Monday, August 24, 1998
Pure World, Inc.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PURW)") else Response.Write("(Nasdaq: PURW)") end if %>
Phone: 908-234-9220
Website: http://www.pureworld.com
Price (8/21/98): $10
HOW DID IT DOUBLE?
If you think kava leads to a pleasant high, imagine if you had invested in a company that produces the stuff! The craze for the anti-anxiety herb -- and, some say, sexual stimulant -- has so pumped up Pure World's stock that Viagra's impact on Pfizer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PFE)") else Response.Write("(NYSE: PFE)") end if %> looks rather lame by comparison.
Just a few years ago, Pure World was a mere shell of a public company that couldn't decide what business to be in. The stock resided comfortably in penny stock land. But after acquiring Madis Botanicals in early 1995, Pure World teamed up with Chris Kilham, author of Kava Medicine Hunting in Paradise. Kilham took off to the South Pacific in search of an ample supply of the plant that is kava's source.
Kilham's adventures have left Pure World supplying some 60 companies with KavaPure kava extract. The kava craze has also led to glowing high-profile media attention from the likes of the Wall Street Journal and ABC's 20/20.
Pure World's recent financial results reflect the kava effect, plus strong sales for CimiPure black cohosh and the anti-depression herb St. John's Wort. Revenue rose 132% in the second quarter to $6.2 million, pushing sales up 122% to $11.3 million for the first six months of FY98. With gross margins moving higher, second quarter net income soared 209% to $2.05 million, or $0.27 per share. Earnings for the first half of the year increased 198% to $3.5 million, or $0.46 per share.
A hot story and a small float sent the stock to a recent high of $18. Though it's given back much of that gain in the last few weeks, partly due to price pressures hitting manufacturers of herbal supplements, Pure World still enjoys a pure double.
BUSINESS DESCRIPTION
Pure World extracts active ingredients from botanical sources for use in dietary supplements, cosmetics, foods, and flavors.
Previously known as Computer Memories Inc. and American Holdings Inc., the company spun off to shareholders much of its NorthCorp Realty Advisors subsidiary back in July 1994, selling the rest shortly thereafter. In January 1995, it acquired most of Madis, then in Chapter 11 bankruptcy, for $2.3 million plus the assumption of debt. Madis had annual sales of $6.2 million at the time.
The company has recently spent $5 to $6 million to expand and upgrade its 125,000 square foot manufacturing and laboratory facility and build a new 13,000 square foot warehouse. Over the last two years, it has paid $1.5 million to obtain a 35% ownership stake in privately held Gaia Herbs, a manufacturer and distributor of fluid botanical extracts. In July, Pure World acquired 400,000 shares (a 7.5% stake) in financially troubled HealthRite <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HLRT)") else Response.Write("(Nasdaq: HLRT)") end if %>, a manufacturer of herbal supplements with $14 million in FY97 sales.
Together, chair Paul Koether and his wife Natalie, the company's president, control 38% of the stock, partly through holdings of Sun Equities.
FINANCIAL FACTS
Income Statement
12-month sales: $16.94 million
12-month income: $4.65 million
12-month EPS: $0.56
Profit Margin: 27.4%
Market Cap: $75.2 million
Balance Sheet
Cash: $7.3 million
Current Assets: $16.4 million
Current Liabilities: $4.3 million
Long-term Debt: $3.4 million
Ratios
Price-to-earnings: 17.9
Price-to-sales: 4.4
HOW COULD YOU HAVE FOUND THIS DOUBLE?
The dietary and herbal supplements market has enjoyed booming sales in recent years as Americans have become more interested in "natural" ways to treat common ailments and serious diseases and to enhance athletic performance. Companies like General Nutrition Companies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GNCI)") else Response.Write("(Nasdaq: GNCI)") end if %>, Whole Foods Markets <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WFMI)") else Response.Write("(Nasdaq: WFMI)") end if %>, Rexall Sundown <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RXSD)") else Response.Write("(Nasdaq: RXSD)") end if %>, TwinLab <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TWLB)") else Response.Write("(Nasdaq: TWLB)") end if %>, and Nature's Bounty <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NBTY)") else Response.Write("(Nasdaq: NBTY)") end if %> have all enjoyed periods of great success.
Investors might have found Pure World simply by following the trends of what's hot in the supplements market or by screening for companies with rising sales and margins.
WHERE TO FROM HERE?
Just looking at the hefty 26% operating margins recorded in the first six months of 1998, the stock appears reasonably priced. Factor in the recent growth and it begins to look inexpensive, especially with consensus earnings estimates of two analysts standing at $0.66 for FY98 and $0.95 for FY99.
However, an investor needs to work through the numbers. For starters, a substantial 21% of reported pre-tax income is coming from net gains on marketable securities and interest and dividend income. Also, the company's $22.8 million accumulated deficit is allowing it to pay minimal taxes (a 6.7% rate so far this year).
Assuming a 35% tax rate, the adjusted trailing 12-month EPS would be $0.43. Investors should apply an earnings multiple to that figure with the potential tax benefit from previous operating losses (roughly $8 million, or about a dollar per share) added to the mix to arrive at a price target.
For example, assuming Pure World should trade at 30 times earnings, fair value would be $14 per share. Interestingly, after a wave of insider buys earlier in the year, Paul Koether sold 40,000 of his over three million shares in April at prices ranging from $12.50 to $13.72.
Investors also ought to look at the 10-K for details on related party transactions. In FY97, Pure World paid Paul Koether's brokerage firm $36,000 in commissions. It also paid Rosenman & Colin, a law firm with which Natalie Koether is affiliated, some $19,000 last year after forking over $118,000 in 1996, $630,000 in 1995, and $615,000 in 1994.
Also, Pure World buys its group medical insurance and office supplies through an arrangement with the Koether-controlled Sun Equities. Reimbursements totaled $419,000 last year. Indeed, Pure World has a long history of doing business with these and other affiliated companies and of providing various financial favors to Vice Chair Voldemar Madis.
Related party transactions are relatively common with mom-and-pop style public companies, and they're usually perfectly legitimate. On the other hand, unscrupulous executives can use such arrangements to skim money from a company's shareowners. That's why investors should make sure that a company that engages in such transactions has a strong, independent board of directors to provide adequate oversight.
Pure World's four-member board consists of Paul Koether plus three outside directors (Mark Jaindl, Alfredo Mena, and William Mahomes). The latter three make up the audit committee. So the company can be said to have an independent board.
However, leading corporate governance theorists contend that directors who once served as executives at a company (as did Jaindl) should not be considered independent directors. These theorists also argue that outside directors need to have a meaningful financial investment in a company to be sufficiently motivated to show independence. In my view, the company's SEC filings suggest that Mahomes and Mena do not have a significant financial investment in the company.
Pure World has a promising story, and there's no indication of any wrongdoing by management. But the related party dealings raise the kind of caution flag that investors should at least consider when analyzing the company.
-- Louis Corrigan
([email protected]