Saturday, November 6, 2010

Central European Distribution ( CEDC - Nasdaq ) - Follow-up Report

Central European Distribution (CEDC $26.75) reported Q3 results that were below our expectation.  We had anticipated a down period.  Results came in even lower due to a summer heat wave in Eastern Europe, which encouraged drinkers to switch from vodka to beer (which the company doesn't manufacture).  Fires in Russia contributed added pressure.  And Central European spent a lot of time and effort selling off its Polish distribution business and restructuring its Russian operations.  Earnings slid 75% to $.12 a share.  Sales 16% to $157.8 million.  Central European predicts a better showing in Q4, which is its strongest selling season due to the holidays.  Still, full year earnings are likely to finish in the $1.50-$1.70 a share range, somewhat below our previous $1.75 a share estimate.

Things could pick up in 2011.  Pricing has improved in Russia, bolstered by government measures aimed at cutting into the black market.  Untaxed sales represent approximately 50% of the entire market at present.  Greater enforcement could divert more business to legal producers, as well, lending Central European a further boost.  How much of the black market the company will ultimately get its hands on remains to be seen.  Much of the illegal output is made at otherwise legal facilities, just on an extra shift.  And police and government officials are believed to benefit from various profit sharing arrangements with black market operators.  New entities may crop up if those enterprises convert to a legal format, blocking Central European from simply scooping up the extra business.

Competition is more intense now that it was in early 2000s, when the company originally entered the Polish vodka market.  Back then the Americans who ran Central European exerted superior management know-how and stronger finances to zoom past its competition and garner 30%-40% of the industry.  The company already holds about 20% of the Russian market.  Expansion from there are likely to be grudging, in the neighborhood of 1%-2% a year if everything goes great.

Outsize earnings gains may be difficult to achieve in the future.  Income could climb back to the $3.00 a share level over the coming 2-3 years, but a lengthier time horizon may be required.  Downside risk is limited by Central European's appeal as a potential takeover candidate.  Value investors may want to hang on and see some more cards.  Due to the company's uncertain earnings prospects, however, aggressive investors are advised to close out positions and reinvest the proceeds in a stock with more clear cut appreciation potential.

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