This private equity firm beat EPS estimates by $0.26 last quarter. The shares have a current dividend yield of 4.86%, paid quarterly.
Compass Diversified (CODI)
From Cabot Dividend Investor
Compass Diversified is a holding company that invests in niche middle-market businesses, a segment historically reserved for traditional private equity. It owns ten companies, six in branded consumer businesses and four niche industrial companies.
The businesses are unrelated and therefore provide diversification. The branded businesses include companies that make and sell outdoor wear, food warming systems, baseball equipment, diamonds, and baby products. The industrial businesses make circuit boards, magnetic technologies, and custom packaging.
It’s like a Business Development Company (BDC) in that it invests in promising companies to take them to the next level. These companies tend to be unserved by traditional lenders and need capital and management expertise to get to the next level. Compass targets what is referred to as middle-market companies in the $200 million to $600 million range.
Compass seeks out companies located in North America that have market-leading niches in strong growth sectors. It’s different than traditional private equity companies in that it uses “permanent capital,” which is an open-ended investment for no specified period of time. Private equity companies typically take a stake in a company for five to seven years and then sell it.
It views these companies as longer-term investments and doesn’t try to turn them around and sell them for the quick buck. Compass does sell or divest companies when the price is right, but more in tune with a longer-term strategy. It tends to have a more stabilizing influence for a company when it can focus on the long-term strategy instead of being hampered by short-term targets and fundraising.
Compass refers to itself as a business builder, not an asset trader.
The strategy apparently works. CODI has blown away the performance of its peers as well as that of the overall market, returning 454% over the last ten years and 148% over the last five (with dividends reinvested).
Compass, until recently, was classified as a Master Limited Partnership but recently simplified to a regular corporation. The September 1st conversion should be a catalyst for the stock in the near term.
As a regular corporation, CODI generates a regular 1099 and not those annoying K-1 tax forms. Dividends also qualify for the maximum 15% tax rate (or 20% in some rare cases). Also, the regular corporation classification greatly broadens its appeal to investors. CODI can now be purchased by institutions that are forbidden to buy MLPs and is also now eligible to be listed on indexes.
Lower costs and cost of capital from the simplification will be a huge advantage over competitors. And increasing margins and profitability should ultimately benefit the stock price. The returns were strong already. Now, they should be better.
Simplification has proven to serve stocks well. Stocks in similar businesses including Ares Management Corp. (ARES), KKR & Co. (KKR), The Carlyle Group (CG) and Blackstone Inc. (BX) all recently converted from BDCs or MLPs and saw their PE ratios expand significantly after the conversion.
Currently the dividend, formerly the distribution, has been paid consistently every quarter since 2006. The current $0.36 quarterly payout translates to $1.44 per year. The dividend is well-supported by a strong balance sheet and very reasonable for the industry’s 55% to 65% payout ratio.
The stock should get a near-term bump not only from the strong economy, which tends to benefit smaller companies disproportionately, but the simplification should provide an additional tailwind. This is also a great company over the longer term.
When the economy is expanding, like it is now, the companies thrive. During times of contraction or recession, Compass has dry powder available to make great acquisitions on the cheap, which ultimately increases profitability when the economy recovers.
It’s a great time in the economic cycle for this type of company. And Compass is a better way to go than any of the BDCs both in terms of overall strategy and its stock return history.
Tom Hutchinson, Cabot Dividend Investor, cabotwealth.com, 978-745-5532, October 13, 2021