Some Thoughts on Calloway’s Nursery, Inc.
I plan to use Focused Compounding as my investing journal. My “writeups” will be less structured than Geoff’s, but could serve as a starting point for members to research a new stock. My posts will literally be similar to emails that I send to Geoff whenever I have thoughts on a business — basically straight from the stream of my consciousness, lol.
Feedback/your notes/thoughts are highly encouraged in the comment section below.
The first stock that I want to talk about is Calloway’s Nursery, the garden and landscape retail store in DFW/Houston. Here’s a brief history on the origins of the company: taken from http://www.fundinguniverse.com/company-histories/calloway-s-nursery-inc-history/
The garden center industry in Texas underwent significant change during the 1990s as competitors fought for market supremacy–or, at the very least, for survival. Some market participants buckled under the pressure exerted by mass-merchandise, discount chains such as Wal-Mart and Kmart, while other garden center firms consolidated their operations to improve their odds for survival. Caught in the midst of the pitched battle for the garden business of Texas was relative newcomer, Calloway’s Nursery.
Calloway’s Nursery was founded in 1986 by three former senior executives at Sunbelt Nursery Group. Formed in 1984, Sunbelt Nursery was created to help expand Pier 1 Imports’ Wolfe Nursery Inc. concept. Selected to lead the company toward such an objective were Jim Estill, Sunbelt Nursery’s president and chief executive officer; John Cosby, the company’s vice-president of corporate development; and John Peters, its vice-president of operations. Together, the three executives helped develop the company into a regional force with more than 100 stores in a five-state area. After a change in ownership at Sunbelt Nursery, the trio disagreed with the new owners about the future direction of the company. In March 1986, they formed Estill/Cosby Enterprises to facilitate the creation of their entry in the garden center market, Calloway’s Nursery.
Although Estill, Cosby, and Peters were veterans of the industry, they consulted the patriarch of the garden center industry in the Southwest, 65-year-old Sterling Cornelius, before starting out on their own. Sterling Cornelius’ father, Frank Cornelius, started the family nursery business in 1937, initially occupying a portable building that measured only slightly larger than 100 square feet. Except for a four-year stint in the U.S. Navy during World War II, Sterling Cornelius was employed by his father’s company from its start, witnessing the addition of Turkey Creek Farms, a nursery operation, in 1951 and the company’s development into a favorite among Houston’s lawn and garden enthusiasts. Estill, Cosby, and Peters solicited the help of Sterling Cornelius because, by their own admission, they wished to copy the operating strategy used by Cornelius Nurseries. “We saw an opportunity to create a different kind of nursery in Dallas-Fort Worth, and quite honestly, Cornelius was our pattern,” Estill remarked in a November 26, 1999 interview with Dallas Business Journal. “Cornelius was always the group in Houston that went after the upper-income customer, and there wasn’t anything like that in the Dallas-Fort Worth area.”
After Sterling Cornelius helped Estill, Cosby, and Peters develop a business plan, the effort to build a new chain of garden centers in the Dallas-Fort Worth area began in earnest. Cosby assumed responsibility for developing the company’s retail locations, including site selection and development, and lease and acquisition negotiations. Estill served as the company’s chief strategist, while Peters took responsibility for operations, distribution, administration, and human resources. In April 1987, the first Calloway’s Nursery store, located in Richardson, Texas, opened for business. Before the end of the month, two more stores opened, and before the end of the year the fledgling company opened its fourth store.
General Host Encourages 1991 IPO
Capital was scarce during the company’s first years in business, which led to the intervention of a financial partner in 1988. Stamford, Connecticut-based General Host Corp. invested $2 million in the Forth Worth company, obtaining an 80 percent stake in Calloway’s Nursery in return. After the infusion of cash, the company expanded, adding an average of nearly three new stores a year. General Host, meanwhile, waited for the right time to recoup its investment. In 1989, the company recorded a loss of $1.9 million, which was trimmed to a $545,000 loss the following year. Calloway’s Nursery posted its first annual profit in 1991, registering a $2 million gain that convinced executives at General Host the time was right for the Connecticut company to cash out.
