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The Buckle: The Predictable Stock to Own for the Long-Term

June 09, 2011 | About:
Buckle (BKE) is the retailer of casual apparel, footwear, and accessories for fashion-conscious young men and women. As of January 29, 2011, the company operated 420 retail stores in 41 states nationwide under the names "Buckle" and "The Buckle." It focuses on personalized attention to its customers and provides customer services such as free hemming, free gift-wrapping, easy layaways, the Buckle private label credit card, and a frequent shopper program. Most stores are located in regional, high-traffic shopping malls and lifestyle centers.

Merchandising

Buckle’s strategy is to create customer loyalty by offering a wide selection of key brand name and private label merchandise and providing a broad range of value-added services. Its target customer is from 15-30 years old. Denims and tops are key items for the company’s growth. As of fiscal 2010, denims takes 45% and tops takes 34% of total net sales.

Merchandising and pricing decisions are centralized, which makes the whole chain very consistent; nevertheless, the distribution system allows for variation in the mix of merchandise distributed to each store. This allows individual store inventories to be tailored to reflect differences in customer buying patterns at various locations. And it does not hold store-wide off-price sales at anytime.

Marketing and Advertising

Besides seasonal campaign, online marketing, in point of sales, Buckle offers the frequent shopper program to enhance the loyalty of the customers. The Buckle Black program, launched in October 2007, is an exclusive credit card account for most loyal cardholders. This marketing program is partially funded by WFNNB, a third-party bank that owns the Buckle Card accounts.

Stores operation

Buckle has the program of stressing the prevention and control of shrinkage losses. Methods to avoid shrinkage consists of monitoring cash refunds, voids, inappropriate discounts, employee sales, and returns-to-vendor. It has achieved a merchandise shrinkage rate of 0.4% of net sales in fiscal 2010 and 0.5% of net sales in fiscal 2009 and fiscal 2008.

The average store is approximately 5,000 square feet (average of 80% is selling space), and stores range in size from 2,900 square feet to 8,475 square feet.

For the last 10 years, Buckle has experienced significant growth. The total stores increased from 274 at the beginning of 2001 to 420 at the end of fiscal 2010.

Purchasing

Buckle does not have long-term or exclusive contracts with any brand name manufacturers, private label manufacturers, or any suppliers. Before product delivery, it often plans its private label production with private label vendors three to six months in advance.

In fiscal 2010, Koos Manufacturing Inc. accounted for 26.4% of the company’s net sales and Miss Me/Rock Revival accounted for 12.9%. No other vendor accounted for more than 10% of the company’s net sales.

Distribution

It uses a centralized receiving and distribution center located in Kearney, Neb. Buckle’s goal is to ship the majority of its merchandise out to the stores within one to two business days of receipt. This system allows stores to receive new merchandise almost daily, so the customers can get excited to shop often.

Snapshot of the operations financial figures

Fiscal year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Revenue 388 401 423 471 501 530 620 792 898 950
Operating Income 47 46 48 63 76 79 110 162 199 211
Net Income 33 32 34 43 52 56 75 104 127 135
Operating Cash Flow 43 43 53 73 76 80 121 144 158 180
Cap Spending (11) (26) (15) (17) (26) (22) (27) (47) (51) (55)
Free Cash Flow 32 17 38 56 50 58 94 97 107 125
Earnings Per Share 0.68 0.65 0.69 0.86 1.13 1.24 1.63 2.24 2.73 2.86
Dividends Per Share 0.09 0.2 0.27 0.37 0.6 0.82 0.8 0.8
Source: Morningstar

All figures are USD millions, except Earnings Per Shares and Dividends Per Shares

As can be seen from the snapshot, it has achieved growth of 9.4% annually, while operating income, net income, operating cash flows and free cash flows have grow at the same pace of 15-16% over the last 10 years. For dividends, the payout ratio has been fluctuating with the high rate, ranging 20-37% and stays at 28% for the last year, with the growth rate from 2004 till now the high growth of 36.3% annually

Retail operating figures

Fiscal year 2007 2008 2009 2010 2011
Stores open at end of period 350 368 387 401 420
Average sales per square foot (USD) 302 335 401 428 428
Average sales per store (USD 000’s) 1493 1668 1995 2129 2133
Comparable store sales change (%) 1.2% 7.8% 20.6% 13.2% 0.0%
Source: Buckle’s annual report

Buckle keeps adding stores, with increasing sales per square foot and average sales per store over the last five years, signalling the continuing trend of the company’s growth.

