AMCON DISTRIBUTING COMPANY (AMEX: DIT)<br />Price: $78.00Target Price: $150 Recommendation: BuySector: Food Distributors<br />Investment Summary<br />AMCON Distributing Co. (“AMCON”) is undervalued: Based on a variety of valuation methodologies including Earnings Power Value, Discount Cash Flow – Perpetuity Growth Method, and Discount Cash Flow – EBITDA Multiple Method, the analysis suggests a valuation range of $73 - $160 million with a median range of $118 - $142 million. (For the two discount cash flow methods, sales growth was projected at 1.6% for the next five years.) There is only one other publicly traded company with a similar product mix (70% tobacco) that distributes products to primarily to convenience stores (C-stores), Core-Mark Holding Company (NASDAQ: CORE); thus, comparable companies analysis does not offer particularly useful insight for valuation. For the fiscal year ending September 30, 2010, AMCON had $17.3 million in EBITDA, $11.0 million in Free Cash Flow to Equity, and was trading at EV/EBITDA of 4.3x (versus CORE’s 5.6x). AMCON’s current market capitalization of $45.0 million suggests the Company is undervalued.<br />Debt service has become more manageable: AMCON’s market valuation has historically reflected the Company’s risk of default. Over the last four years, the Company has shed underperforming businesses and used retained earnings to reduce the balance on its Credit Facility with Bank of America. For FY 2006, the Company had a Credit Facility balance of $48.8 million and Long-Term Debt of $7.5 million; for the FY 2010, the Company had a Credit Facility balance of $18.8 million and Long-Term Debt of $5.2 million. EBITDA has expanded over the same period from $8.6 million (FY 2006) to $17.3 million (FY 2010). Related ratios have reflected the reduction in risk of default. Interest Coverage has improved from 1.4 (FY 2006) to 10.3 (FY 2010); Total Liabilities/EBITDA has fallen from 11.2 (FY 2006) to 3.4 (FY 2010); Debt to Market Capitalization has fallen from 836% (FY 2006) to 70% (FY 2010); Debt to Total Capitalization has fallen from 59% (FY 2006) to 27% (FY 2010). As AMCON continues to grow, I expect the Company will continue to pay off its Credit Facility and the market valuation to reflect the increasing viability of AMCON as a going concern.<br />35718751174750400000Strong market player in its geographic market: AMCON’s primary business is the distribution of cigarettes and tobacco-related products to 4,300 retail outlets (C-stores, grocery stores, liquor stores, drug stores, and tobacco shops) across Arkansas, Colorado, Iowa, Illinois, Indiana, Kansas, Minnesota, Missouri, Mississippi, Montana, North Dakota, Nebraska, Oklahoma, South Dakota, Tennessee, Virginia, Wisconsin, and Wyoming. According to an October 2010 report by Convenience Store News, AMCON is the 9th largest distributor to C-stores in the U.S.<br />-476261079500<br />Good Management: Christopher Atayan joined AMCON in October 2006 as CEO and became the Chairman of the Board in January 2008. Mr. Atayan has led a turnaround of the Company’s operations and strategy. Since joining the Company, AMCON has shed underperforming assets, settled complex litigation issues, and used excess cash to pay off debt. Mr. Atayan is also a consultant to Draupnir LLC (the parent of Draupnir Capital, LLC), has served as the Senior Managing Director of Slusser Associates, a private equity and investment banking firm, since 1988, and has been engaged in private equity and investment banking since 1982. During the 1980s, Mr. Atayan worked in High-Yield and Leveraged Finance at PaineWebber, Equities at Goldman Sachs, and M&A at Morgan Stanley. He has an MBA from the University Of Chicago Graduate School Of Business where he was a Vehon Scholar and Paine Webber Scholar.