A Diamond in the Rough?
Trading Below Net Current Asset Value

Lazare Kaplan International
Ticker: LKI
Price: $7.85
Share Out: 8.34 million
Market Cap: $65.4 million
Average Daily Volume: 9600
P/E: 13
NCAV: $81.2 million
NCAV/Market Cap: 1.24

Lets face it, the search for companies trading below their net current asset value is the ultimate treasure hunt. Like finding a diamond in the rough, that is assuming its really a diamond and not just an under baked piece of coal. This week’s company may be more of a diamond company in the rough.

New York based Lazare Kaplan is in the diamond business…many facets of it (no pun intended) including cutting, polishing and selling ideally proportioned diamonds worldwide under the Lazare Diamonds brand name.

What initially caught your Cheap Stocks editor’s attention is that this company not only trades below its NCAV, but is also profitable. You may recall the rarity of this from previous Cheap Stocks Research. Furthermore, the companies inventory also caught my attention, but more on that later.

The Fundamentals
Fiscal Year 2005 sales rose 79 percent to $421.4 million from 2004s $235.8. Net income rose 118 percent in the same period, from $2.4 million to $5.2 million. The diamond business is somewhat cyclical based on the company’s prior years numbers (net losses in 1999 and 2002, slumping sales in 2001 and 2002). For the 3 month period ended 8/31/05, sales rose 77 percent to $138.9 million, while net income decreased 64 percent to $.9 million.

The Balance Sheet
Cash stood at $6.7 million as of 8/31/05, while long term debt was $61 million. The company also listed short term debt (curr portion of long term debt) of $43.2 million. Adding in the debt and subtracting the cash from market cap gives Lazare an Enterprise Value of $163 million. Sure would be more attractive without that debt.

On the plus side, and the other thing that caught my eye was the company’s inventory. As you may recall, inventory is a crucial part of the NCAV calculation, because it’s a sizable component of a company’s current assets. Unlike cash, the true value of inventory is not fixed, the value depends on the quality of the inventory, and ability to convert it into cash. For instance a company whose inventory is composed of last years hottest fashions would have trouble converting that inventory into cash at anything near its carrying value. But a company with an inventory composed of dollar bills (as ridiculous as that seems) would have no trouble realizing that inventories listed value.

Lazare Kaplan’s inventory is composed of the following:
Rough Stones: $26.62 million
Polished Stones: $104.2 million

That’s a lot of diamonds, but impressive because those diamonds are carried at the lower of cost or market value. I don’t purport to know the actual markup of diamonds, but do know that it is substantial. I also assume that Lazare could convert its entire inventory into a substantially larger amount than carrying value.

The NCAV calculation:
Current Assets:
Cash: $6.7 million
Accounts Rec: $118.8
Inventories: $130.8
Prepaid/other: $10.7
Def taxes: $1.8
Total: $268.8

Current Liabilities
Accts Payable: $83.4
Curr portion LT Debt: $43.2
Total: $126.7

Long Term Debt: $61

NCAV: $81.2 million

Institutional Ownership
Total Institutional ownership is about 18.5 percent. The top 5 holders”
Dimensional Fund Advisors: 6 %
Royce and Associates: 3%
Fifth Third Asset Management: 2.4%
AXA Rosenberg: 2.2%
Oberweis Asset Management: 1.6%

Conclusion
We are not sure why this company is so cheap. The net profit margins are not outstanding, but for a company trading below its NCAV to be turning a profit at all, is rare. We suspect that the diamond business is susceptible to the whims of the consumer, and if spending were to drop off, Lazare gets hurt. Although we have not yet initiated a position in Lazare, it’s on our watch list.

*The author does not have a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.