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09:01am EDT 18-May-99 DLJ Securities (Peter N. Schaeffer) SFP
SALTON, INC.: Initiating Coverage with a Buy Rating
DLJ ****** DONALDSON, LUFKIN & JENRETTE ****** DLJ
May 17, 1999 Peter N. Schaeffer US (212) 892-4864
Jasmine Koh US (212) 892-8948
SALTON, INC. (SFP: $38)
Initiating Coverage with a Buy Rating
Range: Earnings Per Share 1999 vs 1998 % Chg
41-9 Old New P/E Ratios F1Q $1.01A vs 0.31 +226%
(FY:Jun.) 2000E $ $4.07 9.3 F2Q 1.25A vs 0.40 +213%
1999E 3.25 11.7 F3Q 0.54A vs 0.16 +238%
1998 1.12 33.9 F4Q 0.44 vs 0.25 +76%
Yield: % Market Cap.: $251 5-Yr. Growth Rate: 25%
Dividend: $0 Avg. Trading Vol.(000): 96.6 Book Value: $4.47
RATING: Buy Change: None 12-Mo. Target: $51
VIEWPOINT
We are initiating coverage of Salton, Inc. with a Buy rating and a 12-month
target price of $51. From a relatively unknown consumer appliance company,
Salton has become one of the most respected and profitable companies in the
kitchen and small household appliance sector. This has been accomplished
through brand and product acquisitions, refinement of manufacturing and
distribution, and, most importantly, through its unique ability to take a
product, market and brand it, and expand it into a full product line.
Today, the company's stable of brands includes the George Forman Grill, The
Juiceman, Breadman, Farberware, White-Westinghouse, Melitta, Toastmaster,
Ingraham, Block China, Sasaki as well as the Salton and Maxim brands. The
company tends to develop, produce and distribute products that offer the
consumer convenience, value and the ability to lead a "healthy lifestyle".
Salton's slogan is "Innovative products for a healthy today and tomorrow";
however, based on our projections and the company's recent performance,
perhaps it should change the slogan to, "Innovative profits for a wealthy
today and tomorrow."
Over the past several years, the company has risen from relative obscurity
to relative obscurity despite growing sales from $77 million in fiscal 1995
to a projected $483 million for the current fiscal year and $674 million in
fiscal 2000. Operating income has also soared from $3.7 million in 1995 to
an estimated $64 million in the current year. In addition, the company has
received a mandate from Kmart and Sears as the sole outside provider of
private label small electric appliances and, recently, began a similar
program for Wal-Mart. It also acquired the license rights for Farberware
appliances. In January 1999, Salton acquired Toastmaster, which is expected
to add approximately $150 million in sales beginning in the second half of
FY99.
Even without the Toastmaster acquisition, the company has been a
performance leader. Sales for FY1998 totaled $306 million, a 67% increase
over the prior year. Operating income surged to $29.7 million, a 184%
increase while earnings per share on a continuing basis rose 234% to $1.12.
Yet in our opinion, this is just the beginning. We project FY1999 sales of
$489 million, which include only two quarters of Toastmaster sales, or
approximately $45 million. Operating income for FY1999 is projected to
grow 115% to $64 million, with EPS of $3.25, a 190% increase. EPS for the
first 9 months of FY1999 which has already been reported and includes the
very profitable July through December period were $2.26 against last year's
$0.71 in the same period. The final quarter of the year includes costs
associated with the Toastmaster integration, yet still reflects a projected
72% increase in earnings per share on a continuing basis. Our preliminary
estimates for FY2000 include sales of $681 million and EPS of $4.07.
Salton manufactures little (except for certain Toastmaster products),
concentrating instead on perfecting its sales and marketing capabilities.
Most of its products are sourced and manufactured in the Far East. The
company sells 99% of its product in North America through a diverse group
of over 4000 accounts.
