Colabor’s earnings were mixed but overshadowed by a major decision to end its biggest contract, worth 20% of revenue. That may sound like bad news but it’s not, because this contract was a money-loser and getting rid of it actually increases the value of the company.
The contract is with Recipe Unlimited (Cara Foods) and produces $255 million of sales but loses Colabor $4 million of EBITDA annually. The former chairman of Colabor once told us this was a distressingly unprofitable contract.
The contract will be phased out over the coming months and will be completely gone by the end of next year. There are severance costs of $8-9 million but these will be paid from the reduction in working capital required to service the contract (inventory, receivables, etc.) Recipe will be buying the associated inventory.
The company says that losing this volume of business won’t affect efficiencies. Some may doubt that statement, but at any rate, the company has already begun to grow its organic business while continuing to shed uneconomic business, especially targeting “street” sales (these are higher margin, smaller customers) and over time the lost revenue could be replaced with profitable sales.
So what does the company look like with the disappearance of this contract? Here’s our stab at it, with a couple of years of subsequent progress:
The following two years are an attempt to map out what the company might look like assuming new business at better margins and continued debt reduction (this has been one of the most impressive successes in the turnaround, almost cut in half.)
Based on these assumptions there is plenty of upside for this stock and today’s market action confirms this.
One big assumption is how quickly, and to what extent, can management replaces the lost revenues with profitable ones. In our discussions with senior management, we’ve come away with the sense that they’re quite confident. One has to assume that the toxic Recipe contract was terribly distracting.
All in all, while this turnaround has taken far longer than we’d hoped, we view today’s news as very concrete evidence that the company’s rehabilitation is getting full traction at last.
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