At the urging of General Host, Estill and his colleagues filed with the Securities and Exchange Commission in May 1991 for an initial public offering (IPO) of stock. The company planned to sell 3.2 million at an expected price of $6.50 per share. At the time of the stock offering, Calloway’s Nursery was generating $22 million in annual sales, a total derived from the company’s 11 retail stores, all of which were located in the Dallas-Fort Worth area. The company had been able to secure a place for itself in a fiercely competitive market, successfully competing against industry veterans such as Wolfe Nursery and the “big-box” discount chains by putting an emphasis on quality rather than price. The completion of the IPO gave Estill $6 million, proceeds he intended to use to pay off $1.7 million in long-term debt owed to General Host and to fund the company’s continued expansion. Following the IPO, Estill, with Cosby as his lieutenant, planned to open two new garden centers a year for the next five years. From its $2 million investment in 1988, General Host received a substantial profit, walking away from the IPO and its affiliation with Calloway’s Nursery with $24 million.
The years immediately following the company’s IPO were difficult ones. Calloway’s Nursery failed to deliver consistent financial growth after registering its first annual profit in 1991, although considering the recessive economic climate of the early 1990s it was not surprising that the company failed to impress. After posting a $2 million profit in 1991, the company recorded a $825,000 gain the following year before suffering a nearly $500,000 loss in 1993. Sales slipped as well, dropping from $28.8 million in 1992 to $28.2 million in 1993. “Nineteen-ninety-three was a difficult year for the nursery industry,” Estill explained in a December 3, 1993 interview with PR Newswire. “Calloway’s Nursery did not achieve the sales increases or profitable operating results that we would have liked,” he added. Despite the company’s anemic financial performance during the early 1990s, it did achieve great strides through expansion. In late 1993, the company opened its 17th store, the sixth new store opening since the company’s IPO. The opening of the new store in a north Dallas suburb marked the end of the company’s internal expansion during the 1990s. Physical growth in the future would be achieved solely through acquisition.
Acquisitions in the Late 1990s
One major problem challenging the company from 1993 forward was maintaining its stock of plants. National retailers such as Wal-Mart, Kmart, and The Home Depot flocked to the Dallas area, hoping to wrest control of the lucrative market away from independent chains. The massive stores purchased large amounts of plants and flowers, causing a drain on the supply that had previously fed Calloway’s Nursery’s demand. To ameliorate what potentially could put the company in a precarious position, Estill looked to secure his own supply of garden products. In mid-1997, Estill made his move, acquiring a nursery production facility near Tyler, Texas. Comprising more than 80 acres and more than 100 greenhouses, Miller Plant Farms was expected to provide Calloway’s Nursery with one-fifth of the living plants its chain of stores required.
Calloway’s Nursery’s next big move on the acquisition front occurred two years after Miller Plant Farms joined the company’s fold. In a bold proposition, Estill announced his intention to acquire two familiar garden center retailers. One of the companies was Wolfe Nursery, the concept he, Cosby, and Peters had presided over during the early 1980s. Sunbelt Nursery had filed for bankruptcy protection and was looking to liquidate its assets. The other company on Estill’s list was the Houston-based chain controlled by his mentor, Sterling Cornelius. By 1999, Cornelius was 77 years old and ready to retire. “I am up in the senior-citizen bracket now,” Cornelius explained in an August 14, 1999 interview with The Houston Chronicle. “We’ve had several offers before,” he continued, “but this seemed like the right time. These people [Calloway’s Nursery] have a good track record. They walk the high moral road. They are good people, and that’s why we are doing this.”
