Central European Dist. ( CEDC - Nasdaq )

Central European Distribution (CEDC $23.75) is the leading producer of vodka in Poland and Russia.  The company holds about 25% of the legal market in Poland, and 20% in Russia.  Early in the decade the black market accounted for an estimated 40% of total Polish consumption.  The Government knocked that down to 5%-10% with a series of measures, mainly excise tax cuts and greater policing.  Today, black market sales still account for 50% of Russian unit volume.  The Kremlin recently implemented a minimum price statute designed to curtail black market activity.  Enforcement is increasing, as well.  So the legal market in Russia could expand significantly over the coming years, improving Central European's potential reach.  Meantime, the company is bouncing back from a decline in business caused by the recession.  Efforts are underway to boost market share in both countries, shore up finances, and restore profit margins to previous levels.  Central European faces direct competition in both markets, so progress is unlikely to come as quickly as did when the company first arrived in Eastern Europe a decade ago.  (Management is American.)  It does appear that financial results are poised to turn the corner, though, setting the stage for better days to come.

Earnings probably will decline for a second straight year in 2010.  Last year they fell 19% to $2.37 a share.  A 26% drop to $1.75 a share appears to be in the cards for the current year.  Most of the shortfall in 2010 was caused by the sale of the company's liquor distribution operation in Poland.  That unit formerly contributed $.40 a share.  Central European entered Poland with that business ten years ago, but performance began to fade as competitors followed its example.  The company now primarily is a vodka manufacturer, although it also imports a range of products for resale in both Poland and Russia.  Vodka sales didn't rebound in 2010 because of continued weakness in consumer spending, more intense competition, and tight budgeting that constrained growth while a series of borrowings were restructured.  Most principal payments now come due in 2016.  Sale of the distribution business generated further flexibility.

A pick-up in 2011 is achievable.  Marketing efforts have been beefed up.  New products are in the pipeline.  Plenty of spare production capacity is available.  Cash flow is positive and expanding again.  And the Russian government may enact additional price floor increases in November.  That would enhance profitability directly.  It also would expose or eliminate a large part of the black market.  We estimate income will climb 29% to $2.25 a share.  In 2-3 years income could make it back to $3.00 a share.  Finances should continue to strengthen over that period, allowing Central European to pay down debt.  Applying a P/E multiple of 13x suggests a target price of $36 a share, potential appreciation of 50% from the current quote.  A higher valuation could result if Central European becomes a takeover candidate, or the Polish and Russian economies develop more rapidly.  If the black market in Russia is reduced to the 5%-10% level, and Central European maintains or expands its market share, earnings might advance far beyond our projection.  Under the right circumstances income could reach $4.50 a share or more.