Idea List: Issue #9

This week I analyze AMCON Distributing, Luna Innovations, and Big 5 Sporting Goods

In this post I want to share three stock ideas that appear to be undervalued. These companies came from the “top of the funnel” of my research process, meaning they came from stock screeners, or recommendations from Twitter and Substack. What I want to do here is present some qualitative and quantitative metrics that determine if I should keep researching the stock or take a pass on it. Further, I want to do a basic valuation to verify that the company is actually undervalued. The end goal is to have some semi-vetted stock ideas that I can add to a watchlist and start doing more thorough research on.

AMCON Distributing Company

AMCON Distributing DIT 0.00%↑ has a market cap of $87M and distributes consumer products to groceries, drug stores, liquor stores, etc. The company also operates a chain of health food retail stores. I found this stock by looking through stocks getting removed from the Russell 3000, since occasionally you find a decent company that becomes cheap due to the forced selling. DIT was trading at $200 earlier in the year, but now it has slide down to $140.

Management mentions inflation and interest rates have been an issue. Sales have been increasing, with a large increase since the pandemic. However profitability has suffered. The lower profit margins might be masking some recent investments the company has made. AMCON has recently made a couple of acquisitions of other distribution companies. They also recently bought a distribution facility in Colorado. That being said, distribution companies are known for having very thin profit margins even in good times.

DIT is currently trading at 10x earnings, but it is hard to work out what a normalized earnings level should be. Returns on assets has been poor so it is probably best to value to company based on replacement value. Currently AMCON’s book value is $168 a share, so it is trading at a 20% discount. The company often trades around book value or at slight discounts. DIT seems to be a decent company for a microcap, but it would be nice if margins expanded a bit. I might be interested in this stock if it traded at a deeper discount to book value.

Luna Innovations

Luna Innovations $LUNA market cap is about $99M, and was trading around $7.50 earlier in the year, but is now down to $2.90. This is another stock that was on the Russell deletion list. Luna provides fiber optic test, measurement, and control products. Initially I thought the company was interesting since it is a microcap with growing revenue, although slightly negative operating profit, trading slightly above book value.

Looking more into the company I discovered there are several things going on. Last year LUNA issued $50M in convertible preferred stock to a fund called White Hat Capital Partners. Part of this capital raise involved the fund manager joining the board. Some of the proceeds of the preferred stock went towards making an acquisition of a British company that also involved in the fiber optic measurement business. Then in March 2024 the company announced they would be late filing their 10K and quarterly results due to revenue recognition issues. Shortly after, the CEO is fired, and eventually core of the C-suite has been replaced. The company still has not filed any financials this year so it is impossible to value the company. Also Luna announced they are seeking strategic alternatives, such as getting acquired.

There is a lot of drama with this stock, but it could be a good opportunity if the company gets acquired. The convertible preferred stock can put a dark cloud over the common stock because current stock owners will get diluted. The preferred’s convert at $6.70, so not likely they will convert any time soon with the current stock price. Once the latest financials are released, then the company could be valued as an acquisition target and there would be a clearer picture of what the capital structure would look like if the preferred stock is converted.

Big 5 Sporting Goods

Big 5 Sporting Goods BGFV 0.00%↑ currently has a market cap of $62M. I didn’t realize it until I starting researching the company, but apparently it was a meme stock back in 2021 with shares peaking at $44. BGFV was trading around $10 a year ago and has steadily declined to $2.70. Big 5 is another company that is getting removed from the Russell index. As you can imagine from the name, Big 5 Sporting Goods is California based sporting goods retailer. Sales peaked in 2021 at $1.16B and have declined to $880M in 2023, with continued declines this year. Management comments through this prolonged decline in sales has been about softening consumer discretionary spending. The retail industry is tricky, so I would want to do more homework to make sure something else is not going on to explain the decline in sales.

Despite the decline in sales, what caught my eye is the company has no long term debt and is trading at 1/4 of book value. Looking back, the stock often trades at or above book value. Additionally, if you adjust for long term lease liabilities, Big 5 is trading below its net current asset value. BGFV seems very undervalued, just have to hope that sales stop declining and the company returns to profitability. With the stock so seemingly cheap, I am very interested, but I will have to do some more research to make sure its not a value trap.