International Value Investing: Danier Leather (DL:CN) - Canada

by Geoff Gannon


A reader sent me this email:

Hey Geoff,

I saw your call for non-US value ideas. One of my favourite ideas right now is Danier Leather, a Canadian retailer that is really cheap and has its downside limited due to its asset-rich and debt-free balance sheet.

Cheers,

Michael

Below is Michael's write-up on Danier Leather...

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Danier Leather is a vertically integrated designer, manufacturer and retailer of leather goods in Canada. Danier principally sells leather outerwear (53% of sales) and accessories (37%) through 90 locations in Canada (59 shopping mall and street front stores and 31 power centre stores). Its target market is “value-oriented, fashion-conscious” men and women aged 35-55 with middle to upper class household incomes.

Danier trades under the symbol “DL” on the Toronto Stock Exchange. With a current market price of $13.50 and 4.6mn shares outstanding (1.2mn multiple voting shares and 3.4mn subordinate voting shares), Danier has a market cap of ~$61mn.

The market seems to ignore Danier because of its small market cap, lack of equity research coverage, limited liquidity and dual share structure. However, these factors allow an investor to buy an asset rich, debt-free company at substantially less than its intrinsic value.

 

Asset Perspective

Looking at Danier from an asset perspective, an investment presents limited downside due to the cash, inventory and real estate on the balance sheet. While cash currently represents ~15% of the company’s market cap, after the Christmas shopping season, much of the company’s inventory should convert into cash and I would expect Danier’s cash level to increase to 30-40% of its current market cap. In addition, Danier owns a 130,000 sf facility in Toronto where it conducts some manufacturing, warehousing and administrative operations. I believe there are a number of options to monetize this facility should the Company wish to do so, including:

  • A sale/leaseback transaction.
  • An outright sale, which could involve the Company shifting additional production to Asia and warehousing and administrative functions to leased premises. Currently, over 80% of Danier’s production is from Asia, with the remainder from its Toronto facility.
  • Conversion to higher use. This facility is located in a predominantly residential area of Toronto and could be sold for, or co-developed into, residential properties.

The following is an estimate of Danier’s book value and liquidation value at September 25, 2010. While I do not think one should value Danier on a liquidation basis, I have included an estimate anyways:

 

Earnings Perspective

Looking at Danier from an earnings perspective, it is significantly undervalued as it is currently trading at only 2.3x LTM EBITDA. (Note: Given that we are currently in the Christmas shopping season when Danier’s cash is unusually low, I adjusted Danier’s cash balance to be the average of its cash balances over the last four quarters, thereby smoothing out the variance.) Investors can and will argue over what is an appropriate multiple but all would agree that 2.3x is too low, especially for a stable and growing company with a rock-solid balance sheet.

If one applies a 5.0x multiple to Danier’s LTM EBITDA as I have done for my valuation, I reach a valuation in excess of $23/share:

I also believe there is additional upside for Danier through store expansion, higher margins and new product lines. With only 90 stores for a country of 34mn people, Danier can expand its store base. It currently expects to add one or two stores per year. In addition, Danier has focused in recent years on expanding its line of accessories, which carry higher margins than outerwear, and they have been very successful in this regard.

 

Good Capital Allocation

Danier’s President and CEO currently controls the company through his ownership of all of the company’s multiple voting shares (77% of the total voting rights). Nonetheless, the company has been very active (and disciplined) in returning capital to shareholders through share repurchase programs. In 2010 alone, Danier repurchased 23% of its outstanding shares. The following is a summary Danier’s share repurchases during the last ten years:

 

Finally, it is worth noting that Chou Asset Management, a well-known Canadian value fund, owns ~20% of the subordinate voting shares and Baker Street Capital L.P. owns ~14% of the subordinated voting shares.

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