CCA Industries (NYSE:CAW): Undemanding Valuation; But I Lack Confidence in Growth Outlook

Company Overview

CCA Industries, Inc. (CCA) is a consumer products company with the following sales mix:

As can be seen, CCA’s key categories are Skin Care and Oral Care.

CCA’s Oral Care category comprises solely of the Plus+ White brand. The main Plus+ White product is a gel used to whiten teeth which is priced an order of magnitude below Crest Whitestrips (ie. $5-6 vs $40).

The annual sales trend of Oral Care can be seen in the chart below. The declines in recent years are largely attributable to CCA discontinuing the production of toothpaste. CCA has cited intense price competition between Colgate and Crest in toothpaste.

CCA’s Skin Care category is comprised of multiple brands. The two largest brands are Bikini Zone and Sudden Change. Bikini Zone’s main benefit is to prevent razor burn in “sensitive” areas. Sudden Change promises to reduce under eye circles. Porcelana (a licensed brand) is also included in the category and growing at a high rate. Porcelana’s main benefit is to even skin tone and reduce the appearance of “age spots”.

The annual sales trend in the Skin Care category is in the chart below. Recent declines can be attributed to discontinuing to Solar Sense (due to lack of profitability) and reducing the number of Sudden Change SKUs.

Why I looked at CCA

I got interested in looking at CCA Industries because it operates in a noncyclical industry (a prerequisite for me at this stage in the cycle) and has a very undemanding valuation.

Summary

The key factor in determining CCA’s future share price will be the trajectory of its top-line growth. This is something I struggle with given CCA’s low price positioning and threat of private label substitution in an increasingly competitive retail environment. I wrote out my thoughts in some detail – you may disagree… If you disagree, the valuation definitely seems undemanding and could be a set up for good returns in the future. I have some trouble trusting management given the obsession with share price and why it is not higher (makes me wonder what they would say / selectively disclose in order to try and increase the share price).

Management

The Chairman and CEO of CCA Industries (CCA) is Lance Funston. Funston was named Chairman in Aug 2015 and became CEO in Jan 2016. Funston has a control ownership position in CCA which stems back to a transaction in Sept 2014 in which he: 1) acquired 100% of the Class A common shares, 2) a warrant to purchase 1.9M shares of common stock (exercise price $3.17), 3) Lent CCA a $1M term loan (LIBOR +6%), and 4) provided CCA with a $5M line of credit (LIBOR +6%). In March 2018, Funston exercised 450,000 of his warrants providing the company with $1.4M in cash which is intended to help launch new products. (Note: Class A and common shares are equal in nature other than the stipulation that Class A common shares separately elect 4 directors and common shares separately elect 3 directors).

Sardar Biglari (Lion Fund and Biglari Holdings) owns 776,259 shares of CCA common stock. Shortly after the 2014 transaction, Funston entered into an agreement with Biglari giving Biglari the right to sell him his shares at $6.00. Funston did this in an attempt to lock-up the largest shareholder and prevent further selling pressure on the stock. The right becomes exercisable on Jan 1, 2019 and is very likely to be exercised given CCA’s current share price of ~$3.00 (ie. Funston is on the hook to buy shares at $6.00 even though the current share price is only $3.00).

Funston is currently 75 years old and as he says himself, “it’s not my first rodeo.” Some of his past successes include Larami Toys which developed the Super Soaker, and TelAmerica which was sold to Cross MediaWorks (85% in 2008) and Lee Group (15% in 2013). Funston also founded Ultimark in 2000 which sold the Prell, Denorex and Zincon brands to Scott’s Liquid Gold in 2016 for $9.0 million. Ultimark continues to own the Porcelana brand which is currently being licensed to CCA (CCA pays Ultimark a 10% royalty on gross sales).

One unsettling claim from Funston is that he sold the Prell, Denorex, and Zincon brands for 3x sales to Scott’s Liquid Gold. Based on SLGD disclosure, the brands were actually sold for only 1.4x sales ($9 million purchase price on $6.5 million of sales).

The dealing/licensing between Ultimark and CCA also raises an eyebrow as Funston is Chairman of Ultimark and control owner of CCA. This is compounded by more self-dealing as Funston also earns fees for CCA Industries advertising (through Funston Media Management) and owns a building that CCA rents.

The other named officers are Douglas Haas who is COO and Stephen Heit who is CFO. Heit has been at the company since 2005 and provides Funston with some “institutional knowledge” that he may otherwise be lacking. Funston brought Haas into CCA in 2015. Haas previously worked with Funston at Ultimark since 2015.

What concerns me the most is Funston’s obsession with the share price on the conference calls. When management is too concerned with the short-term share price, they may take actions that hurt the sustainability of the business over the long-term. They also become difficult to trust and take their word at face value; as demonstrated by Funston’s claim that he sold the brands to SLGD at a higher multiple than he did.

