It hasn't been a universally great time for companies dependent on the infant and juvenile products market. Mattel (MAT) has done pretty well, and Summer Infant (SUMR) is still up by double-digits, but companies like Dorel and Kid Brands (KID) have found this to be a more challenging environment as a low birth rate and a shift from many major retailers towards their own private label brands have impacted sales.
Crown Crafts (CRWS), though, has enjoyed a good run this year. Up more than 35% over the past year, the company has recently gotten a sales growth boost from new product launches, while a change in product mix has boost operating margins nicely. While the small float, low volume, and minimal sell-side coverage all mean that investors may have to exercise some patience in waiting for this idea to develop, the model and valuation look compelling today.
A Textiles-Focused Infant And Juvenile Products Company
Unlike Summer Infant, which is more focused on hard goods like monitors, gates, cribs, strollers, and so on, Crown Crafts is based around textiles. Infant and toddler bedding is nearly half of the company's sales base (much of it through the NoJo brand), with another third coming from textiles like bibs and blankets.
It shouldn't surprise readers that Crown Crafts does not manufacture its own products. Instead, the company uses outsourced manufacturing, sourcing a large amount of its products from China. While rising labor and production costs in China are therefore a threat, I don't believe that Crown Crafts is significantly more exposed than its rivals.
It also shouldn't surprise investors that Crown Crafts depends on many of the same retailers as Summer Infant, Kid Brands, Gerber Childrenswear, and other rivals. Wal-Mart (WMT) represents nearly 40% of the company's revenue, with Toys/Babies R Us adding more than another quarter, and Target (TGT) representing about 10%. Although the company exited its private label bedding business a little while ago (the profitability was not good enough for management), the company continues to supply private label products for Wal-Mart ("Parent's Choice"), Toys/Babies R Us ("Koala Baby"), and Target ("Circo").
Readers should also note that Crown Crafts isn't just an infant/juvenile products company. A few years back, the company entered the pet products market with its Neat Solutions for Pets line of pet bedding products.
A Disciplined Model Pointing Toward Better Results
One of the big challenges for Crown Crafts' publicly-traded rivals and comparables is maintaining an attractive mix of growth and profitability. Kid Brands, for instance, has been remarkably inconsistent on the top line and has only very occasionally posted attractive margins or returns on capital. Summer Infant has done a little better on margins (though not in recent years), but has used debt-funded acquisitions to boost its growth rate.
To be sure, Crown Crafts does not have a great growth profile - while revenue was up 16% in the last quarter, the trailing 10-year sales CAGR is (1.1%). Some of this can be attributed to the challenges of the child product market, but more of it has to do with management's deliberate willingness to forgo revenue that doesn't carry strong enough margins - such was the case with the company's decision to exit the private-label bedding business.
Crown Crafts is also looking to build up its proprietary brands. Like Kid Brands and Summer Infant, licensed products have featured prominently in the company's sales mix. More than half of the company's fiscal 2013 sales came from licensed products, with Disney (DIS) making up more than one-third of sales, along with other well-known brands like Nickelodeon, Fischer-Price, Sesame Street, Looney Tunes, and Hello Kitty.
While licensed brands can be a shortcut to consumer popularity (an Elmo bib or Hello Kidding blanket can draw more attention than an unknown brand), these licenses are often expensive for the license holder. Summer Infant, for instance, has started backing away and deprioritizing its licensed business due to that issue. With that in mind, Crown is trying to build its proprietary brands. Excluding toddler products (which are overwhelmingly license-based), the company has grown its branded sales from 20% in fiscal 2009 to 37% last year, with nearly equal amounts coming from declines in licensed sales and private label. This strategy does increase the risks that Crown Crafts will come into some conflict with those retailers who want to build their private label brands, but the margin leverage should be worth the gamble.
A Lean Model Is A Mixed Blessing
Crown Crafts runs a fairly tight ship, which is great for long-term shareholders but paradoxically can be a problem for the stock (as it eliminates cost-cutting as a "catalyst" and it reduces the appeal to private equity buyers). I'm also concerned that the company is not in what I believe is fundamentally a growth market. Crown Crafts may be a decent play on a recovery in the U.S. birth rate, but I'm not all that eager to buy into that story. Likewise, I don't Crown Crafts as particularly well-positioned to become a global player and take advantage of higher birth rates in emerging markets.
Even so, I think there will be decent growth here. If the company can continue to boost its proprietary brands and modestly gain market share (through new product introductions like the recent Sadie & Scout line), a long-term revenue growth rate of 4% doesn't seem ridiculous. While new product introductions are compressing free cash flow today (due to higher inventory levels), margins are improving nicely and I believe the company can reclaim double-digit free cash flow margins on a sustained basis. With that, I see long-term free cash flow growth of around 5%.
The Bottom Line
This is still very much an under-followed and under-owned company (Yahoo! Finance says institutional holdings are just one-third of the share count), but it boasts quality holders like Royce. A recent surge in insider sales is a bit concerning, but I don't believe it invalidates the overall thesis.
Maybe the most attractive part of the Crown Crafts story is that just 5% long-term free cash flow growth, coupled with a high discount rate, still points to a fair value over $10 today. Crown Crafts is going to take some patience to work out as a stock, as the float, volume, and scant coverage make it nonviable for many institutions. But for individual investors who don't need to worry as much about volume, I believe Crown Crafts could still have room to build on what has already been a good run.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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