Calloway's Nursery - CLWY

Calloway’s Nursery is a Texas retailer with 23 locations in the Dallas and Houston areas. Calloway’s offers….well, plants and plant accessories. Roses, hydrangeas, tomato plants, potting soil, and the list goes on. The business itself might sound dull. There’s nothing all that special about peddling flowers. But Calloway’s has a remarkable track record and a bright future.

What do you think of when you hear the word “greenhouse?”

It could be my rural Pennsylvania roots, but to me, a greenhouse is a humble structure sitting along a country road or a farm. Typically a little shabby and not at all sophisticated. Disorganized. A place to go and spend $5 for a flat of pepper seedlings or marigolds, not a destination.

This, on the other hand, is a Calloway’s Nursery location.

Calloway’s creates an all-around better experience. Their garden centers are neat and well-maintained. They employ experts to supply advice and assist customers in creating their dream gardens and landscapes. They have an online directory of available plants, and a rewards system. You can even pay Calloway’s to plant your purchases for you if you would rather drink your beverage of choice and watch. Calloway’s’ target customers are well-off Texas suburbanites, and they do all they can to cater to that market.

And it works! Calloway’s revenues have grown over time, from $50 million in 2015 to almost $74 million in 2020, a respectable annualized rate of 8%. But the real magic is taking place farther down the income statement. In 2015, Calloway’s produced operating income of $3.2 million, just 6% of sales. In 2020, operating profit reached $13.3 million, or 18% of sales. For a business like Calloway’s with relatively high fixed operating expenses, even modest revenue growth can have a transformative effect on profit. Now, Calloway’s certainly benefitted from COVID-19 restrictions. Stuck at home, many Texans dedicated their entertainment budgets to beautifying their surroundings. It is certain that a portion of government stimulus checks also wound up in Calloway’s’ registers. However, the company has also been successful in opening new garden centers and repositioning existing locations to drive growth. The company’s strategy is to open new centers in rapidly growing communities. These stores can take a little while to achieve attractive profitability, but they eventually benefit from incumbency and proximity as the local population grows. Calloway’s opened its newest Dallas center in early April. Another location, adjacent to Dallas Love Field Airport, will open soon. Management has indicated it will continue adding a couple new stores per year when viable sites and markets can be identified.

At this point, it’s worth dedicating a few sentences to the mastermind behind Calloway’s’ success, Peter Kamin. Kamin flies well under the radar, but he is perhaps the most successful investor in public micro-cap equities active today. Kamin’s typical modus operandi is to take majority control of an under-performing small public company, institute common-sense reforms and cost controls, implement a low-risk growth strategy, and make millions upon millions when it works. (And it virtually always does.) Thus far, Kamin’s preference is not to sell these companies to realize value. Rather, Kamin-controlled companies pay generous and frequent special dividends. Readers may wish to check out the other publicly-traded Kamin-controlled companies.

Kamin’s group took control of Calloway’s Nursery in 2016 after an extended activist campaign. Following a tender offer by the company and the purchase of shares from insiders, both at a price of $2.52 per share, Kamin’s group took control in February 2016. Pity the shareholders who sold at $2.52, thinking they were taking advantage of a multi-year high in Calloway’s shares. In the five years since the transaction, Calloway’s has paid out $2.25 in special dividends and shares have risen to $15!

At $15, Calloway’s has a market capitalization of $110 million. Enterprise value is $115 million, adjusting for the special dividend paid in April. In 2020, Calloway’s produced EBITDA of $14.6 million, EBIT of $13.3 million, net income of $9.8 million, and free cash flow of $12.6 million. Return on average equity was a whopping 40%. Any way you slice it, Calloway’s trades at low mulptiples of profit and cash flow, particularly for a business of this quality.

“OK, so it’s cheap on trailing earnings, but have earnings peaked? What happens when the world normalizes and people go back to their regular routines? Won’t consumer dollars wind up in bars again instead of begonias?”

The short answer is: I don’t particularly care. Calloway’s is a long, long-term hold for me, based on my trust in management and my assessment of the business model and potential. I would not be surprised if 2021 results are somewhat lower than 2020’s blowout profits. However, I do think there are reasons to believe Calloway’s future earnings will track closer to 2020 results than those of previous years.

• The housing market. It’s insane. Bananas. I believe America will experience a wave of new home construction and household formation, both of which are extremely positive for garden centers.

• The weather. Texas weather has been wild and will likely continue to be so. Floods, hurricanes, ice…all are destructive, not least to landscapes. I believe Texas homeowners will be forced to replace outdoor plants more frequently than in years past, or to pay to replace them with hardier varieties.

• Texas demographics. While I don’t get the attraction of 95 degree heat and 100% humidity for months on end, people are flocking to the Lone Star state. Texas will experience continued population growth, and that means more and more customers for Calloway’s.

• Revenue composition shift. Calloway’s makes far better margins selling landscaping services than it does hawking tulips. I believe the company will continue emphasizing its service offerings, which will result in increased earnings.

Whatever direction Calloway’s short-term results take, I am highly confident that earnings will be significantly higher five years from now, and that the company will pay me a generous amount of dividends before then.

It should be noted that garden centers are not a license to print money, and Calloway’s does face meaningful competitive threats and economic risks. Big box hardware stores and small greenhouses will sell their plants cheaper than Calloway’s, and it is up to the company to convince customers its higher-touch service and customer experience are worth the mark-up. The firm’s results are also sensitive to the general economic environment as its offerings are the definition of discretionary. Operating leverage goes both ways.

Despite the inevitable ups and downs, I expect Calloway’s to continue thriving. I can’t wait to see where Kamin takes the company this decade.

Alluvial Capital Management, LLC holds shares of Calloway’s Nursery, Inc. for client accounts it manages. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.