Balance Sheet

As at 28 Feb 2018, CCA Industries had $1.5M of debt outstanding and a cash balance of $1.1 million. Net debt of $0.4 million. This is down from net debt of $1.9 million at year end 2017 and $3.0 million at year end 2016. Note that CCA Industries saw a $1.4 million cash inflow from Funston exercising warrants in Q1/18 which accounts for the majority of the change in net debt between y/e 2017 and Q1/18.

In the years 2013 and prior, CCA industries typically operated with a large net cash balance. This changed in 2014 largely from fallout related to returns in two of their product lines: 1) Gel Perfect nail care products, and 2) Mega-T diet supplements.

It is important to note the trend in CCA’s debt agreements. Over time, terms have become less punitive. Most recently, CCA went from paying LIBOR +6% on an agreement with CNH Finance to paying LIBOR + 2.75% with PNC bank. In other words, debtors have re-rated the credit risk associated with CCA industries. This is in large part due to CCA’s increased profitability and associated cash flow in 2016 and 2017.

Growth

While I wholly disagree with blindly extrapolating growth rates forward to forecast target share prices, it is still very useful to know the historical performance of a company. CCA’s Net Sales and EBIT are displayed in the chart below. Two things to note:

  1. The displayed results do not include the Gel Perfect nail care brand or the Mega-T dietary brand; both of which were discontinued in 2014.
  2. While net sales have been in decline, CCA has done an impressive job at increasing profitability. This has been done by outsourcing all manufacturing and order processing. Payroll at CCA has gone from $11 million at its peak to $2 million currently. CCA has also trimmed the number of SKUs it carries to focus on its most profitable lines.

The key question in my mind is whether or not CCA can return its top-line to growth. This is obviously not a unique insight given that nearly all “turnaround” situations face this dilemma. But nevertheless, it is still very important to analyze…

One important note in making this assessment is that CCA does have major customers with Walmart at 36% of sales, Walgreen at 13% of sales, and Target at 7% of sales. It’s also important to note that sales have been on a decreasing trend at each of these major customers. The implication being that CCA is losing shelf space.

In my view, the positioning of CCA’s brands as low cost leaders within their categories is troublesome. Brands at the low end of the price spectrum are most susceptible to private label competition. I would note for example that CVS Pharmacy has a “store brand” for teeth whitening that looks to have a similar function to CCA’s Plus+ White brand. Private label is playing an increasing role in US retail due to the entrance of Aldi and Lidl.

In order to reverse the trend and sell more to its large customers, CCA needs to innovate and introduce new products. There are some promising developments on this front: 1) CCA’s Bikini Zone brand has four new products (exfoliating gel, ingrown hair syrum, medicated pad, depilatory), 2) CCA plans to extend its Bikini Zone product to males with a trademark known as “Manscape Grooming”, 3) Porcelana brand is introducing a new hand cream, and 4) Plus+ White has a new product specifically targeting sensitive teeth.

If CCA is not able to convince retailers to carry its new products, the company does have potential to sell direct to consumer through e-commerce. On a related note, CCA has committed to increasing digital advertising to 50% of its media spend in 2018.

I estimate CCA’s largest brands are: 1) Plus+ White at $7.5 million of sales, 2) Bikini Zone at $3-5 million of sales, 3) Sudden Change at $3-5 million of sales, and 4) Porcelana at $2 million of sales. Add it all up, and these brands represent nearly 90% of CCA’s sales. Further, CCA has noted Plus+ White and Bikini Zone are “Millennial” brands where things like social media presence matter.

We can take a look Plus+ White and Bikini Zone’s online presence to gauge their likelihood for e-commerce success.

Amazon Star Rating

Like it or not, the star rating generated by consumer reviews on Amazon matters.  Depending on the exact product, both Plus+ White and Bikini Zone have reviews that range between 3.5 and 4.0 stars on Amazon. I would classify this as “okay”. Generally, you need at least a 4-star product to show up on the first page of Amazon search results.

Instagram Followers

Both Plus+ White and Bikini Zone have about 20,000 Instagram followers. This is good when compared to a brand like Crest which also happens to have about 20,000 followers, but small relative to brands that have been built on social media like Quest Nutrition (813K followers), The Honest Company (812K followers) and StichFix (654K followers). The engagement of both brands seems relatively limited. Plus+ White averages 50 to 100 likes per post, while Bikini Zone can get up to 200 likes (which still seems low given over ½ of its posts are attractive females in bikinis).

YouTube Influencers

Plus+ White has better traction than Bikini Zone on YouTube.

There are three Plus+ White “influencers” I found on YouTube promoting Plus+ White. The videos have 5.2 million views (https://www.youtube.com/watch?v=u_M5MaxLL5U), 709 thousand (https://www.youtube.com/watch?v=2pFAr6hgIEM&t=2s), and 252 thousand views respectively (https://www.youtube.com/watch?v=jtlI4nUuPf8).

