Investors Shouldn't Take the Omega Protein Bait

 | Mar 20, 2017 | 10:00 AM EDT
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It's been nearly a year since my last piece on Omega Protein (OME) , an interesting smaller name, if for no other reason than the company's business line. Omega is the leading provider of fish oil, fish meal, and organic fish solubles in the U.S. These products are primarily used for dietary supplements (Omega 3), as well as animal feed. The interesting part (to me, anyway) is the product source, an oily fish (menhaden, or more commonly known as bunker) that the company harvests. If you've ever gone crabbing, it's likely that you used bunker for bait.

Last we left it, Omega was in the crosshairs of an activist investor, Wynnfield Capital, which owned a 7.9% stake at the time and was unhappy with the way the company was being run (the list of grievances was rather long). In June, following a proxy fight, OME shareholders elected Wynnefield's two nominees to the board of directors.

The stock had been on a nice run; between last May and early March, shares were up more than 40%. Much of the gain, however, was given back on March 2, following the announcement of third-quarter earnings. While revenue of $84.6 million beat consensus estimates by $2 million, earnings per share ($0.30) missed by $0.06. In reaction, shares fell nearly 24%.

There's another potential cloud that was also revealed in the company's 10K, regarding violations of the Clean Water Act at two of the company's plants. This has only added some fuel to the fire.

I've owned OME in the past, and it is important to understand a couple of other things about the company. First, there are quotas on the amount of menhaden that the company is permitted to harvest. While this has not been an issue as of yet, it could be in the future. Second, the company's products are commodities, and changes in the going prices for those commodities can have a dramatic effect on revenue and profitability.

There are some positives here. The balance sheet has improved over the past year. The company ended the year with $37.4 million, or $1.70 per share in cash (up from a total of $700,000 last year), while debt has fallen from $24.1 million to $1.1 million.

While the company recently initiated a $0.05 quarterly dividend, which equates to a 1% yield, it has yet to follow through on the share buyback announced last year. It appears as though that share repurchase is on hold now, given a recently announced "strategic review". This review is focused on the company's human nutrition business, which it has hinted at selling. That business was a huge bone of contention with Wynnefield Capital, which believed that OME had misallocated capital towards what provides lower margins than the animal feed business.

All of this currently adds up to a pile of uncertainty, in my view. While shares are trading at just 11x 2018 consensus estimates, the current share price does not provide a big enough margin of safety to take bait.

For its part, Wynnefield has reduced its stake in OME since winning the proxy contest.

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