<br />-9461519341100<br />Company Description<br />Founded in 1986 and headquartered in Omaha, Nebraska, AMCON operates both a wholesale and a retail segment. AMCON’s wholesale segment distributes 14,000 different consumer products to approximately 4,300 retail outlets in the Central Rocky Mountain and Southern regions of the United States. Retail outlets include convenience stores, grocery stores, liquor stores, drug stores, and tobacco shops. The Company employs 674 full-time and 111 part-time employees. Notably, the distribution of cigarettes represented 72.4% of total sales. Confectionary distribution and the retail segment represented 6.5% and 3.6% of total sales, respectively. The Company’s retail segment operates six Chamberlin’s Market and Café stores around Orlando, Florida and eight Akin’s Natural Foods Market stores in Oklahoma, Nebraska, Missouri, and Kansas. These two health food store chains offer over 30,000 different national and regionally branded and private label products. Both health food store chains were founded in 1935. For the fiscal year ended September 30, 2010, AMCON generated over $1 billion in annual sales. <br />Figure 1: Daily Stock Price of AMCON<br />Source: Bigcharts.com<br />Risks<br /><ul><li>Distributor (Thin) Margins: Gross margin, operating margin, EBITDA margin, and net margin were 7.1%, 1.6%, 1.7%, and 0.9%, respectively. These slim margins suggest that AMCON has very little room to make mistakes with acquisitions, product mix, capital expenditures, or strategy.
Leverage: Despite reducing its debt profile over the years, AMCON relies on a credit facility and long-term debt that represents 27% of its total capitalization and 70% of market capitalization. Interest expense, thus, requires management to be disciplined in its operations. The credit facility restricts annual dividends to $0.72 per share.
Credit Facility terminates January 1, 2012: AMCON has a $55 million credit facility with Bank of America. The Company has steadily reduced the balance from an initial $49.1 million on September 30, 2005 to the $19.6 million balance as of September 30, 2010. AMCON has amended the credit facility three times before. There is no indication that Bank of America will not renegotiate/extend the credit agreement after the existing one expires January 1, 2012. There is a risk that the spread will widen as credit conditions have deteriorated since the credit crisis. According to the terms of the credit agreement, the interest rate is either the bank’s prime rate (currently 3.25%) or at LIBOR (1 month: 0.26%) plus 250 bps – at the election of the Company.
New cigarette/tobacco regulation could negatively affect sales: On June 22, 2009, President Obama signed the Family Smoking Prevention and Tobacco Control Act, landmark legislation that gives the U.S. Food and Drug Administration authority to regulate the manufacturing and marketing of tobacco. Two months earlier, federal taxes on cigarettes increased from 39 cents per pack to $1.01 per pack. Federal and state taxes have steadily increased to discourage smoking.
In April 2010, President Obama signed the Prevent All Cigarette Trafficking (PACT) Act which restricts remote sales of cigarette and tobacco products. Remote sellers are required to charge applicable state cigarette and sales taxes when they ship tobacco products, and the U.S. Postal Service (USPS) is prohibited from delivering tobacco products. USPS was one of few shipping methods left for tobacco products, as other carriers including Fedex and DHL had previously adopted policies against delivering tobacco products. The PACT should boost sales that had been diverted to online cigarette sellers.