For the most current year, as in the management discussion, the comparable store sales increase in fiscal 2011 was primarily due to a 1.9% increase in the average retail price and a 2.9% increase in the average number of units sold per transaction, partially offset by a 3.3% decrease in the number of transactions at comparable stores during the year. Sales growth for the fiscal year was also because of the 20 new stores opened during fiscal 2009, to the opening of 21 new stores during fiscal 2010, and to growth in online sales.

Profitability

We will look at the profitability based on DuPont Model

Fiscal year 2007 2008 2009 2010 2011
Operating Margin 14.9 17.7 20.5 22.2 22.2
Net Margin 10.51 12.14 13.18 14.17 14.18
Asset Turnover 1.43 1.51 1.73 1.88 1.93
Return on Assets 15.01 18.38 22.8 26.68 27.38
Financial Leverage 1.28 1.33 1.38 1.38 1.43
Return on Equity 19.01 24.08 30.91 36.82 38.48
Source: Morningstar

All figures are in %, except Asset Turnover and Financial Leverage

For the last five years, Buckle has been achieving very impressive return, due to increasing net margins as well as asset turnover with little of financial leverage. So it has been seen that Buckle’s growing fast combining with impressive dividend records, high return on equity as well as growing margins. However, any value investor would post the questions of whether this trend will continue in the future, or any bad events can wipe out the company’s competitive advantage permanently. Let’s check the financial strength of Buckle by examining its balance sheet.

Financial Strength

In the most current balance sheet, the amount of cash is 28% of the total assets, standing at $136 million, fixtures and equipments takes 35%. There is little debt on the balance sheet; the total liabilities account for 30% of the total assets. However, for majority of retails sales, we need to look at the purchase commitments as well as operating leases which are kept off-balance sheets. The total off balance sheet obligations are $55 million within a year, $94 million for 1-3 years, $76 million for 4-5 years and $124 million five years after. With the amount of cash on the balance sheet, as well as the OCF, FCF is growing, the company’s financial position is quite strong currently.

Management

Any great company is built from loyal, competent employees with a lot of experience in the industry. Here in The Buckle, the majority of the management has been with the company for the long time, since they were still in university, working as part-time employees and now advanced to management positions. The management's total holdings comprised approximately of 1.9% of the total shares.

Dennis Nelson, President, Chief Executive Officer and Director

He has held the titles of president and director since April 19, 1991. Mr. Nelson was elected chief executive officer on March 17, 1997. Mr. Nelson began his career with the company in 1970 as a part-time salesman when he was just a student. Upon graduation from college in 1973, Mr. Nelson became a full-time employee of the company, and he has worked in all phases of the company's operations since that date.

Karen B. Rhoads. Vice President of Finance and Chief Financial Officer and a Director

Ms. Rhoads was elected a director on April 19, 1991. She worked in the corporate office while a student and later worked part time on the sales floor. She has been employed with Buckle since November 1987.

Thomas B. Heacock, Treasurer and Corporate Controller

Mr. Heacock has been employed by The Buckle since October 2003 and has served as corporate controller since February 2007. He is the son-in-law of Dennis H. Nelson, who serves as president and chief executive officer and a director of The Buckle Inc.

Kari Smith, Vice President of Sales

Ms. Smith joined the Company on May 16, 1978, as a part-time salesperson. Since 2001, she has held this position.

Patricia Whisler, Vice President of Women's Merchandising

Ms. Whisler joined the company in February 1976 as a part-time salesperson and later became manager of a Buckle store before returning to the corporate office in 1983 to work as part of the growing merchandising team. She held this position from 2001.

