The average Liquidation World employee is holding stock at an average cost of $10 and they aren't selling."
As long as consumers keep looking for the best prices, the future prospects of the company are bright. When businesses carry too much inventory, natural disasters occur causing damage to merchandise and companies go bankrupt, Liquidation World is apt to be available to liquidate the merchandise.
Furthermore, the current setbacks to many of the soon-to-be-bankrupt dotcom businesses mean Liquidation World's prospects are better than ever. An enthused Mr. Gillespie added, "We are seeing amazing inventories becoming available" and when these businesses realize they can no longer afford their leases: "We'll be there to seize the opportunity and open new outlets at bargain basement prices."
As another talented Canadian, Wayne Gretzky once said: "Go where the puck is going. Not where it's been." |