Illiquidity: Daily volume of shares is less than a thousand shares. Low trading volumes with wide bid-ask spreads prevent an investor from actively trading the stock and require the investor take a long-term view on the company.</li></ul>Company Background<br />Founded in 1986 and headquartered in Omaha, Nebraska, AMCON operates both a wholesale and a retail segment. The Company employs 674 full-time and 111 part-time employees. For the fiscal year ended September 30, 2010, AMCON generated over $1 billion in annual sales. Notably, the distribution of cigarettes represented 72.4% of total sales. Confectionary distribution and the retail segment represented 6.5% and 3.6% of total sales, respectively.<br />Wholesale Segment<br />AMCON’s wholesale segment distributes 14,000 different consumer products to approximately 4,300 retail outlets in the Central Rocky Mountain and Southern regions of the United States. Retail outlets include C-stores, grocery stores, liquor stores, drug stores, and tobacco shops. These products include cigarettes, tobacco products, candy, beverages, groceries, paper products, health and beauty care products, frozen and chilled products, and institutional food service products. The Company also markets private label snuff, water, candy products, batteries, and film. In October 2010, Convenience Store News ranked AMCON as the ninth largest C-store distributor based on annual sales.<br />Figure 3: AMCON Distributing Revenues FY 2006-2010<br />14287571120$ in thousands00$ in thousands<br />Source: Company reports<br />Figure 4: AMCON Distributing FY 2010 Revenue Breakdown<br />Source: Company reports<br />Distribution<br />AMCON operates five distribution centers in Illinois, Missouri, North Dakota, Nebraska, and South Dakota. The Company owns the three facilities in Illinois, North Dakota, and South Dakota and is subject to non-cancellable operating and capital leases in Missouri and South Dakota. All five distribution facilities have 487,000 square feet among them.<br />Convenience stores represent the largest portion of the Wholesale Segment customer base. The C-store sales channel is a highly fragmented industry comprised of national, regional, and “mom and pop” owners. With over 144,000 locations at the end of 2009, convenience stores outnumbered all other sales channels. <br />Suppliers<br />AMCON’s principal suppliers include Philip Morris USA, RJ Reynolds Tobacco, Proctor & Gamble, Hershey, Mars, Quaker and Nabisco. The Company does not have any long-term purchase contracts with suppliers.<br />Competition<br />The Wholesale sector is highly fragmented. <br />Figure 5: Top 25 Convenience Store Wholesalers<br />Source: Convenience Store News Market Research, October 2010<br />Retail Segment<br />The Company’s retail segment operates six Chamberlin’s Market and Café stores around Orlando, Florida and eight Akin’s Natural Foods Market stores in Oklahoma, Nebraska, Missouri, and Kansas. These two health food store chains offer over 30,000 different national and regionally branded and private label products. Both health food store chains were founded in 1935. <br />Akin’s Natural Foods Market operates eight natural foods markets with five stores in Oklahoma and one store in Nebraska, Missouri, and Kansas. These stores offer vitamins and supplements, cruelty-free cosmetics, organic groceries, organic produce, fresh packaged foods, pet supplies, and unusual cooking and gift items.<br />Chamberlin’s Market and Café operates six full service natural foods grocery stores in the Orlando, Florida area. These grocery stores include fresh organic produce, baked goods, natural supplements and remedies, cruelty-free and all-natural personal care items, and healthy-fast food and beverages.<br />Business Strategy<br />AMCON has maintained a policy of growing by acquisition and organic growth. Over time, the company has tried to distribute products other than cigarettes and candy. In November 2009, AMCON acquired the C-store distribution assets of Discount Distributors from Harps Food Stores, Inc., an operator of C-stores. Since the arrival of Mr. Atayan, the Company has focused on tobacco and confectionary products.<br />Employees<br />As of September 30, 2010, the Company had 674 full-time and 111 part-time employees. Approximately 30 of the Company’s wholesale delivery employees in the Quincy, IL distribution center are represented by the International Association of Machinists and Aerospace Workers. The current labor agreement with the union is effective through December 2011.