This small cap is gaining ammunition for its future growth
Compass (ticker: CODI) has 10 subsidiaries in a variety of consumer and industrial end markets, and has bought and sold companies on several occasions since its IPO in 2006. The company, which has a market value of approximately 1 , $ 6 billion, looks like a publicly traded company. private equity funds, but with permanent capital – rather than funds that are raised periodically and for a defined period of time. Its mergers and acquisitions are funded by a combination of cash and debt, which Compass does at the holding company level.
Compass’s consumer-focused subsidiaries include companies engaged in the sale of tactical clothing and products, baseball bats, gun safes, and buckles for ski boots, helmets and other sports equipment. This group has weathered the pandemic relatively well, given an inclination towards outdoor activities which has boosted demand.
“The trends of remote working, spending more time outdoors and de-urbanization during the pandemic have really boosted our companies’ products,” says Elias Sabo, CEO. Barron’s.
In the first quarter, stimulus checks put extra money in consumers’ pockets and the impact was felt almost the next day, Sabo says. Sales of Compass’s six consumer affiliates increased 33% year-over-year in the first quarter to about $ 292 million.
Its largest of the four industrial subsidiaries is Sterno Group, a manufacturer of candles and other warming tools for the restaurant industry. Sales there have been affected by the closure of restaurants across the country and the lack of major catering events. Its four industrial subsidiaries saw their sales increase by 4% compared to last year, to reach approximately 169 million dollars.
In total, Compass sales reached nearly $ 462 million in the first quarter, ahead of the analysts’ average estimate of $ 405 million and up 21% from the prior year period. Net income attributable to Compass was $ 19 million, or one penny per share, compared to the consensus forecast of two cents per share.
Cash available for distribution was around $ 46 million, down from less than $ 18 million a year ago and well above Wall Street’s average forecast of $ 19 million. This is a more important metric for Compass because it measures cash flow at the holding company level that management can allocate to dividends, retained earnings, or investments.
Compass is also considering changing the company’s tax classification, a move that would help attract a growing shareholder base and increase trading liquidity in small-cap stocks.
Compass is currently structured as a publicly traded partnership, which essentially means that its profits are taxed on the annual income tax returns of its shareholders, who receive a Schedule K-1 form from the Internal Revenue Service. This is an additional hurdle for investors to overcome and means that Compass stock is excluded from many mutual funds and other portfolios that cannot include such companies.
However, management announced Thursday that it is considering changing Compass’s tax classification from a partnership to a standard C-Corporation. This would mean that Compass is taxed at the corporate tax rate like any other business. This follows similar conversions in recent years by
Global management of Apollo
(CG) – all major private equity firms that have seen their stocks outperform following the abandonment of their tax partnership structures.
This move would potentially make Compass eligible for inclusion in stock indices and attract demand to buy passive exchange-traded funds.
If approved by the board of directors and shareholders of the company, management expects the change to take effect in the third quarter of 2021. The reclassification would result in a taxable capital gain for shareholders this year, but it would also increase the cost base of the company’s subsidiaries by the same amount, reducing its future taxes. Compass would pay shareholders a special distribution of around 88 cents per share to compensate them for their higher tax liability in 2021.
After 2021, Compass would reduce its quarterly dividend from 36 cents per share per quarter – an annual yield of 5.8% – to 25 cents. These future dividends would count as qualified dividends, which are taxed at a lower rate than ordinary dividends. Overall, after-tax dividend income for shareholders is expected to be roughly neutral, says Ryan Faulkingham, CFO of Compass.
Compass management also took advantage of extremely low interest rates in 2020 to refinance and restructure much of its outstanding debt, reducing the weighted average cost of capital of its bonds and preferred shares to 5.6%, the lower in its history. A more liquid stock with a larger shareholder base should also improve Compass’s ability to obtain equity financing, further lowering its cost of capital.
“We’ve always said that our competitive advantage as a business should be our cost of capital, versus private equity firms that fund on a case-by-case basis,” says Faulkingham.
More capital available to management means more ammunition for future acquisitions and for capital investments in existing subsidiaries. Compass’s latest initiatives are not going to attract attention from outside the investment community. But these are solid steps that should give the company more options in the future.
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