Calloway's Nursery, Inc. (CLWY): Explosive Growth at an Attractive Price

Peter Kamin Masterclass

Calloway’s Nursery is a garden center retailer based in Texas with 24 locations in the two largest metropolitan areas in Texas: Dallas - Fort Worth, and Houston. The company sells plants and related products and offers landscape design and installation services. This is not your average neighborhood plant retailer - a disorganized, small, roadside greenhouse, where you go to spend a couple of bucks on some seeds or flowers and then continue about your day. Calloway’s stores look more like a Home Depot than they do a humble nursery:

Calloway’s is essentially like a Home Depot or Lowes garden center but with better customer service and higher-margin offerings in the form of design and installation services. Calloway’s locations, which they look to expand by 2-3 units per year, are perfectly located and operated for their target customers, the well-of suburbanites of Texas. The proof is in the pudding, in 2015 Calloway’s pre-tax income was $3.2m, and margins were a measly 6%. Fast forward to 2021 - pre-tax income is $20.7m, and margins have grown to 17%! In that time period earnings and free cash flow also have grown to ~$16m each - from $1.6m earnings and negative free cash flow in 2015. That’s good for a compounded annual growth rate of ~40% in earnings over the last 7 years. In addition to fantastic growth rates, Calloway’s has a healthy balance sheet and they have consistently paid out special dividends over the past few years. In 2021 they paid out $2.22/share in dividends - making for a huge dividend yield of 13%.

Clearly, management is aligned with shareholder interests. It’s well worth taking a further look at who is behind this shareholder-friendly company and all of its success. That individual is Peter Kamin - perhaps the most well-regarded investor in the micro-cap space. He is known for taking control of underperforming firms and implementing common-sense cost-controls and growth strategies. He is almost always successful and one of the best parts for shareholders is that he doesn’t favor dismanteling and selling the companies he takes over. Instead, Kamin-controlled firms, love to pay out special dividends, which in addition to enriching him, also benefits shareholders. In 2016, Peter Kamin took control of the company after an activist campaign. When he took over Calloway’s, shares were ~$2.50, today they trade for almost $17. With Kamin in command, shareholders can sleep well knowing management has their best interests in mind.

Calloway’s has been one of the few companies that actually benefitted slightly from the COVID-19 Pandemic. During the lockdown, many homeowners in Texas took up landscaping and gardening as a hobby. Earnings grew over 220% in 2020, and a further 67% this year. It’s unlikely that a similar growth rate can be expected moving forward. However, the company has proven 2020 wasn’t their peak, as every quarter profitability and sales have continued to grow. It’s difficult to project how much revenues and earnings will grow in the future, but with shares trading at only 7.8x earnings, the market is pricing Calloway’s as if it was a company in decline. Some of the markets concerns have to do with the usual discounts the market puts on micro-caps: liquidity and reporting concerns, etc. But ~8x earnings for a company of this quality with great management and clear plans for growth is absurd. I think there is also some doubt concerning the durability of Calloway’s moat - they aren’t that different from the Home Depot’s and Lowe’s of the world nor are they as cheap as neighborhood greenhouses. In my opinion, these concerns are overblown, Calloway’s installation and design offerings separate them from both the smaller and larger retailers. It’s been proven that Calloway’s target customers are willing to pay up for the benefits of their extra services, so I don’t really see the cheaper and smaller retialers taking away any of their market share.

The bigger concern is what happens if Home Depot/Lowes decide to compete directly with Calloway. For this to happen, the competitor would have to invest substantially in human capital, and in building new locations. I don’t think the cost of making these investments would be worth the potential reward to a big company like Home Depot or Lowes. For reference, Home Depot made $16b in 2021, even if they took 100% of Calloway’s earnings power away for themselves ($16m), they would hardly see any difference in their own earnings. The potential rewards simply don’t outweigh the costs and risks. Therefore I believe its far more likely that a bigger corporation would acquire Calloway’s if they decide to enter the market rather than try to compete directly. Given Kamin and Co. have no reason to sell unless they receive an excellent offer, a buyout would most likely be very rewarding for shareholders. The market is a strange place, perhaps a big part of the reason why the company is so cheap is because it goes unnoticed - it won’t show up on any fancy stock screening tools, and it’s too small and illiquid for big investment firms.

Needless to say, whatever the reasons, I disagree with the market’s sentiment on future growth, and I find the current valuation especially attractive.

My expectations for more growth stem from management’s intelligent capital allocation skills, new store openings, and the unforgiving weather in Texas. The state has experienced a lot of harsh conditions in recent years such as the deep freezes. These conditions destroy plants and force customers to buy replacements. As global warming and environmental damage (unfortunately) continue to get worse, it is likely damaging weather events will only increase in frequency. Keep in mind that even a slight shift in weather can benefit Calloway’s significantly, as Texas isn’t the ideal place for plant growing, even in normal conditions.

Considering the aforementioned oppurtunities and events for growth, I think it is quite conservative to expect earnings to only grow at around 5-10% over the next few years. But at current prices, the market is implying it expects that a maximum. The company is valued as if it were selling cigarettes or landline telephones, slowly losing customers until its inevitable closure.

A company with Calloway’s business quality, growth prospects, dividend history, and management, should sell for at minimum somewhere around 15x earnings. If Calloway’s stock was more liquid and the company was bigger, it would easily sell at 20-30x earnings +. But the illiquidity of its shares, and its small size offer a rare opportunity to buy a company of such quality at only ~7-8x earnings.

Im betting on Calloway’s big time and making it a premier position in my portfolio, at about ~30%. What are your thoughts? Thanks as always for reading!