I found one Bikini Zone “influencer” whose video has 1.5 million views. (https://www.youtube.com/watch?v=glRP_kq3CDg).

Overall

While promising, CCA’s online presence still appears to be in its early stages. It will be interesting to see how numbers increase in 2018 as CCA puts more dollars behind digital ad spending. It is worth pointing out that Funston’s expertise is in aggregating local cable operator TV spots in order to reach a national audience. I am not entirely sure that this will translate into the digital world (while also noting that CCA continues to use Funston Media Management – owned by Lance Funston – as its advertising agency).

A couple of final points on growth which I have yet to mention:

  • CCA recently announced a change to its third party sales and distribution organization. CCA is switching from Emerson to Advantage because Advantage has a larger presence in grocery and internet channels. The grocery channel represented $3-4 million in sales for CCA at one point; most of which has been lost.
  • CCA is hopeful it can reinvigorate the nail care category which used to sell $4-6 million annually. CCA recently signed a new trademark agreement for the Nutra Nail brand with a 10% royalty and an option to buy. CCA plans to go back to market with Nutra Nail’s six core products which includes things like nail strengthener and cuticle remover.

Valuation

According to Funston, the going price for CPG companies in M&A transactions is 3x net sales. Using his metric, CCA is undervalued at around 1x net sales. No need to do any further work right? If only it were that easy… I would view Scott’s Liquid Gold (OTCMKTS:SLGD) as one of CCA’s closest comparables. In 2017, SLGD earned revenue of $42M and EBIT of $7.6M. At a share price of $3.35, SLGD currently has a market capitalization of $40.3M and an enterprise value of $37.3M, or a P/S ratio of 0.95x and a EV/EBIT ratio of 4.9x. Based on 2017 sales of $19.8M, EBIT of $3.5M, CCA currently trades at a P/S ratio of 1.2x and EV/EBIT of 6.9x.

One possibility is that both SLGD and CCA are undervalued because of their size. For example, Church and Dwight currently trades at 3.5x P/S and 18.2 EV/EBIT.

Another important note is that while SLGD has grown, CCA has shrunk. SLGD increased revenues from $16M in 2012 to $42M in 2017. Over the same period, CCA Industries revenue went from $53M to $20M (or from $33M to $20M if you exclude CCA’s discontinued Gel Perfect and dietary supplement products). It is possible that the difference in valuation is implying that CCA is expected to outgrow SLGD in the future. This seems reasonable given a significant portion of SLGD’s growth has come from their agreement to distribute Batiste Dry Shampoo. This could provide a headwind in the future as the ownership of Batiste changed in 2011 to Church and Dwight (from Vivalis who is based in the UK). It made more sense for SLGD to distribute the brand when it was owned by a UK-based company. Now that it is owned by a US company (Church and Dwight), the terms have already become more difficult. SLGD has been restricted to only selling in the specialty retail channel, and has also had the definition of what constitutes the specialty retail channel changed (ie. TJ Maxx was excluded from being considered “specialty” in 2017).

Another source of value for CCA relative to SLGD is tax loss carry forward. The carry forward should allow CCA to avoid paying cash taxes over the next 3-4 years (assuming profitability stays roughly the same). As of yearend 2017, SLGD did not have any tax loss carry forwards.

One last point to mention is that there could be some significant dilution if the CCA share price appreciates. There are 871,500 options outstanding with a strike price of $3.27 and 1,442,794 warrants with an exercise price of $3.17. This is significant relative to CCA’s total shares A (common + Class A) of 7.9 million.

The Company’s website: www.shopcca.com/

Author Ownership: NO NYSE: CAW

Read Disclaimer:

This article is for informational purposes only. This article is based on the author’s independent analysis and judgment and does not guarantee the information’s accuracy or completeness. The information contained in this article is subject to change without notice, and the author assumes no responsibility to update the information contained in this article. The information contained within this article should not be construed as offering of investment advice. Those seeking direct investment advice, should consult a qualified, registered, investment professional. This is not a direct or implied solicitation to buy or sell securities. Readers are advised to conduct their own due diligence prior to considering buying or selling any stock.

Qualitysmallcaps.com is not engaged in an investor relations agreement with CCA Industries, Inc. nor has it received any compensation from CCA Industries, Inc.  for the preparation or distribution of this article.

The author may trade shares of CCA Industries, Inc. through open market transactions and for investment purposes only.

One Reply to “CCA Industries (NYSE:CAW): Undemanding Valuation; But I Lack Confidence in Growth Outlook”

  1. I just read your analyses of WFCF and CAW, I am impressed.
    You have done a significant amount of research, and put a lot of thought into what it all means.
    Thank You.

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