Compass Diversified Holdings (CODI) operates as a private equity firm that does acquisitions, buyouts, recapitalizations, etc., to gain and maintain a portfolio of diverse businesses. Compass’s collection of businesses are typically in stable industries. However, COVID-19 did negatively affect some of these businesses.
The good news is that some of Compass’s businesses have still been able to grow revenue during the pandemic. Those businesses, some adaptation, and the company’s strong balance sheet helped Compass to hold up well during the COVID-19 pandemic. Assuming the pandemic will eventually end, Compass should remain a steady dividend-paying investment over the long term.
What Supports Compass’s High Yield?
Compass’s distributions are supported by a steady cash flow generated from the company’s collection of businesses. Under normal circumstances (not during a pandemic), Compass’s businesses are all steady cash flow generators. Some of the company’s businesses experienced weakness as a result of COVID-19 (Sterno, Arnold, Foam Fabricators, but others (5.11, Liberty Safe, and Velocity Outdoor) still achieved growth during the pandemic).
In a normal year (before COVID-19), Compass had $84.6 million in operating cash flow. The cash flow comprised about 5.8% of total revenue and 16.3% of gross profit in 2019. The cash flow does fluctuate from year to year as the company’s portfolio mix changed, but it has remained positive over the past 10 years.
Here is a look at Compass’s operating cash flow over the past 10 years:
Source: Seeking Alpha
Compass does a variety of things with its operating cash flow. One of those things is dividend payments. The company has been consistent with its dividend payments. In fact, Compass paid the same $0.36 per share per quarter or $1.44 per share per year since 2011. It would be nice if Compass raised the dividend each year, but there is no track record of that. In 2019, Compass spent $108 million in common and preferred dividends.
Compass spent more on dividends than it had in cash flow in 2019 because the company received $502.7 million from divestitures and $275.3 million from other investing activities. The company tends to issue new debt in years where they do acquisitions. Compass also issues new shares of stock occasionally. New shares of stock were issued in 2020 instead of issuing new debt. This was done to offset the lost revenue due to COVID-19. So, the company finds a way to pay the same dividend every year regardless of how they manage the cash flow in any particular year.
The last time Compass issued new shares of stock before 2020 was in 2016. So, this is not something Compass does every year. It is a strategy used for certain reasons such as to finance acquisitions.
How Compass is Doing in 2020
Compass reported Q2 earnings on July 29. There were some positives along with the negatives, which were expected due to COVID-19. The revenue for Q2 of $333.6 million was only 0.73% less than in Q2 2019. However, the revenue was $50.6 million higher than expected. The bottom line resulted in a net loss of $7.4 million for the quarter.
Despite the net loss, Compass still ended up with a positive $54.3 million in operating cash flow as a result of a positive change in accounts payable. The company had $88.3 million in operating cash flow for Q1 and Q2 combined.
The strong performing businesses for 2020 included 5.11, Liberty Safe, and Velocity Outdoor. 5.11, the supplier of technical apparel & gear for law enforcement increased revenue by 1.4% in the 1st half of 2020. Liberty Safe achieved a strong 15% revenue increase. Velocity Outdoor had the strongest gain with a 25% revenue increase for the 1st half of the year. Together, these 3 businesses comprise about 47% of total company revenue.
The weakness for Compass came from the following businesses:
|Business||Revenue Loss for 1st half of 2020|
Source: Compass Diversified 10-Q
Compass’s gains were largely the result of increased outdoor activities during the 1st half of the year. Liberty Safe provides heavy-duty secure locking safes for gun owners. Velocity Outdoor supplies air guns and archery products. The global sports gun market is projected to grow at about 4.5% annually to 2025. That should help provide a tailwind for sales growth for Velocity Outdoor and Liberty over the next 5 years.
The weakness in the other businesses was mostly COVID-19-related. For example, Foam Fabricators produces foam protective products used in packaging, appliances, and vehicle bumpers. Vehicle sales have been down significantly this year. Sterno provides food warming products for catering services, which have been mostly shut down during the pandemic. Ergobaby products are sold at buybuy Baby (BBBY) stores which were temporarily closed for a few weeks this year.
Sterno offset some of its losses by producing hand sanitizer during the pandemic. This demonstrates an example of the business’s ability to adapt to uncertain circumstances.
Compass acquired baseball equipment supplier, Marucci Sports this year. Marucci supplies custom bats, fielding gloves, batting gloves, catcher’s equipment, and apparel for professional and non-professional baseball. Marucci had $5.2 million in sales for the 1st half of 2020. Compass bought Marucci for $200 million.
Marucci may experience some weakness as a result of limited pro and non-pro baseball during the pandemic. However, the business should provide steady revenue and cash flow after the pandemic is over.
Compass had an add-on acquisition with Polyfoam, which was added to its Foam Fabricators business. Polyfoam specializes in protective, temperature-sensitive packaging for the food, medical, and pharmaceutical industries. Polyfoam adds a new customer base to Foam Fabricators.
These acquisitions should help Compass over the long term. Both businesses expand Compass’s revenue and cash flow generation. Revenue from these businesses is poised to move higher as the recovery from the pandemic continues.
The valuation metric that stands out for Compass is the price to sales ratio of 0.77. Price to sales ratios below one are considered attractively low. The industrial conglomerate industry which Compass is a part of is trading with a price to sales ratio of 0.36. The industry tends to maintain a low price to sales ratio.
While Compass is trading above the industry average, it is trading significantly below the S&P 500’s (SPY) price to sales ratio of 2.39. So, Compass and its industry represent value in a market is trading further and further above its long-term average. The long-term average price to sales ratio for the S&P 500 is 1.5.
Compass Diversified’s Long-Term Investment Outlook
Compass is not likely to experience high-flying multiple-year growth like the top tech companies. However, Compass offers a high yield backed by steady cash flow businesses. COVID-19 is having a negative impact this year on Compass, but that should be temporary once we get past the pandemic.
Compass’s revenue and earnings are expected to decline in 2020. Overall growth is expected to return in 2021. That could change if the virus continues to wreak havoc on the population. However, history shows that pandemics typically last 12 to 18 months. Evidence points to COVID-19 not being seasonal. So, business conditions may improve in 2021 for those negatively affected by the pandemic.
Compass is the type of company that is always changing. The company may divest some businesses and purchase new ones on a regular basis. Overall, the cash flow that backs the dividend payments tends to be consistent. That should allow income investors to be pleased with the high 8.5% yield.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: The article was written by David Zanoni for Kirk Spano’s Margin of Safety Investing service [MoSI]. Subscribers also get access to SWOT analyses (strengths, weaknesses, opportunities, threats) on this company and others.
Additional disclosure: The article is for informational purposes only (not a solicitation to buy or sell stocks). David is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.