Robert Carlberg, Vice President of Men's Merchandising

Mr. Carlberg started with the company as a salesperson and also worked as a store manager and as an area and district. He has been full-time with the merchandising team since January 2001.

Brett Milkie, Vice President of Leasing

Mr. Milkie joined the company in January 1992 as director of leasing. Prior to that, he was a leasing agent for a national retail mall developer for six years.

Kyle Hanson, Corporate Secretary and General Counsel

Ms. Hanson joined the company in 1998 as general counsel. She also worked for the company as a part-time salesperson while a student. She has held this position since 2001.

Notably, Daniel Hirschfeld, Chairman of the Board is the biggest shareholder of Buckle. He has served as president and CEO until 1991, and then the chairman of the board since April 19, 1991. He is the biggest shareholder in the company with a position of nearly 35%.

Competitors

The main competitors of The Buckle are Abercrombie & Fitch (ANF), American Eagle Outfitters (AEO) and GAP (GPS). The comparison valuation table is as follows:

TTM figures BKE ANF AEO GPS Industry average
Operating margin (%) 22.14 9.31 10.41 12.91 8.13
Net margin (%) 14.18 5.18 5.4 7.76 N/A
ROE (%) 38.48 10.1 11 26.16 N/A
P/E 13.7 32.49 16.15 9.65 15.61
P/S 1.9 1.6 0.84 0.7 0.71
P/CF 10.3 15.2 6.8 6.4 7.9


As it can be seen, BKE TTM figures are very impressive, growing over the years with the operating margin and the net margins the highest, twice the next competitor. That is why the valuation in terms of P/CF and P/S is higher than the competitors. However, with the average growth of 15% of FCF and dividends of 36% annually, it is certainly cheap for the potential of the company. It is the company not for trading but for buy and keep for 5-10 years unless something comes along to change its fundamentals.

Valuation

We would use the Discounted FCF model with the assumption as follows:

The growth is continued like the average past 10 years for the next 5 years, and we will see growth at 3% to infinity afterwards; the required rate of return is 8%.

Base case:

Growth for first 5 years 15%
Growth after that to infinity 3%
Discount rate 8%
Fiscal year 2012 2013 2014 2015 2016 Terminal value
FCF (USD mil) 144 165 190 219 251 5,179
PV of FCF 133 142 151 161 171 3,525
Valuation 4,282


Low case

Growth for first 5 years 10%
Growth after that to infinity 2%
Discount rate 8%
Fiscal year 2012 2013 2014 2015 2016 Terminal value
FCF (USD mil) 138 151 166 183 201 3,422
PV of FCF 127 130 132 135 137 2,329
Valuation 2,990


The valuation of the total business is around $3 to $4.2 billion, and the valuation can be changed when the new inputs in the FCF that affect the growth and the potential of the company can change. We would adjust that in the future. For the current market value of $1.9 billion, that’s 57% off the intrinsic estimated value.

Potential risks

The assumptions for valuation can be very subjective, as the change in the growth and discount rate affects the valuation a lot.

The chairman is the biggest shareholder, holding 35% of the total company; his sole decision cannot be aligned with the minority shareholders.

The distribution function for all of the company’s stores is handled from a single place in Nebraska. Any event such as a natural disaster, or other unforeseen causes would damage the distribution of merchandise to the stores, causing a decline in store inventory, a reduction in store sales, and a reduction in company profitability.

Summary

For the retail industry, Buckle is definitely the pick for the buy-and-hold. With the strong balance sheet, the net cash is 28% of the total asset, along with ample debt and off-balance sheet commitments. Free cash flows grew 15-16% annually over the past 10 years, the operating and net margin has been increasing and becoming the best in the industry. ROE is 22% average of the past 10 years, and TTM ROE stays at 38%. Besides, the company has been paying the growing dividends over the last seven years.The management team has been with the company for at least 10 years, some 20-25 years. It seems that they are loyal, experienced and very dedicated to the development of the company.

