Buckle: An Undervalued Survivor (NYSE:BKE)
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Buckle (NYSE:BKE) has suffered with all retailers as coronavirus concerns shut physical stores across the country. The situation could hardly have come at a worse time for the company in light of the company’s sustained incremental improvement in comparable store sales, average months revenues, and more recently, gross and operating margins.
However, despite the headwinds, Buckle is in a strong position to withstand the short-term financial impact of coronavirus-related store closures and the lingering economic effects once stores reopen. Indeed, our financial models suggest Buckle may well remain profitable (if just barely) during the current year, while the company’s net cash position could actually improve by year end assuming dividends are not reinstated until 2021.
Our forward valuation based on current projections is a rather wide range of $18.00 to $27.00 in 2022 with the potential for regular and special dividends of $1.75 per share, resulting in a robust projected compound annual return of between 17% and 40% over the next two years. However, even if core earnings ultimately fell by half from pre-crisis levels in the longer term, the downside risk appears limited based on a continuation of the modest earnings multiple assigned to the core business plus our expected year ahead net cash per share.
Retail is a challenging sector – especially fashion related retail – even under the best conditions. The virtually unprecedented impact of coronavirus only adds to the uncertainty around forward projections. Nonetheless, pockets of opportunity existing, especially among retailers with the liquidity – and lack of debt – necessary to survive the current environment. Buckle is clearly one of these companies and should prove worthwhile from a long-term investment standpoint.
Buckle was building on a recovery in revenues after a long period of negative comparable store sales results when coronavirus burst onto the retail scene. The company’s monthly progress was somewhat uneven but the trailing trends we’ve been tracking for some time now continue to show a clear upward trajectory and, importantly, one that had been accelerating into the second quarter.
Source: Winter Harbor Capital
In addition, average monthly revenue had grown nearly every month over the last year through February results. The improvement, which was the company’s first sustained upward trend in average monthly revenues in more than half a decade, is reflected in the following chart:
Obviously, it remains to be seen whether Buckle can recapture this momentum after what will almost certainly be the company’s most challenging first and second quarters on record likely far exceeding even the darkest days of revenue declines in 2016/2017. The market is clearly pessimistic as reflected by the company’s discounted valuation and significant short interest position although, to be quite blunt, the market is presently rather pessimistic about many things, and these conditions have persisted for years despite the company’s ability to defy particularly dire expectations.
We expect Buckle will be able to recapture that prior momentum although doing so will take time, possibly up to two years before the trends reassert themselves in the company’s results. In the meantime, though, Buckle has at least a couple significant advantages working in its favor, especially relative to at least some of its peers. The first is a far superior gross and operating margin position while the second is a trend in seasonality which may limit the impact of current store closures.
Buckle’s gross and operating margins improved from the prior year in each of the last two quarters of 2019. The trend in selling, general, and administrative expenses as a percentage of revenues improved in the last three quarters, marking the longest period this has been the case in at least 2015.
Our model had projected a continuing if modest improvement in gross margins for 2020 before the impact of coronavirus, reflected in the following chart:
Source: Winter Harbor Capital
The four quarters of 2020, it should be noted, are based on our gross margin projections.
We’ve since revised the expectations, given store closures as a result of the coronavirus, which we discuss in a moment. Still, Buckle remains remarkable for its consistently high gross, operating, and net margins relative to peers, as reflected in the following table:
Source: Winter Harbor Capital
The company’s gross margins have remained relatively consistent over the last several years while operating margins have been compressed somewhat due largely to selling, general, and administrative expenses rising as a proportion of revenues. The company has done a decent job, especially in light of the severe revenue declines experienced between 2015 and 2017, of controlling operating expenses but hasn’t been able to offset the full cost on the SG&A line. The result is that although the net income margin was 11.6% last year, an improvement from 10.8% the year before, the net income margin remains below the 14.2% to 14.6% range prior to the steep decline in revenues as fashion shifted away from high end denim. In the interim, net margins have also benefited from the reduction in corporate income tax rates which also ameliorated some of the impact on net income margin.
Still, Buckle remains in an enviable position relative to peers from a margin standpoint.
Buckle should also benefit from its relative seasonality in comparison to most retail peers. Buckle and Zumiez (NASDAQ:ZUMZ) generate proportionately less of their revenue and net income during the second quarter when compared to peers, the second quarter likely being most impacted by physical store closures.