<br />Key Developments<br />November 2009: AMCON acquired the C-store distribution assets of Discount Distributors from Harps Food Stores, Inc., an operator of convenience stores. Discount Distributors was a wholesale distributor to convenience stores in Arkansas, Oklahoma, and Missouri with annual sales of approximately $59.6 million. The Company paid $3.1 million cash, issued $0.5 million note payable in quarterly installments over two years and could pay an additional $1.0 million in contingent consideration for certain fixed assets, inventory, and customer lists of Discount Distributors. The contingent consideration is based on achieving predetermined two-year revenue targets. This transaction was funded through the Company’s existing credit facility. No significant liabilities were assumed in connection with the transaction and costs incurred to effect the acquisition were not significant and were expensed as incurred. The acquisition expands the Company’s strategic footprint in the southern portion of the US and enhances its ability to service customers in the region.<br />May 2009: Trinity Springs Inc. (TSI), a wholly owned subsidiary of the Company, and Crystal Paradise Holdings (CPH) completed a transaction in which CPH exchanged a $5.0 million note receivable plus $0.1 million in accrued interest due from TSI, for the operating assets of TSI. The Company recorded a $4.7 million pre-tax gain ($3.0 million after-tax) in conjunction with the transaction, which included the recognition of a $1.5 million deferred gain attributable to a previously executed Mutual Release and Settlement Agreement between the Company, TSI, and CPH. The $4.7 million gain has been reflected in the Statement of Operations as a component of discontinued operations.<br />March 2, 2009: the holder of the Company’s Series C Convertible Preferred Stock redeemed all 80,000 shares of the issuance. The Series C issuance had been outstanding since 2006, paid a dividend of 6.00% per annum, and was convertible into 146,842 shares of common stock. AMCON paid the liquidation value, or $2.0 million, plus accumulated and unpaid dividends to fully redeem all of the outstanding shares. The redemption was funded through borrowings on the Company’s credit facility and satisfied all of the Company’s obligations under the Series C Convertible Preferred Stock Agreement.<br />February 4, 2008: Christopher Atayan, the Company’s Chief Executive Officer, named Chairman of the Board.<br />October 4, 2007: the Company fully settled all residual litigation among and between AMCON, TSI, and Crystal Paradise Holdings, Inc. ("CPH") regarding TSI's fiscal 2004 purchase of assets from CPH. In connection with this settlement, the Company recorded a $1.5 million deferred gain during the fourth quarter of fiscal 2007. As part of the agreement, CPH has received an option to purchase TSI's assets from the Company for a period of up to eighteen months.<br />August 2, 2007: The Company settled its outstanding litigation with Television Events & Marketing, Inc. (TEAM). The settlement did not result in any material impact on AMCON’s operating results and provided for certain promotional considerations to be rendered by TEAM to AMCON.<br />November 28, 2006: AMCON sold substantially all of the assets of Hawaiian Natural Water Company, Inc. to a newly formed investor group, Hawaiian Springs, LLC. The purchase price for the assets was $3.8 million in cash; in addition Hawaiian Springs, LLC assumed operating and capital leases. Proceeds were used to reduce outstanding debt and capitalized liabilities. “Historically HNWC has incurred significant operating losses which have hampered earnings. With this transaction, we will no longer have to absorb reported losses from this business which totaled approximately $6.2 million before tax for all of fiscal 2005 and $1.6 million before tax for the nine months ended June 30, 2006,” noted Andrew Plummer, AMCON’s Acting Chief Financial Officer.<br />October 4, 2006: AMCON named Christopher Atayan as Chief Executive Officer. <br />Publicly Traded Comparable Company Profiles<br />Core-Mark Holding Company (NASDAQ: CORE): Engages in the business of distributing packaged consumer products to C-stores in the United States and Canada. Seventy percent of Net Sales are from cigarettes to C-stores. It distributes approximately 42,000 stock keeping units of packaged consumable goods, including cigarettes, tobacco products, candy, snacks, fast food, fresh products, groceries, dairy, non-alcoholic beverages, general merchandise, and health and beauty care products. As of March 12, 2010, it provided distribution and logistics services, as well as marketing programs to approximately 24,000 retail locations in 50 states, and 5 Canadian provinces through 26 distribution centers. The company was founded in 1888 and is headquartered in South San Francisco, CA.