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Rising Margins Quartet      

by Louis Corrigan (TMF Seymor)

Atlanta, GA (March 30, 1999) -- Today I'll highlight four companies that appear on our Rising Margins screen for last week.

First up, Chattem <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CHTT)") else Response.Write("(Nasdaq: CHTT)") end if %>, a 120 year-old marketer and manufacturer of branded consumer products, including over-the-counter pharmaceuticals, antiperspirants and deodorants, dietary supplements, and toiletries and skin care products. Its brands include Gold Bond, Pamprin, Ban, and Sunsource. In December, it acquired certain brands from Thompson Medical, including Dexatrim and Aspercreme.

Chattem reported that Q1 revenues surged 80% to $62.7 million with EPS before extraordinary items shooting up to $0.35 from just $0.06 a year ago, a 483% increase. While the company spends heavily to advertise its brands (39.4% of revenues go to ads), it's getting quite a bang for its buck. Sales of its Gold Bond products doubled thanks to the introduction of Gold Bond Medicated Lotion, pushing gross margins up to 73%. Meanwhile, selling, general and administrative (SG&A) expenses increased just 30% for the quarter, leaving SG&A expenses at 10.7% of sales, down from 14.8%.

At $33, Chattem shares are well off their early January high of $50. The shares dipped after the company missed the Q4 earnings target. Even so, the three-year compound annual growth rate in sales and earnings is an exceptional 30% and 74%, respectively. The stock has reflected these good times, rising from just over $4 a share in March 1996.

Moreover, management indicated it's "comfortable" with a FY99 earnings estimate of $2.35, which would represent a 85% jump from the $1.25 reported in FY98 and slightly above the current consensus. At about $33, Chattem trades for just 14 times that estimate and just 11.4 times the $2.90 consensus for FY 2000.

The caveat here is that the Fool Snapshot reveals a highly leveraged company. Chattem had just $25 million in shareholder equity at the end of Q4 but is now weighed down with $381 million in debt. In December, the company filed a shelf registration to sell $250 million in securities (stock, preferred, debt securities, or other), meaning it's looking to adjust its capital structure in whatever form seems most attractive. However, with the stock in the mid $20s in February, Chattem's board authorized the repurchase of $5 million worth of stock because it believed the company's shares were "significantly undervalued."

While the company has ample cash flow to cover the current interest payments, investors should note that the company's enterprise value (market cap + debt net of cash) is more than twice its market cap. In other words, it just ain't as cheap as it looks on a P/E basis. Still, it's worth a closer look.

Next up, Blyth Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BTH)") else Response.Write("(NYSE: BTH)") end if %>, a company that designs, manufactures, markets, and distributes a line of candles and home fragrance products. It also produces Sterno portable heating products. Q4 sales rose 25% to $252.3 million while EPS flickered to $0.45, up 29% and in line with estimates. For the fiscal year ending in January, sales burnt 27% brighter to $875.1 million, boosting EPS 36% to $1.50.

On the face of it, Blyth looks appealing enough. The Fool Snapshot shows a company with a 23% return on equity thanks to some, but not too much, debt. At $22 1/2, the stock trades for 15 times trailing earnings and just 12 times the consensus earnings estimate of $1.87 for FY99. Analysts project 23% long-term growth. If you add the $122 million in debt minus some cash to the market cap, you get an enterprise value around $1.2 billion, or 1.4 times sales. With Blyth's net profit margin of 8.5%, that seems reasonably cheap.

Yet something seems amiss. The market reacted poorly to Blyth's news, dropping the stock below its 52-week low set last October when nearly every stock was on its lows. A three-year chart reveals that after lots of ups and downs, the stock has ultimately not advanced a wick. There's also been substantial insider selling whenever the stock has topped $30. Institutional ownership is already reported at 59%, which means that professional investors have already discovered Blyth and could, if anything, be a negative influence on the stock if the company disappoints.

And someone apparently thinks that it will. Although the 1.5 million shares short as of February is small relative to the 26.1 million shares in the float, it's high relative to the normal daily trading volume. That's why the days to cover ratio is a very high 15 days. Blyth's fundamentals suggest a strong investment prospect, but anyone researching this stock should be sure to track down the bear case, too.

Next, discount retailer Family Dollar <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FDO)") else Response.Write("(NYSE: FDO)") end if %>, which operates a chain of 3,172 general stores in 38 states, mostly in small towns. Like other discount chains, Family Dollar continues to produce rocking results. Q2 sales jumped 18.3% to $752.2 million while EPS soared 50% to $0.24, beating the consensus by three cents. Year-to-date, sales are up 17.1% and EPS up 37% to $0.41.

The stronger Q2 results benefited from an extra selling day versus last year. Still, same-store sales continue to be terrific, up 8.8% in Q2 and 8.5% YTD. The store expansion also continues in strong fashion, with a net 62 new stores added during the quarter. Q2 operating expenses declined to 23.3% of revenues from 24.3% while gross margins improved to 32.2% from 31.3%. The company switched to everyday low prices a few years back and has cut back on ad circulars, which saves on marketing expenses and allows Family Dollar to curtail price markdowns.

The Fool Snapshot reveals a firm with a terrific 19.4% ROE and no debt. At $22, the stock trades for 29 times the consensus estimate of $0.75 for the year ending in August, or a premium to the 21% projected long-term growth. But the FY99 estimate should be revised up to at least $0.80. Moreover, Family Dollar is like Dollar General <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DG)") else Response.Write("(NYSE: DG)") end if %> and a few other discounters that have found that delivering value and convenience to low- to moderate-income shoppers is a great business. Even trading near its 52-week high, Family Dollar is well worth getting to know.

Finally, a quick paw at Big Dog <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BDOG)") else Response.Write("(Nasdaq: BDOG)") end if %>, a 175-store retailer of apparel for baby boomers and their kids. Q4 sales barked ahead 16% to $36 million, boosting EPS to $0.30 from $0.22 a year ago. Similarly, FY98 sales wagged 17% higher to $101 million, pushing EPS to $0.32 from $0.24. The problem is that same-store sales rose just 0.7% in Q4 and 0.6% for the year.

Investors liked the news, leaving this Dog trading 11% higher Friday to $5 1/2. That's about 17 times trailing earnings and 14 times one analyst's FY99 estimate of $0.40. Plus, Big Dog has a dollar a share in cash and no debt.

Still, it's hard to get excited about this stock, which has been ruffed up repeatedly since going public in late 1997. Indeed, the FY98 numbers were half what the underwriters had been projecting when this puppy appeared as a Daily Trouble just over a year ago. Yet I doubt those analysts (who've mostly dropped the stock) have thought twice about Big Dog since. That's why investors should all but ignore estimates offered by a firm's underwriters or investment bankers.



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