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Monday, June 2, 1997
Paragon Trade
Brands
"Lawsuit, n. a machine which you go into as a pig HOW DID IT FIND TROUBLE? In the two years prior to January 1997, the shares of disposable diaper maker Paragon Trade Brands had increased in value nearly threefold. On January 31st, the company warned that 1997 was going to be a "challenging year," citing competition, material prices, and development costs. In addition, the costs of defending significant patent infringement claims were expected to impact earnings negatively. In spite of the excellent earnings reported that same day, investors took this as a sign that the diaper was dirty and dumped the shares into the hamper. BUSINESS DESCRIPTION Paragon Trade Brands is a maker of store-brand disposable diapers and other paper products. These diapers are sold under the store name of grocery stores, mass merchandisers, toy stores and the like. The company has approximately 16% of the disposable diaper market in the U.S. and has recently expanded into the area of feminine care products. FINANCIAL FACTS Income Statement 12-month sales: $580.3 million
12-month income: $25.6 million
12-month EPS: $2.13
Profit Margin: 4.4%
Market Cap: $189.1 million
Balance Sheet
Cash: $3.6 million
Current Assets: $107.8 million
Current Liabilities: $84.7 million
Long-term Debt: $60 million
Ratios
Price-to-earnings: 7.5
Price-to-sales 0.3
HOW COULD YOU HAVE SEEN IT COMING? The news of lawsuits by Procter & Gamble and Kimberly-Clark Corp. were out long before the warning from the company. Since there are daily announcements of lawsuits related to patent issues, investors often become numb to the affect of such activities on corporate revenues and earnings. In the case of Paragon, essentially a single product company, such lawsuits pose a significant risk. Paper prices have been rising for some time. This impacts all paper products companies as their pricing will rise to less competitive levels. This is especially true for a company like Paragon, which is targeting the lower priced sector of the market. Foolish investors pay attention to larger economic trends and attempts to assess the potential effect on their stocks. Rising paper prices would not be good news for Paragon, and this could have been anticipated by a savvy Fool. WHERE TO FROM HERE? In the recent first quarter earnings report, the company again warned of lower pricing for baby diaper products due to competitive pressures. However, the company has beaten estimates each of the past two quarters in spite of the warnings. In the past 30 days, earnings estimates have been consistently lowered. The next two quarters and the next fiscal year are projected to show negative growth, not exactly an enticing proposition. For commodity companies such as Paragon, the utility of the PEG and YPEG is questionable. That said, the long-term growth estimate of 12% combined with estimates of $2.29 per share for FY 1998 imply a fair value as high as $27 per share. That's a big step up from here. A Fool would be wise to wait for a positive turn in the business and successful outcomes from the lawsuits before plunking down hard-earned dollars on this stock. This pig could still be turned to sausage if Paragon loses the lawsuits. -Mark Weaver, MD ([email protected])
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