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In my initial article on Jewett-Cameron (NASDAQ:JCTCF) that was posted on Seeking Alpha on May 5, 2022, I focused on how the company has undergone a significant transformation that is not reflected in the stock price. This article is a follow-up with comments on the company’s most recent fiscal quarter and new perspectives about what to look for going forward.
I was CFO of Jewett-Cameron from 2007 to 2009, and I have followed the company very closely ever since then. Also, within the last year, I have had communications with senior management. However, they have not disclosed any material non-public information to me.
Comments on Fiscal Q3 (QE May 31, 2022)
For fiscal Q3 the company reported sales of $20.9 million, EPS of $.43, and EBITDA of $2.1 million. Latest 12-month sales, EPS, and EBITDA are now $63.0 million, $.57, and $2.8 million respectively.
A year ago in fiscal Q3, sales, EPS, and EBITDA were $21.6 million, $.69, and $3.4 million respectively. However, a gain on the extinguishment of COVID-related Paycheck Protection Program debt of $0.7 million was reflected in that quarter and excluding this abnormal gain, EPS would have been $.55 and EBITDA would have been $2.7 million.
My sales, EPS, and EBITDA estimates for Q3 were $29.3 million, $.79, and $3.9 million, which would have been a record quarter for sales and earnings. So, reported results were a big miss relative to my forecast.
My sales estimate for Q3 was $29.3 million, which would have been a 108% increase from Q2, looks like a very large percentage increase. However, it was a justifiable increase based on the fact that in fiscal 2000 this Q2 to Q3 increase was 113% and in fiscal 2021 it was 107%.
Q3 EPS and EBITDA were well below my forecast because actual sales were so much less than my estimate.
Gross margin in Q3 was 25.6%, which was slightly lower than my forecast of 25.9%, and means that they were able to increase selling prices. Furthermore, this indicates that sales volume is most of the explanation for the sales shortfall.
The company cited some factors that negatively affected sales during the quarter as follows.
- Supply chain issues slowed the introduction of several new products.
- Some poop bag sales were delayed due to the switch to new product packaging.
- They replaced some existing pet product lines with newer models, which resulted in slower sales in the quarter during the transition.
- Sales in the non-core industrial wood products and seed segments were negatively impacted by problems that are likely to be transitory.
Gross margin is the financial metric that most clearly shows how well the company is managing the effect of higher product costs and this most recent quarterly number is significantly better than the 19.8% and 19.1% gross margins that the company reported for their fiscal quarters ended August 31, 2021 and November 30, 2021 respectively, when they were not able to pass through higher costs quickly enough.
The fact that sales were so far short of my estimate concerns me, and I think we will have to wait to see Q4 results to start to conclude that sales are not growing as much as expected.
The company has indicated that consumer demand for fencing and pet products has remained high. Also, FeedbackWhiz monitors activity on Amazon, and they have identified the six fastest growing product categories in 2022 on Amazon. Interestingly, three of the six product categories include Jewett-Cameron’s most important products. These three categories are Patio Lawn & Garden, Tools & Home Improvement, and Pet Supplies. So, in addition to having the infrastructure in place to generate strong sales, demand for the company’s products is good.
Debt at the end of the quarter was $9.0 million and cash was $2.1 million resulting in net debt of $6.9 million. This unusually high level of debt has been used to temporarily carry higher than normal inventory to mitigate supply chain problems and rising prices. Furthermore, in June they repaid $1.0 million borrowed under the company’s line of credit reducing debt to $8.0 million.
Jewett-Cameron continues to maintain a safe balance sheet with a current ratio of 2.54 and a net debt to latest 12-month adjusted EBITDA ratio of 2.9.
Settlement of Legal Claim Related to Misleading Poop Bag Packaging
Jewett-Cameron has disclosed that they reached a final settlement with an association of District Attorneys in California related to misleading poop bag packaging. The company will pay the expense of $0.3 million that had been accrued in fiscal Q2. Payment of this fine will occur over a four-month period with no admission of guilt by the company.
Seed Company Operation and Land
Jewett-Cameron’s seed company is a processor and distributor of agricultural seeds. The business and the land on which it operates were acquired in fiscal 2000. It consistently loses money, and the value of Jewett-Cameron would increase simply by discontinuing the operation of the business. It should have been discontinued years ago for this reason, and now I think it is likely to happen in the near future.
The seed company operates on land that is adjacent to North Plains, Oregon and is just across a highway from the town. Notably, North Plains has been conducting an urban growth boundary expansion study since the middle of 2021, and Charlie Hopewell, Jewett-Cameron’s Chairman of the Board, is a member of the Project Advisory Committee related to this study. Progress with this study can be monitored at Urban Growth Boundary Expansion.