Disclosure: The author currently does not own any shares in The Buckle at the time of writing. And this research is subjective to the author’s view. It’s not the recommendation of buying or selling. Please do your own research for your own decision.

About the author:

Anh HOANG
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh HOANG's Website


Rating: 3.6/5 (28 votes)

Comments

Adib Motiwala
Adib Motiwala - 2 years ago
Ken,

Good work and analysis. Can you do us an exercise.

For the discount rate, use 11% and report what the low and base case look like.\

Also, then change the growth rate for the next 5 years such that intrinsic value equals current valuation. This will help us understand the 'expectations' of FCF growth that are priced in the stock at current prices.
batbeer2
Batbeer2 premium member - 2 years ago
Hi Ken,

Thanks for the article; an interesting company.

It looks like net margin over the last decade has expanded from 8% to 16%. Most of that comes from an increase in gross margin from 35% to 45%..... sure looks like the stuff is in fashion.

Given that margin expansion has been an important factor in driving FCF growth......

Will they be able to expand their margins even more going forward, if so, how ?

Adib Motiwala
Adib Motiwala - 2 years ago
While they might hit the low end of the price target indicated ($60), I would prefer to buy much lower than current prices.
ken_hoang
Ken_hoang - 2 years ago
@ Adib: Thanks a lot for your comments. I have tried some figures as you indicated. For the discount rate of 11%, the base case would give the valuation of $2.6billion, and the low case would give the current valuation. (10% growth annual for 5 years, then 2% growth infinity)

Why do you use the discount rate of 11% Adib? any formula based on current interest rate level that gives you to use that discount rate?

And that's true, I would also like it to come down so that we can acquire the stocks much cheaper. It certainly not the bargain which can scream at us. But the recent trend is so satisfactory that the high probability that it can keep going in the future.

For my private partnership, a lot of my mistakes has been selling too soon. For example, PETD, I sold at $22 in March 2010 and it keeps going to $49, now it stays at $33.

@Batbeer2: Thanks, any companies that cut costs overtime always make me excited. And it tells us something about the management too. First it's not sudden cut, but the cost gradually being lower over the years. Second the cash keeps increasing.. and overtime as well. Will they be able to expand its margin? I think there is high probability that they can.

Before, Sam Walton of Walmart start by opening a little shop, then gradually he just cut costs, and that gradually drove other supermarkets out of business. In 1980, WMT traded at $0.2/share, and at the end of 1999, it even reach $65.

@ both: Have you looked at AMT? (The American Tower Corporation), please let me know your thought on this. Thanks

batbeer2
Batbeer2 premium member - 2 years ago
Much of the margin expansion comes from better gross margin dropping to the bottom line. WMT's gradual margin expansion is a bit different in nature.

I'm not so sure they are running the business more efficiently; gross margin comes from pricing and product mix, not leaner operations. In the case of Buckle, I would expect they are changing the product mix over time to higher priced, more profitable, items. The problem with this is that I'm not sure. It may or may not depend on factors beyond the control of management..... fashion.

The point to this is that it's important to know the driver of the trend before extrapolating it.
batbeer2
Batbeer2 premium member - 2 years ago
Try asking user cm1750 about AMT. He's probably forgotten more about that company than I'll ever know about it.
AlbertaSunwapta
AlbertaSunwapta - 2 years ago
Over the years Jim Chuong has had a couple things to say about it too.

His letters from prior years are at the bottom of this link...

http:\\www.ticonline.com
Adib Motiwala
Adib Motiwala - 2 years ago
Ken,

thanks for doing that exercise. I use 11% as the discount rate as that is the minimum return i expect from any investment. So, I just use discount rate as more my bogey/ hurdle rate , rather than comparing what the interest rate is. I typically leave it the same for all companies. Now, I avoid getting in trouble by avoiding poor balance sheets.

The exercise shows that 10% FCF growth rate is priced in the stock assuming 11% discount rate. Means one can expect a 11% rate of return going forward if FCF grows at the 10% rate for the next 5 years followed by 2% growth forever. While, they may even exceed that FCF growth, its good to know this information.

