Compass Diversified Holdings SWOT Report


Summary

  • Compass Diversified Holdings is a collection of businesses in numerous industries.
  • The firm is constantly evolving as new acquisitions are made.
  • Compass has key strengths, but also room for improvement in some areas.

Compass Diversified Holdings (CODI) operates as a private equity firm with a focus on acquisitions, buyouts, recapitalization, industry consolidation, and middle-market investments mostly in North America. This 9% yielding dividend payer targets companies that are worth $4 million to $700 million with a cash flow of $10 million to $450 million and enterprise values of $5 million to $75 million. 

Compass Diversified lumps its business into two categories:

1. Branded Consumer Businesses:

5.11 provides technical apparel & gear for law enforcement, firefighters, EMS, and military special operations. The company also offers outdoor fitness products.

Ergobaby provides ergonomic strollers, baby carriers, car seats, swaddlers, etc.

Velocity Outdoor has the following products: airguns, archery products, and laser aiming devices.

Liberty Safe provides safes for personal products, guns, etc. 

Marucci Sports supplies equipment (bats, gloves, balls, protective gear) and apparel for baseball. The company makes custom wood bats for MLB players.  

2. Niche Industrial Businesses:

Advanced Circuits produces custom printed circuit boards [PCBs].

Foam Fabricators produces polysterene-based molded protective foam solutions. 

Arnold provides magnets and precision foil products for motors, generators, sensors, and more.

Sterno sells portable food warming fuels used by catering services and consumers. Sterno also offers lighting and hand sanitizer.  

Although COVID-19 may have led to decreased demand for some of these products, these businesses are likely to produce steady cash flow over the long-term. The cash flow from these businesses allows Compass to pay dividends regularly. Compass invests in businesses that offer products that are needed on a regular basis. Investing in new businesses is a part of Compass’ strategy. New investments are likely to help drive long-term growth.

Strengths

Compass Diversified has positive internal characteristics that help drive growth and long-term stability.

  • The company has a diverse product portfolio across multiple industries. This helps reduce risk as it is spread out among different types of businesses. The recent example is how COVID-19 negatively affected the catering industry, reducing demand for Sterno’s products. However, the other businesses in the portfolio can help offset the loss of business from the negatively affected ones. 
  • Management has an effective ability to acquire businesses with steady cash flow. This helps the company achieve long-term growth with the ability to maintain steady dividend payments. 
  • The return on assets [ROA] improved to 9.6% for the past twelve months over CODI’s 5-yr. average of 6.7%. This is also higher than the sector median of 0.89%. 
  • The balance sheet is strong with 2.3x more total assets than total liabilities and 3.24x more current assets than current liabilities. Compass has total equity of about $1.2 billion. 
  • Operating cash flow increased to $164 million over the past 12 months as compared to $84.6 million in 2019. The strong cash flow allows Compass to acquire new businesses, pay CapEx, repay existing debt, and paying dividends. 

Weaknesses

Some of Compass’s businesses were negatively impacted by COVID-19. Sterno experienced significantly less demand for its food warming products due to the lack of catering during the pandemic. Foam Fabricators also experienced less demand as a result of many of their customers temporarily shutting down. 

  • The trailing twelve month [TTM] return on equity of -16% and return on invested capital of 3% lags the sector median ROE of 8.3% and ROIC of 5.3%. 
  • While the overall balance sheet is strong, there is a weak point. The total debt of $591.8 million is 2.9x higher than the total cash of $205.2 million. Having more cash would put the company in a better financial position for future acquisitions. 
  • Management’s decision on dividends: The dividend payment hasn’t increased. Compass has been paying the same $0.36 per share per quarter or $1.44 per share per year since 2011. With the exception of 2020, Compass has been growing earnings and cash flow over this time period. So, there have been opportunities to increase the payments. 

Opportunities

Compass Diversified has opportunities to improve on weaknesses and to implement strategies for growth.

  • Compass can look for opportunities to reduce costs in existing businesses by finding new efficiencies and through production increases. This will help to increase margins. 
  • Increase market share for existing businesses by seeking new market opportunities. 
  • New acquisitions: Compass can keep their eyes out for new businesses to acquire as an ongoing growth strategy. The company can stick with its current 2 main businesses (consumer and industrial) and/or expand into high-growth technology-related industries to accelerate growth. 
  • Consider increasing the dividend payments in years where cash flow increases. This can help attract new shareholders, which might lead to improved price appreciation. 

Threats

Unexpected external events could have a negative impact on the company.

  • It is not clear when we will be clear enough from COVID-19 for businesses to resume normal operations.  So far, COVID-19 negatively impacted Compass’s food service-related businesses. The guidelines to halt catering services could go on longer than expected. The impact to MLB baseball  (Marucci business) is not clear with some teams stopping play after just a few games into the already delayed season. Some non-pro sports (baseball/softball) could also be canceled temporarily, leading to a loss for the Marucci business.  
  • Increased competition from new or existing competitors could take market share away from Compass’s businesses.  
  • New taxes or government regulations could have a negative impact on Compass. New COVID-19 shutdowns could be implemented that could negatively impact Compass’s businesses. Other COVID-related or non-COVID-related regulations could be created that could add costs for the company. 

Compass Diversified Holdings’ Long-Term Outlook

COVID-19 does create some negative implications for Compass in the short-term. Having catering services on pause is likely to hurt the Sterno and Foam Fabricators businesses. However, this can be temporary if COVID-19 lasts the same length of time that most pandemics last (12 – 18 months). In the meantime, Compass can balance the weakness in catering-related businesses with its other businesses such Velocity Outdoors, Liberty Safe, 5.11, Ergobaby, and others. 

Unless something unusual happens with COVID-19 or other viruses, sales should improve for the businesses that are currently harmed by the pandemic looking a few years ahead. 

Investors should watch for new acquisitions which could help shape the future for Compass for the long-term. That is a key feature for this holdings company. Compass can mold the company by purchasing steady, growing businesses over time. 

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].

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.

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