<br />Nash-Finch Company (NASDAQ: NAFC): NAFC operates as the second largest, publicly traded wholesale food distributor in the US in terms of revenues. The company serves the retail grocery industry and military commissary and exchange systems. Nash Finch Company operates as a food distribution company. Its Food Distribution segment sells and distributes various nationally branded and private label grocery products and perishable food products to approximately 1,700 independent retail locations in 28 states across the United States. It also provides services, including promotional, advertising, and merchandising programs; installation of computerized ordering, receiving, and scanning systems; retail equipment procurement assistance; accounting, budgeting, and payroll services; consumer and market research; remodeling and store development services; and supply chain through Internet services. The company was founded in 1885 and is based in Minneapolis, Minnesota.<br />Sysco Corporation (NYSE: SYY): Markets and distributes a range of food and related products primarily to the foodservice industry in the US. It distributes a line of frozen foods, such as meats, fully prepared entrees, fruits, vegetables, and desserts; a line of canned and dry foods; fresh meats; dairy products; beverage products; imported specialties; and fresh produce. The company also supplies various non-food items, including paper products, such as disposable napkins, plates, and cups; tableware comprising china and silverware; cookware consisting of pots, pans, and utensils; restaurant and kitchen equipment and supplies; and cleaning supplies. Sysco Corporation offers its products to restaurants, hospitals and nursing homes, schools and colleges, hotels and motels, lodging establishments, and industrial caterers. As of June 27, 2009, it operated 186 distribution facilities serving approximately 400,000 customers. The company was founded in 1969 and is headquartered in Houston, Texas.<br />United Natural Foods, Inc. (NASDAQ: UNFI): Distributes natural, organic, and specialty foods, as well as non-food products in the United States. It carries approximately 60,000 products, consisting of national brand, regional brand, private label, and master distribution products in 6 product categories: grocery and general merchandise, produce, perishables and frozen foods, nutritional supplements, bulk and food service products, and personal care items. The company serves approximately 17,000 customer locations primarily located across the United States, which include independently owned natural products retailers, supernatural chains, conventional supermarkets, and food service centers. Its other distribution channels include international mass market chains and buying clubs. The company also owns and operates natural products retail stores. As of August 1, 2009, it had 13 natural products retail stores located primarily in Florida. In addition, the company engages in the international importing, roasting, packaging, and distribution of nuts, seeds, dried fruits, and snack items. It sells these items in bulk in its own packaged snack lines, EXPRESSnacks, Woodfield Farms, and Woodstock Farms, as well as through private label packaging arrangements. The company was founded in 1978 and is headquartered in Providence, Rhode Island.<br />Figure 6: Comparable Companies Analysis<br />Source: Company reports<br />Industry Background: Convenience Stores <br />A convenience store (C-store) is a small store that sells a limited variety of items including tobacco, soft drinks, confectionary items, alcohol, newspapers, and magazines. C-stores that are part of gas stations may sell automobile-related products such as motor oil and maps; some convenience stores may also serve hot food and beverages. C-stores may be part of national/regional company-operated chains or may be operated as franchisee/licensee stores. At the end of 2009, there were over 144,000 C-stores in the U.S. For the year ending May 2010, C-store growth was 0.3 percent or 389 stores; C-stores are a mature retail channel. <br />Despite the involvement of large players, the C-store industry is highly fragmented. According to Convenience Store News, the top 100 C-store chains operated nearly 40 percent (57,800 stores as of May 2010) of the total industry store count. With over 6,500 C-Stores, 7-Eleven has the most total stores and the most franchised/licensed outlets (4,815 C-stores). There is a trend within the industry for the largest chains to rely on franchising/licensing for store growth. <br />Figure 7: Largest Convenience Store Chains by Total Stores<br />Source: Nielsen TDLinx, Convenience