I looked at AMT but I could not see it as being attractive at current prices. I know Chuck Akre has owned it for many years and done quite well.

batbeer2 has some excellent points. I would request you to add 2 more data points in the table of profitabiliy. Add Gross and EBITDA margins for the years. That will tell us how much gross margins have increased recently ( which is product mix profits) v/s cutting costs (EBITDA margins).

If you want to look at a company that has cut costs over the years, while keeping gross margins fixed, check Big Lots (BIG). You will come out impressed.

kfh227
Kfh227 premium member - 2 years ago


I have to read up on this one more. GOOD FIND!
ken_hoang
Ken_hoang - 2 years ago


@ Batbeer: Thanks. It would be very helpful if you can talk a little bit about what you know WMT has done in details "everyday lowprice strategy". The average price per unit sold does increase over time as the management discussed it. If it comes from more profitable items due to the change in product mix, that would be good. If I have the chance to talk further with the management, that should be clearer.

For AMT: Does cm1750 own AMT shares?

@Adib: Yes, for the assumptions of 10% for 5 years and 2% to infinity, I think that assumption would be low for the company at this current stage. Yes, I would add gross margin in as it is one important factor for retail business as well. For EBITDA, I normally do not use this as it does not represent cashflow, but that's true when you mention about cutting cost. Normally I often check the SG&A as the % of total revenue over time is whether the business has cut costs in its operation or not.

For AMT, it has single digit ROE for 10 years, high leverage (i think because it owns the tower for reception funded by debt, need to look deeper though), but it has created growing cash flow overtime, which is very impressive. When I ask Chuck how he calculates the return on reinvested excess cash, he gave the very general answer.

Yes, for BIG, it got fixed gross margin, but SG&A has been decreasing from 40% in 2002 to 32% now, how do you think 'bout BIG?

@AlbertaSunwapta: Thanks for your info. Will check out Chuong's letter in a min.

@Kfh227: Thanks. Hope that we can feel free to discuss opportunities.

batbeer2
Batbeer2 premium member - 2 years ago
Hi

I can't/won't speak for cm1750. You can try asking him directly by PM.

WMT... I have nothing to add to what's out there already. You may want to read Longleaf's discussion of Carrefour though.... http://www.longleafpartners.com/pdfs/vii_sam_08.27.10.pdf
cm1750
Cm1750 premium member - 2 years ago
Happened across the question regarding tower companies like AMT.

AMT, CCI and SBAC are good stocks to own as a basket. CCI is probably worth $45-47 today. CCI has been consolidating as it has done in the past and I would not be surprised to see it trend upward soon.

One good thing about towers is that they are not economically sensitive - towers are necessary and all the 3 big tower companies have long-term contracts. Like RSG, V etc., it is a "tollbridge" business where you have pretty certain recurring revenues.

I have owned CCI for a couple years, but AMT is also very good as it has less leverage than SBAC and CCI as well as more international exposure.

They are all good stocks. The key is to look at FCF rather than net income as towers cost alot and the depreciation hits GAAP EPS.

Towers can generally hold 5-6 tenants (VZ, T etc.). The most important determinant for valuation is looking out at future FCF. Each incremental tenant has a 90% FCF/revenue so it almost all flows to the bottom line as there really is no incremental costs once a tower is put up.

Furthermore, contracts have a 3-4% annual price escalators (or CPI) so inflation is not a hardship. In fact, given the heavy debt loads of CCI and SBAC, it may actually benefit for 5 years as the revenues grow at inflation but the debt coupons are fixed until expiration.

There is a technolgical risk as ALU is coming up with a smaller box which *may* be an alternative to using "terrestrial" towers. These small boxes I think will be tested with customers in November so we should know more about their feasibility then.

In summary, towers are a great play on smartphone usage with lots of visibility. Buying on dips at good valuations is the key.
ken_hoang
Ken_hoang - 2 years ago
@ Batbeer: Thanks for the introduction.

