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Liquidity Services: An Undervalued Growth Story

Josh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Today I have decided to take a look at one of my favorite stocks through a different shade of sunglasses. Having thought back to The Motley Fool's Rule Breakers, Rule Makers, I have chosen to take a slightly unorthodox look at a business that isn't really all that large, or even maturing, but rather a pure dominator of its market space.  While this may be a strange concept in contrast to Tom Gardner's original thoughts in his book, I couldn't help but notice how many of the company's metrics were in line with what Mr. Gardner likes to see.

An Overview

Reverse logistics provider, Liquidity Services (NASDAQ: LQDT), or LSI, has watched its stock price slide from $65 to $38, a decline of over 40%.  Despite this major drop since May 1, LSI is still up 25% on the year, outperforming the S&P 500.  What's left behind following this summer long sell-off, is a growing company with a near monopoly over its valuable market.

By angling itself away from the consumer market, LSI avoids direct competition with eBay (NASDAQ: EBAY), Amazon.com (NASDAQ: AMZN), and even Overstock.com (NASDAQ: OSTK).  While all three businesses are driven by online sales, LSI is the only wholesaler of the group, as eBay's attempt to enter the market was a failure back in 2005.

As for the wholesale scene, LSI has more direct competition in Ritchie Bros. Auctioneers (NYSE: RBA), who operates in a very similar manner to LSI.  However, Ritchie Bros. is focused more directly on machinery and heavy equipment and does not have quite as large of an online presence as LSI.  With this virtual monopoly in its online wholesale niche, LSI is able to hold a large competitive advantage over its peers.

The Criteria

60-10-10: Three numbers from the Rule Makers concept immediately jumped out at me when I initiated my research on Liquidity Services.  These included Gross Margin, Net Profit Margin, and Yearly Sales Growth, which, per Rule Maker standards, we would like to see come in above 60%, 10%, and 10% respectively.  With LSI reporting a Gross Margin of 60.9% and a Net Profit Margin of 10.8%, I couldn't help but think of the Rule Maker's criteria as they were so close to the exact numbers.

Furthermore, LSI was able to demonstrate Sales Growth in excess of 10% over the last year, three years, five years, and ten years with 14%, 18%, 13.5%, and 25% growth respectively.  With these numbers easily outpacing the ideal 10% rate, I decided to take a look at how they stacked up against their nearest competition:

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>Gross Margin</strong></td> <td><strong>Profit Margin</strong></td> <td><strong>1 Yr Rev. Growth</strong></td> <td><strong>3 Yr Rev. Growth</strong></td> <td><strong>5 Yr Rev. Growth</strong></td> <td><strong>10 Yr Rev Growth</strong></td> </tr> <tr> <td><strong>Liquidity Services</strong></td> <td>60.9%</td> <td>10.8%</td> <td>14.2%</td> <td>17.9%</td> <td>13.5%</td> <td>25.7%</td> </tr> <tr> <td><strong>eBay</strong></td> <td>76.2%</td> <td>28.5%</td> <td>27.3%</td> <td>14.8%</td> <td>10.8%</td> <td>27.2%</td> </tr> <tr> <td><strong>Amazon.com</strong></td> <td>27%</td> <td>0.1%</td> <td>40.6%</td> <td>32.2%</td> <td>31.7%</td> <td>30.7%</td> </tr> <tr> <td><strong>Overstock.com</strong></td> <td>18.6%</td> <td>-0.8%</td> <td>-3.3%</td> <td>7.9%</td> <td>7.8%</td> <td>27.8%</td> </tr> <tr> <td><strong>Ritchie Bros.</strong></td> <td>88.4%</td> <td>19.4%</td> <td>10.8%</td> <td>5.5%</td> <td>7.3%</td> <td>11.7</td> </tr> </tbody> </table>

With these margins and growth rates in hand, we can see that LSI is in very good company.  However, being the only true online wholesale auctioneer, they have strong market share in their specific niche, leaving Ebay, Amazon.com, Ovestock.com, and others to fight it out for the online consumer market.  

All in all, outside of eBay's high profit margin, as it pushes its highly touted PayPal, and Amazon's ongoing determination to sell every product in the world at a razor thin margin, Liquidity Services posts some of the most consistent numbers of its peers.  

Cash/Debt, Cash Margin, and the Foolish Flow Ratio

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>Cash/Debt</strong></td> <td><strong>Cash Margin</strong></td> <td><strong>Foolish Flow Ratio</strong></td> </tr> <tr> <td><strong>Liquidity Services</strong></td> <td>2.04</td> <td>10.6%</td> <td>.86</td> </tr> <tr> <td><strong>eBay</strong></td> <td>2.02</td> <td>16.2%</td> <td>1.17</td> </tr> <tr> <td><strong>Amazon.com</strong></td> <td>No Debt</td> <td>1.8%</td> <td>.62</td> </tr> <tr> <td><strong>Overstock.com</strong></td> <td>4.26</td> <td>1.5%</td> <td>.5</td> </tr> <tr> <td><strong>Ritchie Bros. </strong></td> <td>.92</td> <td>14.7%</td> <td>.74</td> </tr> </tbody> </table>

For a Rule Maker, the general rule of thumb for a Cash to Debt ratio is 1.5, or 50% more cash on hand than debt.  With everybody in the group coming in well above the mark, outside of Ritchie Bros., this is not a major problem for any of the peers.  Amazon holds the enviable position of being completely debt free, but none of the five are in dire straits by any means.

As for the Cash Margins, LSI's marks look solid once more as it comes in third, close behind Ritchie Bros.  Yet again eBay is able to dominate this metric, as it does with so many others, while Overstock.com and Amazon.com lag behind with their low margin strategies.

Finally, with the Foolish Flow Ratio, Overstock.com and Amazon.com come in with the healthiest numbers and all five companies are clear of the 1.25 Fool Flow level they need to be below.

Management, a Sticky Business, and a Clear Competitive Advantage

Liquidity Services management has recently done everything it has needed to and then some.  With its 12-month extension in place from the DoD for its scrap sales, LSI has proven once again that has a sticky business.  With few relevant competitors and high barriers to entry on its side, LSI has locked up business from 139 of the Fortune 1000 companies, 4,700 state and local government agencies, and the vast majority of retailers, including: Wal-Mart, Target, Costco, Lowe's, Home Depot, and many others.

Furthermore, this doesn't even begin to account for its business from Online Retailers, Original Equipment Manufacturers, or Major Warehouses.  Needless to say, there is plenty of business to keep LSI busy and with only 14% of the Fortune 1000 companies working with LSI, there is still a large growth runway ahead.  Having such a clear competitive advantage in its space, Liquidity Services could continue to act as a near monopoly far into the future and generate sales with new companies as it goes.

A Few Foolish Final Thoughts

Much of Liquidity Services' business does not match up with what makes a true Rule Maker.  However, I do believe that LSI has many areas that are representative of what leads to the creation of a great Rule Maker.  From its sticky sales, to its competitive advantage in dominating its own niche market, to having all of the numbers required to be a Rule Maker, I see Liquidity Services ready to capitalize on its tremendous market position.

Trading at a Forward PE of 17 and a 5 Year PEG of only .7, I am placing a 5+ year call on CAPS for LSI and I will consider it for a future portfolio spot upon further investigation and reports.


joryko owns shares of eBay. The Motley Fool owns shares of Amazon.com and Liquidity Services. Motley Fool newsletter services recommend Amazon.com, eBay, Liquidity Services, Overstock.com, and Ritchie Bros. Auctioneers (USA). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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