Estill’s ambitious plan promised to triple the size of Calloway’s Nursery and to expand the company’s geographic scope considerably, adding properties in Austin, San Antonio, and Houston to its established presence in the Dallas-Fort Worth area. The acquisitions did not go ahead as planned, however. In July 1999, one month after the acquisitions were announced, Calloway’s Nursery terminated its plan to acquire the Wolfe Nursery chain, explaining that it lacked the financial resources to complete both acquisitions. Forced to chose only one of the candidates, Estill opted for Cornelius Nurseries. In late 1999, the acquisition, valued at between $15 million and $20 million, was completed, giving Calloway’s Nursery control of four Cornelius Nurseries garden centers in Houston, a 160-acre nursery production operation named Turkey Creek Farms, and two wholesale distribution centers, one in Houston, the other in Austin.
Calloway’s Nursery exited the 1990s as the largest garden center retailer in Texas. The Texas market, ranked as the third largest in the country, generated an estimated $1.6 billion in sales in 1999, a total that excluded the sales recorded by mass merchandisers, who did not separately report nursery product sales. As they had for more than a decade, retailers such as Lowe’s, The Home Depot, and Wal-Mart represented a formidable force in the market, presenting Estill and Calloway’s Nursery’s management team with a perennial threat. To distinguish itself from the discount retailers, the company unveiled a prototype store before the end of the 1990s. The store’s design was expected to be the model for the future, as the company sought to strengthen its image as an upscale retailer.
Calloway’s Nursery’s new flagship store, located in southwest Fort Worth, was designed to replicate a historic Texas homestead. Measuring 100,000 square feet, the Stonegate store featured a greenhouse decorated with garden benches and pottery, wandering landscaped paths, and a courtyard with a fountain. The merchandise differed from the traditional selection found at a discount retailer as well, including items such as pots imported from Vietnam, China, and Malaysia. The store also sold potting soil with added sulfur and iron, which the soil found in the Dallas-Fort Worth area required. The Stonegate store did not offer a precise blueprint for future store design–a store in McKinney, Texas, for example, featured a scaled-down replica of Monticello in the nursery–but its essence as an upscale, specialty retail location provided a direction the company opted to pursue in the 21st century.
As Estill and his team planned for the future, there was cause for celebration and concern. In August 2000, the company reported the most profitable fiscal quarter in its history, posting $3.2 million in the third quarter. During the first nine months of 2001, however, the company reported a loss of $1.15 million, partly because of losses stemming from its wholesale business. In response, Calloway’s Nursery sold its wholesale operation, comprising distribution centers in Austin and Houston, to Coppell, Texas-based Landmark Nurseries. The divestiture was completed in October 2001. With the drag on its profits removed, Calloway’s Nursery looked forward to consistent financial growth in the years ahead and to maintaining its lead in the lucrative Texas market.
————————————————————————————————————————————————————————–
First, let me start by saying that I don’t view the company as a screaming buy today. The business has benefited tremendously through COVID home improvement + people having extra spending money. Your guess is as good as mine as to how things will normalize in the future. That said, I think this stock should be on your watchlist as it’s a great business and given its illiquidity, could give you a chance to buy in the future at a lower price. Who knows — maybe Texas will have another freeze and the stock will sell off, or perhaps numbers will normalize and investors will pound the stock.
Calloway’s current MC is $127 million with an EV of $110 million (I did not include leases in debt). I expect the company to generate north of $17 million in FCF in FY2021 — so, call it a 15% FCF yield. In 2020, they did $13.2 million in FCF, which gives us a TTM EV/FCF yield of around 12%. Return metrics (ROE, ROTC, Gross Profits/Net tangible assets, inventory turns, etc.) are all strong across the board. Calloway’s makes money by retailing living plants (and products, food, etc., that are associated with that), landscape design, and installation services. They used to sell wholesale but exited that business a while ago. The business from an operations standpoint has changed a lot since the 90s.
Gross margins are stable and have gone up a few % points over the past few years. Going further back to 1994, gross margins were 42.5% and are an average of 50% today. To get an idea of pricing power, I estimated the % mark up on goods over the past 10 years and it’s basically been a little less than inflation. Calloway’s turns their inventory over on avg 8x a year compared to 3-5x at Home Depot and Lowes. This makes sense given they’re mainly selling live plants. They do private label as well.
