I had planned on posting this a few days ago, but don’t think that the drop in Buckle’s stock affected this decision- if anything, I wish it was posted beforehand because it makes me look like I’m validating my research by Buckle’s 12% drop today.
For those few of you who follow my blog, you’ll know I previously wrote an article about Buckle in August talking about the company. The business is solid, it was undervalued, and I liked what I was seeing. Since, it has run up 75% or so. This is not a bragging moment- I sold out before it ended up above $40 and think it’s somewhat crazy how high the stock has gone in such a short time. It was frustrating for me because my sale was pretty close to when they announced a special dividend & it shot up 30% or so in about a month. I had predicted a special dividend in September, as they had done the previous two years, but they waited a little longer this year. It was their main way of returning excess cash to shareholders and I figured it was coming again in the same month… maybe they were on vacation, who knows…
Compare that now to Aeropostale. I found a similar valuation with them in October when I wrote an article discussing my decision to invest. In a subsequent 7-month time frame, the stock has come down about 15% and I’m scratching my head. So here I’m thinking: am I wrong, or is everyone else just crazy? That’s what I’m here to analyze.
Buckle hasn’t opened any new stores since my article, and has actually closed three. Apparently my original vision of 800-1200 stores may not have been accurate (currently 420), but then again, they do expect 12 new stores in 2011. This is far lower than their avg. growth of 20 stores/year, but I’m not too worried for them. They have one of the best store location selections of any retailer and you can read about it in their ann’l report, or just visit a nearby mall & see what I’m talking about. With 43.5% director ownership, you know every action they make is still in the best interest of the shareholder. So, my views of the business have changed little since the original article. Adjusted for working capital changes, their earning power was:
- 2010: $180 MM
- 2009: $157 MM
- 2008: $133 MM
This growth trend will continue, although stated previously, perhaps at a slightly lower rate. So, in buying Buckle today, what are you getting?
- 420 stores
- $100 MM reserve cash
- $180 MM earning power growing at perhaps 3-6% per year (if store growth continues at current pace)
At a current valuation of $2 B, you’re effectively getting a 9% owner earning’s yield with some growth in front of you. Not bad, but also not near a price I’d be interested. My original purchase was much closer to $1.1 B and that was a much better time to invest.
Now, let’s compare that to Aeropostale. Unlike Buckle, who returns excess cash in the form of dividends, Aeropostale buys back as much stock as possible. Here are the latest figures for shares outstanding:
- 80,723,152- May 2011 Proxy
- 81,776,929- March 2011 10-k
- 87,968,635- December 2010 10-q
- 92,445,136- September 2010 10-q
- 93,523,697- June 2010 10-q
- 94,207,445- March 2010 10-q
I think I’ve made my point. You’ll notice between December & March, Aeropostale bought back 7% of shares outstanding. This was done without additional cash on the balance sheet & all from operating earnings- what other companies do you know that do this without explicitly stating an aggressive repurchase program or borrowing money to recap? I’d like to hear about them if you can find one.
So, although the stock has fallen from $24/share to $21/share, a 12.5% drop, the market cap has fallen from $2.25 B down to $1.7 B, a 24.5% drop.
So, what has happened to the business to deserve such a valuation decline? Some good, some bad, but nothing close to what Wall Street seems to believe in terms of how bad things really are. Here are some goodies since my last article:
- 15 new U.S. Aero stores (now up to 906)
- 7 new Aero stores in Canada (now up to 59)
- 8 new P.S. From Aeropostale stores (now up to 47)
- 5 new license stores in the U.A.E. (now up to 10)
- New licensing agreement for 25 new licensee stores the next 5 years in Singapore, Malaysia, and Indonesia
I said there was some bad; the items above are the good stuff. Now, brace yourself, here comes the bad news:
- Same store sales have declined last few quarters or stayed flat (figures below)
- Margins are taking a hit from a highly promotional teen environment
- Sales/square foot likely coming down this year (figures below)
- Management hired Barclays to block a takeover offer
As you can see above, the last few quarters have hardly been something to get excited over. However, did anyone stop to check sales/square foot the past decade to see what happens if same store sales decline 7% for the year?
As you can see, during the recent recessionary period, Aeropostale added on a considerable amount of efficiency to their stores. The business has increased in productivity every year since 2003, the year of the IPO, and their sales/square foot are the highest in the industry. What I believe happened during the recession was Aeropostale added some customers that I would consider “non-core”, whose parents were struggling with tough times & went to the more discount stores to buy clothing for their children. Lately, these “non-core” customers have been defecting back to the stores they used to shop at, namely Abercrombie & Fitch, American Eagle, Buckle, etc… and as a result, Aero’s figures have come down. While I expect their sales/square foot to drop back to perhaps the $600 or as low as the $550 level in normal times, this is still above all their competitors and is hardly reason for concern. And yet, Wall Street has worried with recent news events from Aeropostale the business is dying or that they’re running into serious margin problems.
However, their margins peaked in fiscal 2010 at 17.2% operating and 10.3% net. Fiscal 2011 was a slight drop to 16.1% operating and 9.6% net. Even if they came down to the worst year in the last decade, at 13.1% operating and 7% net (which I view as highly unlikely), the business would still earn $325 MM operating and $175 MM net on sales of $2.5 B (a reasonable estimate).
The only really frustrating negative is management not accepting the previous takeover offer and hiring Barclays to advise them on how not to be bought out. I guess they want to receive more options on Aero’s stock and ride the gravy train… at less than 5% inside ownership, I feel as though a lawsuit should be filed. In any event, the business will eventually print enough money to overcome these frustrating management antics.
So, to summarize the bad, the margins aren’t a major issue because they’re pretty high and the store efficiency argument about declining same store sales doesn’t have any economic reality. They’re well-positioned with their business and I have little concerns about either. Oh, and did I mention? Throughout this entire period of declining same store sales, they’re still posting increased sales because of the additional stores that they’ve built. They’re outgrowing the declines in efficiency for now, and because I don’t expect them to continue declining indefinitely, I think the business is perfectly fine.
Here’s earning power adjusted for working capital changes the past 3 years (fiscal years):
- 2011: $317 MM
- 2010: $284 MM
- 2009: $207 MM
Now, on to what you’re getting today at Aeropostale:
- 965 Aeropostale stores (906 U.S., 59 Canada)
- 47 P.S. From Aeropostale Stores
- 10 current U.A.E. licensed stores
- 25 future licensee stores in Singapore, Malaysia, and Indonesia
- $265 MM cash balance
- $300 MM conservative earning power
- Growing perhaps 5-10% moving forward
- Aggressive share repurchases (tax efficient)
So, at a valuation of $1.7 B, you’re getting an owner earning’s yield of 17.5%. If I were to be more aggressive on earning power, I could argue closer to perhaps $325 MM, giving us closer to a 19% yield. There’s also some flow-through from working capital changes for the next year or two to be expected that should increase that further up to 20% or so.
So, would you rather have 965 stores from Aeropostale at $1.7 B or 420 stores from Buckle at $2 B? For me, the answer is simple. I think Wall Street is wrong and I no longer own Buckle. Aeropostale is now my largest position.