Yankee Candle

Yankee Candle (YCC) is a manufacturer, designer, wholesaler, and retailer of premium scented candles with the largest market share (over 40%) in the premium, quality end of the market. The company has also announced plans to enter the “premium mass” market which could add significantly to its wholesale volume.

The company continues to tinker with its retail store initiative, having some 400 stores currently, and has plans to add another 200-300 stores, as it gets its formula right. Retail same store sales have been flat to negative for some time and to some extent has been hurt by the wholesale division’s expansion into supplying stores like Bed Bath and Beyond which has hurt not only YCC retail stores but also small wholesale customers of YCC such as gift shops. The company has recently teamed with Hallmark stores in a line called Celebrate Home.

The premium mass market initiative includes shelf space in Kohl’s, Costco, Target, as well as odor-eliminating candles at PetSmart!

Analysts seem to fret over earnings growth which has slowed down from the heady pace of a few years ago:

Earnings growth
2002 48.1%
2003 19.7%
2004 20.0%
2005 2.9%

The company generates a steady and growing free cash flow stream:

FCF
2001 $20.2 million
2002 $60.2 million
2003 $65.9 million
2004 $91.4 million
2005 $92.4 million

Because of the strong free cash flow, the company has returned capital to shareholders with a $100 million share buyback in 2003, followed by two subsequent $100 million annual buybacks. Its fourth buyback program, initiated in 2005 now of $150 million, I understand is more than half completed at this time.

Operating margins are quite impressive at around 22% and return on capital has been very strong at about 27% for last year, though this is down from the last couple of years where ROIC was 32.5% and 39% respectively.

At a current market cap of $1.23 billion, and an enterprise value of $1.4 billion, this business is selling at only 10.3 times EBIT. From a free cash flow standpoint, the business is selling at a FCF yield of 7.5%.

Why is Wall Street waffling here? What’s wrong with the story?

1. There is some margin pressure because of energy costs and the cost of wax moving higher. The company has addressed this to some degree with a 4% price hike in the fourth quarter.


2. Insider sales.


3. Seasonality…this is a company that generates significant sales and earnings in the fourth quarter.


4. Conflicting distribution channels…can the retail operation be managed to improve same store sales. Can gorwth in new store openings be resumed?

One should be aware that there is a 13D filer in YCC, Blue Harbour Group, of Greenwich, CT with a 5.3% stake. This was filed on January 18th of this year.

The valuation and the free cash flow characteristics are very attractive in my view. Given the share buybacks, the share base has been trimmed from about 54.5 million shares a few years ago to the current fully diluted base of 43 million shares. I view these share buybacks as being very effective.

I find the stock quite interesting and will be buying it after our 24 hour rule. Clients already have a position here.