As most know, this is a Peter Kamin controlled company. His firm, 3k limited partnership, owns like 60% of the company. I had an incorrect view of him in the past. Everything he has done does not seem crazy to me. His track record in creating shareholder value has been solid. His modus operandi, from what I could gather online, is to buy stock over a period of years, get on the board, implement changes, and control capital allocation from there. You can read their investor presentation here. https://3klp.com/3KLP_Overview_2018.pdf
From a business perspective, I like the nursery retail business. There are two things that Amazon will never kill. Food + plants. People like to go pick these things out. Calloway’s competes with local nurseries and the garden centers in Home Depot / Lowes. Now, in reality, they mainly only compete with local nurseries. Before living in an apartment, I rented a house and exclusively went to Calloway’s over Home Depot / Lowes to buy flowers/plants. Anyone serious about paying money for plants that they want to last will not go to Home Depot/Lowes. This is similar to me buying plants for my fish tank. If you are serious enough to want real plants in your fish tank, buying from Petsmart or Petco over buying from a real fish tank store just doesn’t happen… If it does, it’ll only happen once and you’ll be enlightened to what quality is from there. Everyone in the fish tank community knows that Petco/Petsmart has crappy plants that will only last a few weeks. People want quality if you’re going to shell out cash towards things like this. Calloway’s does not offer the cheapest plants, but their customers will pay up because they know the quality is good and the service at Calloway’s is top-notch. I can’t tell if this is still true due to the lack of information in recent filings, but from the 10-Ks I read from the ’90s, one-half of their full-time employees were Texas Certified Nursery Professionals or Texas Master Certified Nursery Professionals. Below was taken from a 1996 10-K.
“All Calloway’s store managers and nearly one-half of its other full-time employees are either Texas Certified Nursery Professionals or Texas Master Certified Nursery Professionals. Candidates for each such certification must pass comprehensive examinations in plant identification, identification and cure of plant problems, landscaping, as well as retail merchandising and sales. The Master certification includes a week-long intensive course and examination conducted at Texas A&M University in College Station. The Company believes that it employs more of these Texas Master Certified Nursery Professionals than any other organization in the state of Texas.”
From reading employee reviews online, Calloway’s cares A LOT about customer service. I repeatedly read that something as simple as not saying hi to a customer can be a firable offense. They take customer service very, very seriously.
Plant and garden buying is a durable business and doesn’t have any obsolescence risk. This will not change in 10-years. I just don’t see anything that could hurt the durableness of the product they sell. Something that we’d have to get comfortable with, though, is their positioning in the industry. Something that I thought was interesting was Home Depot in 2003 opened 7-8 “Landscape Supply” stores in DFW, which competed directly with Calloway’s as a retail nursery. In 2008, Home Depot closed all these stores to “focus on their core business again”. Was the market not big enough for Home Depot? Was it actually too far away from their core business? HD Supply was sold around the same time, so maybe that’s true.
Another thing that I found interesting was Calloway’s (under previous management) entered the San Antonio market in like 2003 and exited around 2008. Why is this? I’ve searched online and haven’t found anything explaining why. Were they not successful because the terrain in San Antonio is more desert-like than Houston/DFW? I’d be interested to learn more about this from the perspective of how possible it is for them to scale from the current 23 stores to, say, 50? Management has been good about opening and relocating unprofitable stores, and I don’t think it’s too much of a stretch to see them open 1-2 new stores a year — which would give the company slow, profitable growth.
I don’t want to get into conspiracies, but the company only recently started disclosing more in their filings instead of a simple 3 page IS, BS, and CFFO statement. Something tells me they want the investor community to follow along more.
Some risks I see are if we go into a recession, the first thing people would stop spending money on is plants/landscaping supplies. Another is the housing market is on fire right now. This directly benefits Calloway’s.
Other than that, the business from an operations standpoint seems solid. The stock is up 8.5x since Kamin took control and shareholders have received special dividends along the way.
I’ve been to 3 stores here in Dallas since reading about the company and really like the business.