Source: Winter Harbor Advisors
The distribution of net income is even more pronounced as both Buckle and Zumiez generate the majority of their annual net income in the third and fourth quarters. The companies experience a significant increase in gross and operating margins into the critical holiday shopping season, amplifying the effect of generating a higher proportion of revenue later in the year. In comparison, peers such as Tilly’s (TLYS) and Urban Outfitters (NASDAQ:URBN) generate substantially less of their annual net income during the fourth quarter in particular, limiting these firms’ ability to recoup losses incurred during the second quarter.
Source: Winter Harbor Capital
In the above chart, it should be noted that the fourth quarter results for American Eagle Outfitters (NYSE:AEO) have been adjusted to exclude impairment charges incurred by the company during the period similar to the adjustment in the earlier margins table.
The seasonality factor may be of particular importance this year since it’s unlikely revenue (and profitability) lost in a given season can be effectively recovered later in the year. Summer will bring little pent up demand for spring clothing once stores reopen (hopefully) around June, limiting the sale-through potential of existing inventory, and the ability of some retailers to recoup lost margins. Buckle’s margins lost in the second quarter will be comparatively less important than margins gained in the fourth quarter, when only lingering effects should impact revenues, potentially allowing the company to remain profitable for the full year despite current events.
Buckle also has the liquidity necessary to absorb short-term market dislocation due to the company’s conservative financial structure. The company had $233.5 million in cash and cash equivalents at the end of the last fiscal year with no dividend payables or long term debt – roughly equivalent to $4.68 per share or 32% of the company’s recent market quotation around $14.50.
Granted, the full balance of cash and cash equivalents is not accessible under the best of circumstances since some is committed to the ongoing financing needs of the business so a calculation based solely on a valuation net of cash and cash equivalents isn’t entirely meaningful. However, that large cash and cash equivalents balance provides ample flexibility for the company to absorb the impact of store closures with a wide margin for error.
Impact of Store Closures
Buckle was our initial focus when we began developing a model to assess the potential financial impact of store closures. The model – which we continue to refine – incorporates a number of factors to project the cash flow and earnings impact on a given retailer and establish a basis for assessing the company’s ability to sustain operations in light of the company’s cash position and available liquidity relative to cash requirements and debt maturities.
The variables which go into our analysis are myriad, include the following:
- the degree to which physical retail sales transfer to online channels;
- the degree to which revenues are impacted by general economic conditions;
- the gross and operating margins applicable to cost of goods separate from selling expenses and store operating costs;
- the gross and operating margins of online sales as differentiated from physical store sales;
- the degree to which the company continues to compensate employees despite store closures;
- the degree of which the company receives rent concession from landlords;
- the impact on income taxes associated with losses.
In addition, in calculating the cash flows for the business, it’s necessary to estimate various cash flows items, such as capital expenditures and depreciation, existing commitments for inventory which may noncancelable, nondeferrable, or already in transit, payment of dividends, etc. In most cases, though, we either have specific announcements from companies that dividends have been suspended, at least for a short term. In cases without specific announcements, we have generally assumed a suspension of stock buyback activity with dividends generally suspended for a period of time if not necessarily the entire projection period.
The estimation of so many variables – many of which are highly uncertain – inherently results in a high degree of uncertainty in the results. The uncertainty manifests itself in a rather wide range of projected potential outcomes. In some cases, we know specific information, for example, that approximately 11% of the company’s revenues are generated through its online channel, even if we’re uncertain the degree to which physical store sales will transition to the online channel during store closures or the magnitude of any cross-pollination effect retail stores have on online channel sales. The specific values for various other factors are often not specifically disclosed in company financial statements (for example, the gross and operating margins applicable to online revenues versus store revenues) in which case we have attempted to estimate these values based on available financial information in combination with referencing general industry percentages and ratios to perform a common sense check on the results and assess their reasonableness. We’ve also projected results based on a range of assumptions for each variable to establish sensitivity and ranges of values which we consider reasonable approximations for outcomes. In cases where results are especially sensitive to certain assumptions, we have more closely assessed and tested those assumptions for reasonableness.
Finally, we’ve also made assumptions with respect to the duration of physical store closures without regard to specific company announcements on projected reopening dates. In many cases, the announced tentative reopening dates appear optimistic and destined to slide further into the future based on the trajectory of infections, discussions with and projections by medical professionals, and the increasing implementation of stay-at-home orders, etc. The baseline we have used in our projections is for stores to remain closed for approximately three months (i.e., roughly though the middle of June), although our more extreme stress testing extends this time period through the middle of July.
