On Wednesday, August 26th, we started tracking EDUC while it was at $4.94, citing the company’s aggressive expansion. We began to establish our position shortly thereafter, notifying our premium members via our morning e-mail on August 28th. With the stock trading near $7 today, we still see significant upside to our target price between $10 and $12.50.
Elevator Pitch
There is nothing sexy about what Educational Development Corporation (EDUC) does. The company operates as a trade publisher in the line of educational children’s books in the United States, functioning with two business segments; a traditional retail business model (publishing) and a multi-level marketing model (UBAM). In fiscal Q1 (May 31) 2015, EDC’s multi-level marketing business generated 73% of net revenue and is expected to generate a greater percentage of revenue going forward.
We are aware of the controversy currently surrounding multi-level marketing businesses, but while the government takes its time to try and figure out what, if any, changes it’s going to make to the industry, EDUC looks like an interesting find. Companies like Natural Health Trends (NHTC), which we have been very skeptical of, have been good examples of the growth that the model can produce when left to operate without strict regulation.
This is what our bullish to bearish timeline on MLM company Natural Health Trends looked like:
- On 2/17/2012, we added NHTC to our 52-Week High Screener, when the stock was trading at $1.25.
- In our 3/18/2013 e-mail to members, we stated that we were putting NHTC back on our active watch list due to bullish commentary from its fourth quarter 2012 earnings release.
- In our 9/5/2013 e-mail, we stated we had nibbled at shares on a technical basis (when shares were trading at around $2.00), but were well aware of the company’s poor track record of delivering consistent quarterly results.
- October 2013 thru July 2014, NHTC reported a string of strong quarterly results
- September 10, 2014 - After being long NHTC for slightly over one year, we went short at ~$15.00 as our preliminary due diligence was not positive. We published our findings in our article titled "Natural Health Trends (NHTC) – Warning of Multi-Level Marketing Scams"
- We covered our short position on January 23, 2015 with the stock trading around $12.65.
We have not fully vetted EDUC’s MLM model, but we are optimistic about the results that it is showing. A factor that gives us comfort with EDC’s MLM model is that books by their nature are not subject to exaggerated product claims as is often the case with many MLM models. Notwithstanding the merits of EDC’s MLM model, however, we view EDUC as a potential near term growth story to capitalize on while the government continues its work on potentially instituting new MLM/pyramid scheme law.
After several years of unexciting top line growth it appears that the company’s near-term growth prospects are dramatically improving as evidenced by annual and quarterly trends. The following charts reflect net revenues by segment annually since 2006 and quarterly since the fiscal Q1 (May 31) 2012
The eventual improvement in the company’s revenue picture can be attributed to management’s decision to remove its books from Amazon.com, where the pricing environment was becoming challenging.
“Amazon is squeezing everyone out of business,” said Randall White, EDC’s chief executive. “I don’t like that. They’re a predator. We’re better off without them.”
Management chose to increase its penetration into traditional book and mortar retailers, while at the same time increasing its emphasis in its MLM business. Another quote from the company’s fiscal year ended February 28, 2015 report was:
The increase in net revenues for the Company represents a significant turnaround in our history. The publishing division, EDC Publishing, registered its largest sales year in history, an increase of 5% despite eliminating 20% of its sales three years ago when sales to Amazon were discontinued. The sales increase came from existing and new customers who have enthusiastically supported this decision.
The home business division, Usborne Books & More, has also greatly benefited from that decision. The Usborne Books & More division responded by posting an annual net sales increase for the second consecutive year, reversing nine years of sales decline, and has now recorded 21 consecutive months of sales increases when compared to the same month in the previous year.
While both of EDUC’s divisions are growing, we believe that the MLM model is what is giving the business a boost due to the increased number of sales consultants since FY 2013.