@Cm1750: Thanks for the snapshot on tower business. As I just scan through the financial statements of those three tower companies, AMT has the best financial structure, lowest leverage, and best operating figures (FCF, gross and net margins)

The new tech curve always the threat to the existing companies, it involves with probability and agree that we have to wait and see how new tech applied and its competitive advantages of it, and whether switching cost for mobile carrier are high?

Scanning AMT 10-K, the majority of long-term obligations are CMO Passthrough Certificates and different level of senior notes. Besides, around $3bil more total in operating lease which is off-balance sheet. However, the minimum receipt lease from tenants in 5 years time is quite consistent and it is like guarantee of at least $1.5billion per year as revenue and the cash inflows.

As Chuck Akre has described for the fact that AMT has been successfully reinvested its excess cash at high rate of return, do you know what items should be included to calculate the ratio of return on reinvestment of excess cash?

cm1750
Cm1750 premium member - 2 years ago
Generally, for capex, the companies will classify it each quarter - land purchases, construction or purch of new towers, sustaining capex and tower improvements.

The last one is mostly helping add new tenants to existing towers so you can model out what the revenue and gross profit would be without the added tenants then figure out the incremental profit.

Generally, the payback on investment is very roughly 100% which is why the EBITDA margins increase so much over time.

One other issue for AMT if that it filed to gain REIT tax treatment so next year they will start paying out at lease 90% of profit as dividends which will be taxed for you. I personally hate this as I hold fo r along time and prefer long-term capital gain tax later than annual dividend taxes.

cm1750
Cm1750 premium member - 2 years ago
Ken,

I looked at your BKE analysis. BKE has been on my watchlist - I missed it when it was in the $20s last year but it still shows up on the MagicFormula and Morningstar screens I do.

Generally, I use a Ke = 9.5% for blue chips like PEP, JNJ etc. and 11% for smaller stocks.

In doing my conservative valuation, I use 12% 5 year FCF growth and assume 2.5% perpetual growth after F2016. With my 11% discount rate, the equity value is $2.257Bn + $50MM excess cash or $49.07 current value at midpoint fiscal 2012 (now).

I think this is probably a more realistic way to value the company.

I think it's OK to buy a starter position at the current $40, but would wait until $34.35 to make a more meaningful purchase.

Let me know if you disagree with my assumptions. Thanks for your summary on the company.
ken_hoang
Ken_hoang - 2 years ago
Hi Cm1750, thanks a lot for the clarification on AMT business. This is quite the position for long-term capital growth. The growth in free cash flow they generated each year can quite cover the leverage they are taking in.

The use of annual growth rate and infinite growth rate as well as discount rate is always arbitrary, Ben Graham often use the discount rate as twice the Aaa corporate bonds rate, with minimum discount of 10%. For both the growth rate, I have some range (10-12 and 1-3%) for base case and worst case. I think it's not the screaming buy for value investors (especially not for cigar-butt one), but for really long term investors who just buy, hold and let the market accumulate the return, this price is quite reasonable.

Again for the return on reinvested excess cashflow, do you think what is the most proper calculation for that?

EBITDA doesn't take into account of the capex, so normally i don't look into EBITDA margin so much.

Besides, Buffett often mentioned the return on unleveraged net tangible assets. Do you have any ideas of how to come up with the figure of unleveraged net tangible asset?
cm1750
Cm1750 premium member - 2 years ago
Generally, look at incremental FCF for all new capex.

Most of new tenatn revenue falls to teh bottom line so I would probably look at FCFROI.

Generally, I don't care what incremental FCF is for additional capex as long as it is much better than cost of capital. For AMT, your gross profit return is generally 75%+ for new tenant capex.
Sander
Sander premium member - 2 years ago


Don't you think that it is dangerous to hold the margins constant in your valuation?

Buckle has sky high margins compared with its competitors, why does they have this, and do you think that it is reasonable to assume that they will have that in the future?

What is their durable competitive advantage that allows these margins to persist?

If the margins revert to the industry norm it could basically half the earnings and the price does not look as compelling.

It would be nice if your are willing to discuss your assumptions :O), as the buckle might be a really nice business if they can sustain their margins.

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