Finally, since the objective of the model is to assess a retailer’s ability to weather physical store closures, our assumptions are somewhat weighted towards a more pessimistic view on outcomes. In cases where the company has made specific statements with respect to compensation of employees, etc., we incorporate those statements into our projections. In cases where no such statement has been made, we assume, for example, that a company will continue to compensate employees, at least to some degree and for some period of time, in addition to paying rent and other fixed expenses associated with its physical stores without any concessions from landlords. In terms of cash flows, we have not assumed a complete cessation of capital expenditures. The biases allow for a more sober estimate of survivability since the results, while by no means a worst case scenario, don’t incorporate overly optimistic assumptions.
Buckle has announced that it will furlough the majority of its employees, reduce compensation for remaining employees and executives, and effectively suspend dividends by deferring any decisions until the next board meeting, all of which we take into account. The company is discounting spring inventory online in an attempt to move merchandise, although our analysis suggests the company’s discounting is not as aggressive as some peers. Buckle has also not made any announcements regarding rent payments on closed store locations though there should be a marginal benefit from reduced contingent rent tied to store revenues. In comparison, certain competitors have announced more aggressive approaches to rent payments in the face of some landlords stating that rent remains due in full. Zumiez, for example, has publicly announced its intention to suspend making rent payments as it negotiates with landlords.
Our model, incorporating all of these factors, suggests the company will not only easily sustain the short-term impact to cash from store closures but may well remain profitable in the current year despite store closures and a potential recession. The projected earnings per share range from a loss of ($0.20) to earnings of $0.55 with a median estimate of $0.22.
In addition, we currently expect the company to generate positive free cash flow for the year of between $5 million and $46 million. The peak cash requirement at the bottom of the cash flow cycle is projected between $23 million and $43 million, a fraction of the company’s cash and cash equivalents of $233.5 million. In the event the company does not pay dividends this year, it’s possible the company’s net cash per share could increase over the course of the year to more than $5.00 per share.
In comparison with our initial normalized gross margin trend chart, the following chart reflects our gross margin projections incorporated into the model, including the impact of physical store closures in the first and second quarters along with our expectations for a nearly (though not fully) complete recovery in gross margins during 2021:
Source: Winter Harbor Capital
In 2021, we currently project earnings per share of between $1.80 and $2.10, assuming lingering economic effects continue to impact same store sales (denting gross and operating margins), while the company retains some of the cost savings implemented due to previous store closures. In this context, we also project cumulative dividends for 2021 of approximately $1.75, comprising a resumption of the company’s regular quarterly dividend of $0.30 per share ($1.20 per annum) and a special dividend of $0.55.
Buckle has historically tended to trade in a rather narrow valuation range between 10 and 15 times earnings per share depending on market expectations for future performance. The shares occasionally trade beyond this range during periods of unusual pessimism or optimism about operating results but frequently revert to this range in rather short order. The fair values projected by our models are in line with this earnings multiple range such that we have defined our forward fair valuation between $18.00 and $27.00 per share depending on how strongly the company rebounds from the current situation. In addition, we project dividends per share of approximately $1.75 for 2021, suggesting a total return potential between 36% and 98% (roughly 17% to 40% per annum on a compound average annual return basis) over the next two years. The high end of the range would suggest a strong rebound in revenues, so our bias is towards the lower end of the valuation range.
The downside potential, given the company’s cash and cash equivalents and the ability to generate $1.75 and $2.00 per share in free cash flow per year, appears very limited at the current quotation. Indeed, were the company to earn only $1.00 per share on an ongoing basis in the future, half of our projections and well below the company’s experience even in previously challenging times, a valuation of six times earnings in combination with cash and cash equivalents would place the shares at $10.50, about 25% below the current quotation.
Buckle’s current valuation reflects the pessimism in the markets concerning the financial impact of store closures and the lingering effects of an economic recession. However, the company has sufficient cash on hand to weather the potential losses while remaining in a position to build on its previous positive trajectory over the longer term.
Indeed, we expect Buckle to emerge from the current situation largely intact with a strong cash and cash equivalents position and a durable business. The ongoing cash generation of the business will support a return to the company’s historic pattern of a decent regular dividend supplemented by annual special dividends which support long-term total returns.
We’d previously indicated we would consider returning the company to our investment portfolios if the company were to each the lows experienced in the middle of 2017. The company having returned to that discounted valuation, we have again added Buckle to our portfolios.
Disclosure: I am/we are long BKE, TLYS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.