Thursday, September 3, 2009

Adventures in Retail

Last week I spent a lot of time shopping around the retail sector. As I mentioned before, the short-list contained 10 disparate retail companies.

Ann Taylor (ANN), Cabela's (CAB), and Children's Place (PLCE) quickly fell off the list.

ANN has a decent balance sheet, but it doesn't exactly give you anything. Cash flow is more stable than earnings, but the company is still more volatile than I'd like. As with all investing, this was an exercise in comparisons and ANN couldn't keep up. I also think this company is at the wrong end of the market. Expensive fare and somewhat focused on professional clothing.

Cabela's is in the same boat. Nice balance sheet, but not great. More stable profitability, but after a nice run, it's not cheap cheap. Investors may get a run to $20, but I'll leave that to someone else. I love the insider ownership (nearly 50%) and the fact that Wally Weitz is a shareholder, but there are clearer winners on my list.

Another casualty was PLCE. the company has a fair amount of net cash and is solidly profitable. Parents will starve themselves before they deprive Jr. of the new, hot thing in children's clothes. Turmoil in the boardroom can be good or bad, and Children's Place has plenty of it. A proxy fight threat from the former CEO was just dropped, I believe, but I don't need this drama. Besides, having owned Gymboree (GYMB) in the past, I know that the competition is very capable. As a consumer and an investor, I prefer Gymboree at a price. So my confidence in owning PLCE would always be on shaky ground.

Like Ann Taylor and Cabela's, Children's Place doesn't pay a dividend either. Not a horrible sin, but it points to a company's priorities. In retail, I prefer slow growth, stability, and solid cash flow. A sustained dividend points to these things.

This brings be to Abercrombie (ANF) and American Eagle (AEO). Both companies have dividend yields in the 2-3% range. But that is not where the similarities end. Market caps are about the same ($2.5 to $3 billion). So is cash (around $450 million) and debt (around $100 million), etc all eerily alike. My gut told me to go no further. Why try to choose? On my mall tour, I decided to take a look. AEO was first. The store was bright (very bright), with a cheerful staff and a catchy video by Kate Nash playing on a flat screen in the back. The "Pumpkin Song" video can be seen HERE. Yes, it's now a guilty pleasure (if you must know), but be warned the alien cats are disturbing. More importantly, the song and video perfectly convey the atmosphere at AEO. The store was busy, with patrons bouncing (and buying) to the Nash beat.

ANF was next. Wow, talk about a difference! Dark and a largely indifferent staff. They are trying to be more exclusive and it's working. Only a handful of shoppers were there... and they were ALL at the Clearance rack. When I asked an associate how ANF compared to AEO. Her answer: "Hmm... Pretty much the same stuff!" Corporate would be so proud! Today's announcement that August sales were down 29% is no surprise to this analyst.

If I had to invest in one, the clear choice is AEO, but I'm taking a pass. Discovering Kate was enough.

Buckle (BKE) was more interesting on paper than either AEO or ANF. Around $200 million in cash and no debt vs. a $1.25 billion market value. A 3+% dividend doesn't hurt either. Adjusted for the cash, Buckle has a single digit P/E multiple too. But it's the margins that scare me. Buckle is very profitable, capturing around 14 cents for every dollar of sales. That's triple those of AEO and ANF. Buckle's merchandise is full of hoodies, jeans, and skater gear covered in Hurly logos, fleur-de-lis, crosses and other highly stylized prints. Perhaps I'm biased, but this is a trend that won't last. Either way, margins have only one way to go... down!

Next stop: Hot Topic (HOTT). On the way in, I passed a guy with a blue mohawk knowing I was among friends. Actually, once Mr. Mohawk left, the store was empty except for the staff. They stared at me in disbelief. Yes, I was out of place, proof that Hot Topic knows its target market. How many black T-shirts does the non-conformist really need? Who knows, but demand must be down. Promotional sales are running high with "Buy One, Get One" deals and the like. Still Hot Topic's balance sheet is gorgeous. $80 million plus in cash and no debt relative to a $300 million market value. This got me interested. I think HOTT is probably undervalued, but the risks are real. If any group is susceptible to the current economic problems, HOTT customers are. With no dividend to compensate me while I wait and see, Hot Topic will go on without me. The cultural experience was enough.

Please don't post comments about how my survey isn't scientific. I know. One town, one mall, one day. The whole point was to help reinforce or disprove what I saw in the numbers. My visits in no way determined my investments. The visits just gave color to what I saw in the financials.

To reinforce this, I bought shares in Foot Locker (FL) and Barnes & Noble (BKS) before I ever stepped foot in their respective stores. My store visits reinforced my enthusiasm for BKS and left me satisfied with FL. BKS was busy for the time of day. The store is new and gorgeous. Barnes & Noble gives people 10 or more reasons to come to the store. From books and magazines to coffee and music, the breadth and depth of this retailer is impressive. Capex is supposed to drop in half this year to $125 million, which will help support free cash flow. The balance sheet isn't loaded with cash, but the company is debt free. And the dividend yield is approaching 5%. Amazon is a worry, but BKS is priced for death. Some people still like to browse the bookstore. The registers were busy, because BKS is providing a unique retail experience. With Borders nearly broke, Barnes & Noble will survive.

Foot Locker? What can I say? FL sports a 6% dividend and $300 million in net cash. It, too, will survive. It hasn't changed in a thousand years. Same wooden benches and staff dressed like referees. The formula works.

Last, but not least, is Cato (CTR). The local store is not in the mall. As such, it had to wait for a different day. What I found is worth a post all its own, so come back soon!

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