Store News Market Research Report, May 2010<br />Figure 8: Top 10 Company-Owned Chains<br />Source: Nielsen TDLinx<br />Figure 9: In-Store Sales by Category<br />Source: Convenience Store News, Industry Report 2010<br />Figure 10: Cigarette Unit Volume Market Share<br />Source: ALCS STARS Database<br />Figure 11: Convenience Store Cigarettes Sales<br />Source: Convenience Store News Market Research, 2010<br />Appendix A: Balance Sheet<br />Appendix B: Income Statement<br />Appendix C: Statement of Cash Flows<br />Appendix D: Ratio Analysis<br />Appendix E: Discount Cash Flow Analysis – EBITDA Multiple Method<br />Appendix F: Discount Cash Flow Analysis – Perpetuity Growth Method<br />Appendix G: Replacement Cost Analysis and Earnings Power Value<br /> <br /> <br />Appendix H: Management Profiles<br />CHRISTOPHER H. ATAYAN has served as the Company’s Chairman of the Board since January 2008, its Chief Executive Officer since October 2006, and has been a director of the Company since 2004. From March 2006 to October 2006, he served the Company in various capacities including Vice Chairman and Chief Corporate Officer. Mr. Atayan is also a consultant to Draupnir LLC (the parent of Draupnir Capital, LLC), has served as the Senior Managing Director of Slusser Associates, a private equity and investment banking firm, since 1988, and has been engaged in private equity and investment banking since 1982. Prior thereto to he worked at PaineWebber Incorporated, Goldman Sachs and Morgan Stanley.<br />Mr. Atayan is also a director of Eastek International, Discovery Toys LLC, Hotlink Inc. and AMCON Corporation.<br />Atayan was also the financial advisor to the Alexander Dawson Schools which operates highly regarded schools in Colorado and Nevada. The School in Colorado was rated recently rated number one in Colorado.<br />He is an honors graduate of the University of Wisconsin Madison and attended the University Of Chicago Graduate School Of Business where he was a Morris Vehon Scholar.<br /> <br />KATHLEEN M. EVANS has been President of the Company since 1991. Prior to that time, Ms. Evans served as Vice President of the AMCON Corporation (the former parent of the Company) from 1985 to 1991. From 1978 to 1985, Ms. Evans acted in various capacities with AMCON Corporation and its operating subsidiaries.<br /> <br />ANDREW C. PLUMMER has served as the Company’s Chief Financial Officer and Secretary since January 2007. From 2004 to 2007, Mr. Plummer served the Company in various roles including Acting Chief Financial Officer, Corporate Controller, and Manager of SEC Compliance. Prior to joining AMCON in 2004, Mr. Plummer practiced public accounting, primarily with the accounting firm Deloitte and Touche, LLP.<br />Although not an executive officer of our Company, Eric. J. Hinkefent is an executive officer of two of our subsidiaries. His business experience is as follows:<br /> <br />ERIC J. HINKEFENT has served as President of both Chamberlin’s Natural Foods, Inc. and Health Food Associates, Inc. since October 2001. Prior to that time, Mr. Hinkefent served as President of Health Food Associates, Inc.<br />Appendix I: Credit Facility:<br />As of September 30, 2010, the Credit Facility had a balance of $18.8 million.<br />The Facility includes the following significant terms:<br /><ul><li>A January 1, 2012 maturity date and a $55.0 million revolving credit limit.
The Facility bears interest at either the bank’s prime rate or LIBOR plus 250 basis points, at the election of the Company
The Facility provides an additional $5.0 million of credit advances for certain inventory purchases. These advances bear interest at the bank’s prime rate plus one-quarter of one percent (1/4 %) per annum and are payable within 45 days of each advance.
Lending limits subject to accounts receivable and inventory limitations
An unused commitment fee equal to one-quarter of one percent (1/4%) per annum on the difference between the maximum loan limit and average monthly borrowings
Secured by collateral including all of the Company’s equipment, intangibles, inventories, and accounts receivable.
Provides that the Company may not pay dividends on its common stock in excess of $0.72 per share on an annual basis.
The Facility includes a prepayment penalty equal to one-half of one percent (1/2%) of the original maximum loan limit ($60.4 million) if the Company prepays the entire Facility or terminates the credit agreement on or before January 1, 2011.
The Facility includes a final covenant which requires the Company to maintain a debt service ratio of 1.0 to 1.0 as measured by the previous twelve month period that ended. The Company was in compliance with this covenant at September 2010.