Lazare Kaplan is a company at which I’ve been looking (how ‘bout that for not ending in a preposition ;-). Their main business is polishing rough diamonds, and selling them under the brand name “Lazare Diamonds.” The reason I’m interested is: to buy this company now you’re paying 75% for it’s current assets* (minus all liabilities) and getting a potentially great business thrown for free.
CC
Press Release
Here are my notes from LKI’s conference call. (This is not a transcript, just my notes)
-Fiscal quarter 2, 2006
-Intro, disclosure, blah, blah, blah
-Industry continues transformation from supply driven to demand driven
-Demand remains good in US, new markets opening
-Sensitive to broad econ. factors
-Rough prices impacts on:
-Margins (prices have run ahead) in transformation from rough to polish
-Deliberately slow down purchases
-Continues to be pleased, but disappointed w/ results
-Increasing uncertainty surrounding diamond business
-Substantial increase of diamonds sold to market
-Taking steps to brace against a market shift, in polished sales (negatively effected results in last quarter)
-Remain focused on 4 elements:
-Manage Conservatively
-Expand Strategic projects in rough diamonds
-Focus on high quality diamonds (increase share by strengthening internal org.)
-Globalization
-Supply from Diamond trading company continues to grow
-Relationship in Russia continues (operations remain stable through reorganization In Russian -\diamond econ.)
-Brought buying prices, of rough diamonds, into equilibrium, w/ polished – worsened ST results
-South Africa Manufacturing facility operational
-Good progress in discussion w/ Little Jon
-Consider policy of strengthening sales & marketing
-Growing acceptance of high quality jewelry line
-Constantly trying to increase market share
-Expanding participation in US and Overseas markets
-Looking at new markets (China India etc)
-This quarter successful implantation of strategic policies discussed in past
-Sales – quarter and 6 months - $96.3 mm $235, compared to 93.2, 171.5
-Increase of 37% six months
-Polished diamond quarter 37.7mm, from 38.9
-6 months 79.7mm, +9% over prior period
-Reflects increased sales of buying cut commercial stones
-Rough 58.6 mm, 54.3
-6 months 155mm, 98.5mm
-sales from rough trading operation began 2nd quarter
-Gross margin ¼ 16.5%, 6months 14.4% - prior year 17.8%, 17.5%
-shift in sales mix, increase in rough diamond prices effected gross margin
-rough gross ¼ -.3%, 2.1% prior year
-6 months 2.3%, 5.3% prior year
-Increased rough costs, fees charged by diamond producers
-SG&A ¼ 6.4mm, 5.7 prior
-Six months 13.1mm, 11.4 prior
-Increased personnel and cost
-Interest expense .3mm,
-Increased interest rates
-Receivables 98.4mm, prior year - 87mm
-Working capital 139.6mm
-150mm in borrowing facilities
-12.6mm CFO
-38,015 OKI Treasury 8.97 per share, 507,060 shares owned, average purchase - $8.07
-Conditions in rough & polished environment?
-A lot of speculative trading in rough market
-Resulted in negative rough margin
-Better level in purchases
-Rough prices running ahead of justified price, happens in commodity business
Please realize my notes aren’t complete, and my analysis may not be that great either ;-), mm means million (just incase I was using the wrong abbreviation)
Conclusion
I like how management assures they are preparing for the future, but doesn’t offer any growth projections – this shows they know it’s not possible to predict growth precisely, and it also shows they can resist the “institutional imperative.” The bottom line on management is, they know what they’re doing, and have a great plan for the future – also they prepare for the future, even though it’s hazardous to their ST results – we just need to see if they can come through with their promise.
The stock went down 8% today on 7x average volume, I’m happy because I only bought a third this weekend.
-Mike
* They are trading ~25% less than their Net Net working capital, which is defined here as Current Assets minus Total Liabilities
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Disclosure: This article in no way represents a recommendations to buy or sell any security, do your own research before making any investment decisions. At the time of posting – though it could change at any time – the author, Mike Price, owned shares of Lazare Kaplan International
3 comments:
Dear Mike,
I can see why you are interested in this company. As you explained clearly, the company is selling below its net net working capital. I have one concern, that is, it is not generating any free cash flow. Net operating activities for 2005, 2004 and 2003 were -22.5m, -21.8m and -4.2m respectively. A lot of money is tying up in the inventories.
Would you comment something on this negative free cash flow please.
Warmest regards,
Dah Hui Lau (David)
Re: LKI
Mike, ask Shai to lend you his views on LKI from exchange of mails between me and him about a month ago.
I'll give you mine:
"OK Shai, here's my input...
1. I wouldn't arbitrarily downgrade value from LKI's current assets. that would be... well, arbitrary. If, on the other hand, one have valid reason to believe receivables (or some of them) are at risk, or that some of the inventory should be written-off, than I would apply your margin of safety to cav.
2. Greenblatt's note is right on the mark. what I didn't like here is the low roe/roic. we're talking less than 5% average ROE.
3. The following point is the most important - I think LKI-2005 is a different company than pre-2005 LKI. this is mostly due to the Angolan operation, which added greatly to the first line (i.e. income), but lowered margins and profits and doubled inventory and A/R levels. I think that this step-up is very significant to the structural integrity of the company and the burden of proof lies with the company. past results are no guarantee here, as past-LKI was a different tune. might be that the higher revenue base will contribute to the bottom line from 2006 onwards... don't know... and that's the key... if there is a doubt...
4. CFFO is negative which, again, is not a good sign.
So, what's our bottom line? pass... i think... next candidate please..."
I think thecoampny will start producing positive FCF soon, they had positive OCF in the last quarter.
-Mike
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