While the $58.4 billion housewares market has been growing at less then
2.5% a year, we believe that Salton will continue to dramatically outpace
industry growth through its marketing capabilities, brand innovation,
varied product offering, quality and reliability recognition and strong
retailer relationships, The small appliance business represented $11.5
billion of the housewares sector in 1998.
Placing a valuation on Salton is difficult since, despite its strong
performance, the company is still saddled with debt. Over the next twelve
months, we expect significant improvements in the company's balance sheet
as its stock continues to perform, allowing the company to ultimately issue
additional equity to pay down debt or pursue acquisition opportunities. In
addition, its projected sales and earnings for FY99 and FY00 will solidify
Salton's financial position as they earn almost $70 million in the two-year
period.
Our DLJ Core-branded Group Index (CBI) is selling at 19.5 times 1999
estimates and 16.7 times 2000 numbers, placing Salton at a substantial
discount to the CBI despite a sector leading earnings growth rate of 25%.
Applying our brand equity discount to the company, we must address the
float, a small market cap, integration risk with the Toastmaster
acquisition and a 80% debt to capital ratio. As the stock has jumped from
$26 to $40 since the last week of April, on the company's strong third
quarter performance, we believe that management would consider a follow-
on/secondary offering to increase the float and pay down debt. This would
relieve two brand equity discount factors but until such action is
forthcoming, we apply a 10% discount for the float/market cap and a 5%
discount for the high debt level. In addition, we still must apply a 5%
discount for the Toastmaster integration risk as well as 5% for strategy
execution that insures the flow of new product. The sum of our equity
discounts results in a 25% discount to our CBI multiple of 17.5x current
estimates.
Given that we are currently in the fourth quarter and the company has
already reported 86% of the year's estimate, we feel more than comfortable
with our projections and are therefore basing our target price on FY2000
estimates. Based on an index-adjusted multiple of 12.5x the company's 2000
estimate of $4.07, we arrive at a 12-month target price of $51. If
however, the company does issue stock and pay down debt, within the next 12
months, our target price could rise.
IMPORTANT POINTS
Despite lackadaisical performance, the small appliance business will
continue to grow as products wear out and replacements are bought.
Favorable demographics such as new households, aging baby-boomers as well
as the gift giving aspect of the sector should also create demand for small
electric products and fuel Salton's revenues.
Salton currently holds significant market share in its key product
categories, which has been enhanced further through the Toastmaster
acquisition.
The company owns a strong portfolio of brands, including Salton, Maxim,
Toastmaster, George Forman Grill, The Juiceman, Breadman, Sasaki and Block
China. In addition, the company licenses several brands, including White-
Westinghouse, Marilyn Monroe, Looney Tunes and Taco Bell and has an
exclusive distribution agreement for the Farberware name in North America.
Due to the company's unique ability to use third party manufacturing in the
Far East rather than company-owned domestic factories, Salton's margins are
sector leading. The company is currently the largest importer of small
appliances from the Far East. Its ability to acquire domestic
manufacturers such as Toastmaster and convert to third party sourcing
should enable the company to continue to grow sales and earnings. Fiscal
2000 results should reflect over $13 million in cost savings associated
with the Toastmaster acquisition.
Salton's distribution is varied with only 44% of its business coming from
the mass merchants. This diversification allows the company to leverage
its product with the retail sector that is performing best, rather than
placing all of its business with a single distribution point such as
discount stores.
We believe that Salton will continue to grow its business through a
combination of market share gains, growth in private label merchandise such
as its White-Westinghouse agreement with K-mart and its Kenmore arrangement
with Sears, as well as additional licensing and acquisition opportunities.
Management 's proven ability to develop and market new product, make
sensible acquisitions and develop additional alliances should ensure
earnings growth in excess of 25%, over the next several years.
Copyright Donaldson, Lufkin & Jenrette Securities Corporation, 1999.
Additional information is available upon request.
First Call Corporation - all rights reserved. 617/345-2500
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