It now looks like the study will conclude that the land on which the seed company operates should be annexed. Furthermore, it looks like this determination might be made around the end of calendar 2022.
The company has provided no information on its intentions related to the seed company and the related land. However, the following is my personal assessment of what I think is likely to happen.
Annexation usually increases the value of land, and I think Jewett-Cameron will wait until the land has been annexed before they sell the property. Furthermore, the company could discontinue operation of the seed business at any time, but they might wait to do this until they are close to a sale of the land.
In my article on Jewett-Cameron posted on May 5, 2022, I described how I estimated the value of the seed company land to be $4.8 million. I also indicated that a sale for this amount could result in after-tax cash proceeds of about $1.00 per share. However, if this land is annexed by North Plains the value might be significantly higher than $4.8 million.
Because I think it is highly likely that the operation of the business will be discontinued and the land will be sold, I reflect the consequences of both actions in my valuation of the company. Specifically, I add $0.2 million to estimated EBITDA for fiscal 2022 to add back an estimated loss from seed company operations. Furthermore, I add the $1.00 per share estimate of the after-tax cash proceeds from a sale of the land to the estimated fair value of the stock that is based solely on earnings.
Estimates for Fiscal Q4 and Fiscal 2022 (QE and YE August 31, 2022)
Fiscal Q4 is normally the second strongest quarter of the year after Q3, and this is what I expect for the current year.
My estimates for Q4 are sales, EPS, and EBITDA of $19.1 million, $.39, and $2.0 million respectively. This would then result in fiscal 2022 sales, EPS, and EBITDA of $67.0 million, $.78, and $4.2 million respectively.
The company has indicated that inflation particularly in the form of higher raw material cost combined with higher shipping costs is expected to remain an issue going forward. However, they also indicate that retailers are currently more receptive to price increases than in the past due to a mutual understanding of the inflationary environment and the objective reasons for such.
I believe the biggest risk to my fiscal Q4 and fiscal 2022 forecast is that demand for Jewett-Cameron’s core products has slowed or is declining, which I think is unlikely.
Valuation
For my estimate of fair value for Jewett-Cameron’s stock, I start with estimated EBITDA for fiscal 2022 of $4.2 million. Then I adjust this by adding back $0.3 million for the poop bag packaging fine, because it is an abnormal and non-recurring expense, and I add back an estimated EBITDA loss of $0.2 million from operating the seed company, because I believe this business will be discontinued and not be ongoing.
This results in an estimate of adjusted EBITDA of $4.7 million and using an enterprise value to EBITDA multiple of 9.0, enterprise value of $42.2 million is calculated. Then subtracting net debt of $6.9 million results in equity value of $35.3 million, which is $10.10 per share. Finally, to this, I add $1.00 per share, which is an estimate of the after-tax cash proceeds from the sale of the seed company land. This results in a fair value for the stock of $11.10, which I round off to $11.00 per share.
For the sake of comparison, the all-time high stock price for Jewett-Cameron was $13.74 per share in September 2021.
Also, it is worth keeping in mind that the estimated EBITDA of $4.2 million for fiscal 2022 includes a bad fiscal Q1, when sudden high supply chain and raw material costs could not be passed on to customers resulting in a 19.1% gross margin. EBITDA for that quarter and the year would be an estimated $1.1 million higher if the company had been able to earn a more normal gross margin in Q1.
Block of Jewett-Cameron Stock at Oregon Community Foundation
Oregon Community Foundation still owns 1,080,534 shares of Jewett-Cameron stock. This is most of the shares the company founder Don Boone owned when he died on May 9, 2019. It represents a 30.9% ownership stake in the company and has a market value of about $7.3 million at the current stock price of $6.75 per share.
The foundation needs to sell the stock to serve its philanthropic beneficiaries. However, given the extreme illiquidity of Jewett-Cameron stock, trying to sell this much stock in the stock market is probably not a viable way for them to proceed. Consequently, they would likely be receptive to direct bids to buy large volumes of stock. Furthermore, because of the illiquidity, this might be the best way for investors to buy large amounts of the stock at a fixed price.
I do not know whether they would do it, but if the company bought this entire block of stock at the current price of $6.75 with borrowed cash, it could be very accretive to EPS. I have modeled the effect of such a buyback if it were to have taken place at the beginning of fiscal 2022. Estimated EPS is $1.07 compared to EPS of $.78 without the buyback.
Conclusion
Over the past five years, the company has developed a strong omni-channel marketing presence for its pet, fencing, and home yard products. The manning and infrastructure have been put in place to drive sales, earnings, and cash flow significantly higher for some time to come.
At the current stock price of $6.75 or even higher, the stock looks attractive relative to an estimated fair value of $11.00 per share and an all-time high of $13.74 in September 2021.
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