We believe that shares of Lakeland Industries Inc. (NASDAQ:LAKE), one our past picks and subject of due diligence could be mispriced and potentially undervalued by 40%. On May 19, 2015 we alerted premium members that we took a small speculative position in the company’s shares based on fiscal Q 4 (January 31, 2015) operating results and management’s decision to exit Brazil. What follows is our near term bullish thesis on the company, which includes Q4 2015 conference call highlights. We think shares could reach $14.40 in the near term. [hide] The company manufactures and sells safety garments and accessories for the industrial protective clothing market worldwide, including high-end chemical protective suits to provide protection from highly concentrated and hazardous chemical and biological toxins.
The GeoTeam has followed the LAKE story closely since February 2012, when we published, “Lakeland (LAKE) Special Situation Bulletin – Big Clues Indicate Take Over Could be in the Cards.” We noted that LAKE was making operational changes designed to create a stronger global company from a domestic business facing significant competitive challenges. While the story was intriguing on its own merits, our interest was really piqued when a large competitor (Ansell USA) established a 9.6% stake in the company leading us to speculate LAKE could become a takeover target. LAKE was trading at around $10 when we published our special situation bulletin and, based on our analysis at the time, we estimated its shares could trade between $14 to $20.
Shortly following our bullish article, LAKE encountered operational difficulties, particularly in Brazil, and the stock sold off and languished for over two years in the $4 to $7 range. However, in the fall of 2014, LAKE became a beneficiary of the Ebola outbreak scare with investors betting that the company’s hazmat products would be in high demand, should the crisis continue. We alerted premium members on 9/15/2014 and 9/16/2014 that we were buying shares. LAKE’s share price rallied with impetus coming from several press releases that reported material Ebola driven orders. During the first two weeks of October 2014, LAKE’s shares surged from around $7.00 to $29.00 per share.
On October 20, 2014, we alerted premium members in a Call to Action that we closed our long position when it was trading at $21. We noted that the previous week Ansell filed a 13D/A showing it sold the majority of its position in LAKE. On October 24, 2014, LAKE announced an $11.2 million private placement of its common stock at $10 per share. Given this private placement price and that the Ebola craze was fading, we chose to step aside and await further developments and operating results to see if management could successfully address the challenges and issues facing the business. Not surprisingly, the shares subsequently dropped and have recently been trading in the $8 to $10 range.
Information Arbitrage Opportunity
The market is a forward looking indicator and the multiple that it assigns to companies is based on the chances of the company’s future success. In that regard, we think the market has mispriced shares of Lakeland at their current price and earnings multiple. Once the company completes its exit from its one languishing market, we believe that the Wall Street will realize the reduced risk and therefore expand the company’s multiple accordingly. We believe, in doing our due diligence and understanding the company’s exit strategy, that we’ve identified an arbitrage that will lead to price appreciation. Accordingly, we are bullish on LAKE for the short term.
On April 30, 2015, LAKE announced its intent to exit Brazil, thus eliminating a material drag on company resources and operations, and allowing management to focus on unlocking value for shareholders. Now that (1) the dust from the Ebola craze has settled, (2) Ansell has sold most of its position in LAKE, and (3) management has decided to exit Brazil, we are revisiting the story.
A strong indication of what investors can expect in the near term from LAKE was disclosed when LAKE released its fiscal Q4 and 2015 operating results and provided color on management’s plans to exit Brazil. LAKE reported fiscal Q4 2015 revenues of $26.5 million and net income of $0.36 (excluding Brazil and tax benefit) vs. analysts estimates of $25.8 million and $0.23, respectively. The Q4 performance leads us to believe that the current analysts estimates for fiscal 2016 (ending January 31, 2016) of $103.4 million and $.92 EPS are conservative. We view the market’s tepid reaction to the Q4 operating results and plans to exit Brazil as a buying opportunity especially given that on May 19, 2015 an analyst at Schaeffer’s Investment Research raised his price target from $17 to $19.
We’re not ready to assign a speculative growth multiple to LAKE until management proves to the street that it can consistently grow sales and earnings, a feat that has challenged the company since 2004. In these scenarios we often use a price to book multiple as a tool to value shares. But we no longer find that to be an accurate representation of the business due to uncertainty surrounding how much of the company’s balance sheet is tied up in its Brazil exit. Lacking that clarity, coupled with the company’s growth prospects now that Ebola headlines have trailed off, we’ve decided to use a conservative low growth forward P/E multiple of 10 on the company’s projected EPS of $1.44 (annualized based on last quarter) to reach our current price target of $14.40. Our price target could prove conservative if the company exhibits that it can grow organically, continue converting new Ebola customers to long-term customers and capitalize on favorable trends taking place in pockets of industry segments that the company serves, such as the power transmission industry.
For further information, we encourage our members to read the Q4 2015 conference call transcript. Following are some of the highlights:
- Management expects to finalize plans for LAKE’s exit from Brazilian operations in the next 30 days. Once the exit plan is executed a significant drag on the company’s resources and operations will be eliminated.
- The positive sales momentum from the demand for the company’s protective apparel products due to the Ebola outbreak is expected to carry over into fiscal 2016 Q1 (April 30, 2015) and Q2 (July 31, 2015).
- Government funding in the US and abroad is being provisioned to employ precautionary and preventive measures to head off possible future outbreaks of Ebola and other infectious diseases. This trend could boost demand for LAKE’s products over time.
- New customers, drawn to the company due to its Ebola offerings, find themselves staying with LAKE for other products in their portfolio.
- The power transmission market is one of the biggest safety markets in the United States. The industry has not been keeping up with OSHA standards, and new regulations are putting pressure on this industry to increase the rate of adoption of regulation standards. As these standards are adopted, increased purchasing of protective apparel by power transmission operators should benefit LAKE.
- LAKE has reduced its total debt outstanding. Paying off subordinated debt was accretive to EPS by $0.04 a share in fiscal Q4 and is expected to add $0.16 per share in FY16, including reduction in the senior debt balances. [/hide]
See our full in depth analysis on by we are bullish on LAKE, as well as our valuation rationale.
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