Calloway’s Nursery operates 18 garden center stores in the Dallas-Fort Worth and Houston, Texas areas. The company has been in operation since 1987. I ran across Calloway’s on Nate Tobik of Oddballstocks.com’s excellent site unlistedstocks.net, a great resource for financial information on these overlooked companies. Calloway’s is tiny, with a market capitalization of $6 million or so and $45 million in sales last year. The company is also heavily indebted, carrying net debt of 2.3 times trailing adjusted EBITDA. However, the company is profitable, produces free cash flow and trades at a modest multiple of each.
Calloway’s operates in a highly competitive market. The company lists its top competitors as Lowe’s, Wal-Mart and Home Depot, all heavy hitters in the garden department. The company also competes with hundreds of small private nurseries in its geographic region. I was able to do a little research on Calloway’s competitive strategy through Yelp. While Yelp reviews are a highly non-scientific source, the company’s reviews are positive. My sense is Calloway’s charges a little more than its competitors and focuses on pleasing its customers through excellent customer service, free education and guarantees on plants sold.
The big issue facing retail chains in the US is the encroaching “show room effect,” or “Amazonification” as I prefer, where customers go to physical stores to appraise merchandise, then buy it online for cheaper. I don’t think garden centers will be significantly affected by this trend. Plants are not fungible. While one iPhone or DVD or vacuum cleaner is the same as another of its kind, plants vary in size, visual appeal and health. When I go to buy a houseplant I need to see it, pick it up and turn it around and compare it to its neighbors. I would be very hesitant to buy a plant sight-unseen. For this reason, I think physical garden centers will be around for as long as gardening is popular.
Despite this advantage, top-line growth has been difficult to come by for Calloway’s. Revenues peaked at $47.35 million in 2003 and have remained largely steady since, aside from a sharp downturn in 2009. However, looking at sales per store shows a rosier trend. Since peaking at 26 stores in 2003, Calloway’s has gradually closed down marginal locations and now operates 18 garden centers. While each store generated $1.84 million in sales in 2003, sales per location hit $2.54 million in trailing twelve months, a 38% increase over the time period.
The company has been successful in increasing its gross margins, which rose to a new high of 48.43% over last four quarters. Operating margins have followed suit, climbing to 6.05%. Operating income in the chart below is adjusted to exclude one-time items like the impairment charge the company took in the most recent quarter. Net income is not adjusted.
Calloway’s turns in an annual profit fairly consistently, but the amounts of these profits are regrettably inconsistent. For the twelve trailing months, Calloway’s adjusted EBITDA and operating profits hit new highs. Free cash flow followed suite, coming in at the highest levels since 2008.
Calloway’s balance sheet is another matter. While the company’s finances are stronger now than they once were, the company carries significant debt.
At $11.26 million, Calloway’s debt is 4.06 times its trailing operating income. Total debt is down $2.35 million since 2008, but the company does not seem overly serious about shaping up its balance sheet. Total debt is still 1.5 times equity and interest payments used up 32.3% of operating income in 2011. If the company would dedicate just a little of its excess cash and a year or two of its free cash flow to reducing debt, it could greatly improve its financial metrics and perhaps even qualify for a lower interest rate refinancing on existing debt. As is, the company’s significant debt load reduces the company’s flexibility.
All the same, it’s hard to argue with success. After sustaining years of losses leading to its reverse split and de-registration in 2004, Calloway’s has built book value per share from $0.41 per share in 2003 to $0.92 at quarter’s end, an annualized rate of 12.7%. Maybe not world-beating, but certainly respectable.
The past is informative, but what is Calloway’s Nursery worth today? Adjusted for non-recurring items and assuming a 35% tax rate, Calloway’s would have earned $1.27 million in net income in the twelve trailing months, and $3.31 in EBITDA. Actual free cash flow was $1.64 million, but the company made nearly no capital investments. Assuming depreciation and maintenance capital expenditures are roughly equal, free cash flow would have been $1.30 million.
With a market capitalization of $6.00 million, Calloway’s looks cheap.
Investors will have to weigh the company’s recent successes, P/E of 4.7 and free cash flow yield of 21.7% against net debt to adjusted EBITDA of 2.3. It’s also worth mentioning that Calloway’s trades at 80% of book value despite recording an ROE of 27.2% in 2011. Nearly all of this book value is tangible, and it’s quite possible that some of the company’s landholdings have appreciated since purchase. The company lists property with a book value of $1.508 million as held for sale. A successful sale would provide a nice opportunity to reduce debt or make a productive investment.
To close with a bit of triva, Calloway’s Nursery boasts a famous shareholder in Peter Lynch, acclaimed former manager of the Fidelity Magellan Fund. Mr. Lynch wrote briefly about Calloway’s in his book One Up On Wall Street and disclosed an 11% interest in the company in 2001. (I can’t guarantee that Mr. Lynch still holds these shares, but his original filing is here.)
Disclosure: No position.