Handleman (HDL), a Turnaround Candidate

Type: Turnaround
Target: $12
Current price: $6.64

Handleman Co., based in Michigan, operates as a category manager and distributor of prerecorded music to retailers in the United States, Canada, and the United Kingdom. A very tough Q1 and Q2 of 2006 has brought HDL’s stock price to a 5-year low.

Stephen Strome, the company's Chairman and CEO is doing the following:

• Acquired Crave Entertainment Group, a distributor of console video game hardware, software and accessories.
• Added greeting cards to product category in UK.
• Hired President/COO Robert Kirby, previously the president of Personal Products Co. at Johnson & Johnson, to replace the recently resigned John Beeder.
• Reducing selling, general and administrative (SG&A) expenses, which will save $20 million annually, or 9% of total annual SG&A.

Percentage of total revenues:

• Music revenue 77%
• Video games 14%
• Greeting cards and DVDs 9%

Valuation & Financial health ratios:
- P/S: 0.1
- P/B: 0.45
- P/E: 12
- Debt/Equity: 0.3

There’s no doubt that the revenue derived from selling music will continue to fall at retail stores as customers go online to shop for music. This trend is reflected in the continued decline of Handleman’s stock price in the last two years. The big question is: whether the cost-cutting and diversifying into the video games & greeting cards businesses are able to offset the decline in music sales?

At today’s bargain-basement price level, the answer won’t matter. A discounted cash flow analysis, which I’m projecting a negative 15% growth over the next 5 years and zero growth afterwards with a discount rate of 8%, shows that Handleman is about 45% undervalued. The company also yields a 4.8% dividend. Handleman is solid undervalued turnaround play.