Given the facts, including record sales in August and Q2 ended August 31 and improved margins; we think the company could be on the cusp of finally reporting consistent quarterly sales and EPS growth in the near-term. If the company can hold Q2 trends and approach the high end of historical pre-tax margins of 12%, we think there is a chance EDUC’s EPS can exceed $0.50, which would be more than double its fiscal EPS of $0.21. We also think the market could assign a P/E of 20 to 25 on EDUC shares, especially after considering that company pays a handsome dividend of 5%. The CEO also just disclosed that he was buying shares on the open market. This gives us a target price of between $10 and $12.50.
A Growth Plus Value Proposition
Here is a summary of our reasons for optimism on EDUC:
- It appears that the company is benefiting from an aggressive expansion of its multi-level marketing sales channel.
- The company announced record monthly revenues for July of $4.3 million vs $2.4 million last July
- EDUC indicated a significant improvement in operational margins for July 2015
- The company increased its quarterly dividend to $0.09, a 12.5% increase (~5.5% yield)
- EDUC recently announced record Q1 2016 results:
- Sales: $9.6 million vs $7.1 million
- EPS: $0.08 vs $0.06
- Book value of $3.08 per share
- Trading at a price to sales of 0.75, much lower than the industry average of 1.63
Critical questions are both, “Is this growth sustainable?” and “Is the model safe from regulatory intervention?” We believe the answers to both of these don’t apply in the short term, but that they will be relevant caveats moving into the longer term future for the company.
UBAM’s surge in internet sales is also significant. DTC sales have highest margins and also generate shipping and handling revenue. With EDC publishing, ultimately, the product has to sell through to the consumer. Returns are always an issue with major retailers, but we see less returns with an MLM model than with a traditional business model.
Here are some of the relevant comments for Q1 2015 from the company’s Form 10-Q:
UBAM’s gross sales increased $2,818,900 during the three-month period ending May 31, 2015 when compared with the same quarterly period a year ago. This increase resulted from increases of:
- 204% in internet sales. The increase in internet sales is attributed to a 193% increase in the total number of orders and a 3% increase in average order size. This significant increase in the total number of orders is a result of the growth in the use of social media by sales consultants to conduct online events such as virtual home parties.
- 24% in school and library sales. The increase in school and library sales is attributed to a 24% increase in the total number of orders. Much of this change is a result of the increase in the number of sales consultants.
- 25% in home party sales. The increase in home party sales is attributed to a 94% increase in the total number of orders, offset by a 36% decrease in average order size. Much of this change is a result of the increase in the number of sales consultants.
- 13% in direct sales. The increase in direct sales is attributed to a 20% increase in the average order size, partially offset by a 5% decrease in the total number of orders.
- 9% in fundraiser sales. The increase in fundraiser sales is attributed to an 8% increase in the average order size and a 1% increase in total number of orders.
EDC Publishing’s gross sales decreased $236,200 during the three-month period ending May 31, 2015 when compared with the same quarterly period a year ago. We attribute this to a 43% decrease in sales to major national accounts, offset by a 15% increase in sales to smaller retail stores. This decrease in sales to major national accounts was due in part to timing of reorders.
Some of our selected caveats are as follows:
- MLM business models such as Herbalife Ltd. (NYSE:HLF) have been receiving immense scrutiny from investors and regulators. While we acknowledge EDC has a somewhat different angle in selling books instead of wellness products, it could nevertheless be painted with the same MLM brush by investors if things turn out badly for Herbalife and other MLM operators.
- We have not interviewed management thoroughly
- One of the company’s two divisions operates through a licensing relationship with a book publisher (Usborne). We need to perform more due diligence on the nature of this relationship
- We would like to gain an understanding of how big of a threat the internet is to the company’s brick and mortar business.
- It should again be noted that the stock is very illiquid and operates in the highly controversial MLM industry. MLM business models such as Herbalife have been receiving immense scrutiny from investors and regulators, including private MLM Vemma recently being temporarily shut down by Federal regulators while the FTC takes the company and its CEO to court, alleging it’s a pyramid scheme. The court’s decision to grant or deny an injunction to halt the business is scheduled for mid-September, and the result of this decision will likely have an impact on all public MLM companies.
