Compass Diversified: Reasonable return at a reasonable valuation (NYSE: CODI)

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Thesis

diverse compass (NYSE: CODI) is a stock that could make sense in your portfolio. The company at the current price presents a unique opportunity to buy a stock with strong fundamentals at a discount, with predictable returns like good. We believe the company can be a great way for investors to earn dividend income during times of economic uncertainty.

Company presentation

Compass Diversified is a publicly traded holding company that invests in middle market companies. The company currently has 11 assets in its portfolio, representing a value of $3.1 billion. Compass Diversified retains a controlling interest in these assets (or subsidiaries) and strives to maximize its value by increasing cash flow generation. The Company invests in both equity and debt capital structure. Since its IPO in 2006, Compass Diversified has completed more than $6.4 billion in global trades and generated more than $1.1 billion in realized gains. Year-to-date, Compass Diversified has returned -32.34%, compared to a -16.54% return for the S&P 500.

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CODI Data on Year-to-Date Price Returns (Daily) by YCharts

Strong portfolio performance

Compass Diversified posted another quarter of strong financial performance, including net sales and operating profit. Management reported quarterly revenue growth of 19% and operating profit growth of 38%. Management cites revenue growth to the strong performance of niche consumer and industrial brand subsidiaries. For example, portfolio companies such as 5.11 (designer of bespoke technical clothing) recorded 6.7% revenue growth in a half of 2022, while other companies such as Dialed In recorded revenue growth of 44.5% year on year over the same period. Management also noted that across all subsidiaries, the adjusted EBITDA margin was 20%, which shows the company’s effective management of its portfolio. These strong results among portfolio companies allowed the company to post strong overall results for the quarter.

Presentation of Q2 2022 results

Presentation of Q2 2022 results

Reasonable assessment

We believe Compass Diversified is trading at a reasonable valuation multiple and looks attractive on a few metrics. First, we believe that on a price-to-book ratio, the company is trading at a reasonable multiple, trading nearly 40% below its 2021 highs. Given growth across all segments and good financial outlook, we think this multiple could increase when market sentiment changes.

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CODI Price to Book Value data by YCharts

In addition, company management indicated that earnings this year will be $130-145 million on adjusted EBITDA of $445-470 million. Taking the midpoint of the FY22 net profit forecast ($137.5 million), the company is currently trading at around 10.6x the P/E ratio. The estimated P/E ratio is well below the average financials sector P/E multiple of 21.86x. Even taking into account the P/E ratio of 16.48x, Compass Diversified is well below the industry average.

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CODI P/E Report Data by YCharts

Are the distros safe?

Compass Diversified currently has a dividend yield of 4.79% at an annualized dividend payment of $1.00. At this rate, the dividend payout ratio is around 40%, allowing the company to increase dividend payouts and/or maintain dividends in the event of a financial downturn. We believe that at this price level, current yields are very attractive, especially given the current S&P 500 yield of 1.69% and Treasury yields of around ~3%. Moreover, one can see the divergence between the performance of the company and the stock price. At the beginning of this year, we see a divergence between the share price and revenue growth. Although some of the revenue growth came from acquisitions, we believe the share price was largely impacted by market scare and fears of a deepening recession. However, the company continued to post strong annual results and the company has ample access to cash. Management said it had more than $100 million in cash and had access to an additional $500 million in cash through a revolver. They also have no debt maturing before 2029, which should give the company plenty of time to navigate through any prolonged recession scenario in the years to come. Therefore, we are confident in the company’s ability to sustain this dividend and believe it has sufficient financial flexibility to increase its dividend once macroeconomic conditions improve.

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CODI data by YCharts

Conclusion

Compass Diversified is another investment worth considering during uncertain times. The company has seen strong financial growth in its subsidiaries and the share price is currently at historically low valuation levels. Additionally, we believe the current yield is attractive and, based on our assessment, we believe dividends are likely to increase over time given the strong fundamentals or, at the very least, hold steady for the foreseeable future.

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