Sometimes great companies can be found in the most unexpected places, and this one would certainly be my most optimistic prospect for the value idea contest. I first took a look at Buckle back in 2009 but, at the time, I thought that the clothing world was coming to some sort of apocalyptic end and decided to pass. They came back to mind lately as I was clicking through the Magic Formula screen and decided to give them another go. There was an article submission on them here at GuruFocus about a year ago, and it was interesting to read through the commentary as the audience poked about trying to figure this company out. It was in reading this that I decided that I should write an article, as I think I can shed some light on this situation.
There is a durable competitive advantage with this company, and it's something that's deeply ingrained in their corporate structure and culture. We will get into what this is, and how to identify it, after a short overview on the company.
Are you ready to be a fashion tycoon?
The Buckle is a (mostly) mall-based clothing retailer. Their main focus is on jeans, but they also sell a lot of tops, and then small amounts of other fashionable accompaniments. When you buy into this company you get a main office with a fulfillment center (owned), 431 retail stores in 43 states (leased), inventory on the shelves, a bunch of employees buzzing around, and what comes to a net cash balance of about $110m million*. In other words, this is a very simple company with a strong balance sheet.
Over the past 10 years their store count has done this:
They also have plans to continue opening more locations. A quick Google search pulls up that we have about 1,000 malls across America. Certainly, not all of the malls are going to meet their target consumer demographic profile, but they also open some locations in strip centers and lifestyle centers, then there is always Canada - so we can ballpark a location potential of about 1,000 into the foreseeable future.
Meanwhile, average sales per store, in thousands of $;
This is steadily increasing, surprisingly, through both good times and bad, at a CAGR of 5.66%. Their average sales per square foot metric is also steadily increasing, in a similar manner, with 2011 reporting $462 sales/sq ft.
It is with these numbers that we can project out into the future and come up with a very enticing estimation for investment returns. However, unless someone in the comments section wants to go crystal ball bowling into the future, let's leave such speculation out of this report for now. Instead, Price Earnings Growth Ratio, or PEGR, works great for situations like these.
Average growth for the last 10 years is 20%, 19% for the last 5 years, and then 20% again if we subtract the high and low growth years and then reaverage the rest. This is a company that is growing at a pretty steady 20%. We can also see that they even grew earnings through 2008/2009/2010 while everything was turning ito pumpkins and mice. They must have missed the memo that we were in a severe recession. There is an endless list of things that can get in the way of future growth, but we can atleast surmise that they still have plenty of room left to expand. Let's give them a conservative 15% future long term growth rate, the numbers we need after that would be their current PE of 11.63, and their dividend yield of 2.10.
PEGR = PE (Estimated Growth + div yld) = 11.63 / (15% + 2.10%) = .68 =<1 = A value purchase
Awesome. What we have here is a company with an excellent growth history, good future growth prospects, selling at a very reasonable price. As investors, with this information we need to then consider everything that can go wrong with this proposition; competitive landscape, fasion trends, economic factors, the whole shebag. This requires countless hours of indepth research and an expert level undersanding of the entire retail industry... or maybe not.
If you don't know jewelry, know the jeweler
When buying ownership into a company, we are essentially hiring the workers on as our own, and here is where their competitive advantage comes in. A good place to start with this would be to get into your car and visit some of their stores - they have some of the most eager-beaver fashionistas that I have ever encountered in a clothing retailer. They will literally walk around the store with you, help you coordinate your purchase, give you their advice on the fit, and even make additional recommendations. The next place to look would be to open up their proxy and give it a read-a-roo, sometimes these documents can get quite wordy but theirs is particularly short and sweet. Their executive compensation is based on some very simple factors:
Competitive base salary, increasing by a bit each year
Long term stock awards, not too excessive
Incentive cash bonus, based on three metrics that are grouped together into a bonus pool, and then awards portioned out among the executive staff:
- 8% of the increase in Same Store Sales
- 5% of of the increase in Gross Margin
- 15% of the increase in Pre-Bonus Net Income
- The base year amounts under the plan are immediately preceding fiscal year for Same Store Sales and the prior three-year rolling average for Gross Margin and Pre-Bonus Net Income.
Bingo. They picked the right metrics and their compensation policy effectively ties management together into looking for ways to continually improve them, and they have even managed to accomplish this despite severe economic difficulties. The Buckle is like a See's Candies or Shaw Carpets of jeans and shirts. We can see from this setup that the company is designed to have a fierce executive team at the top, we can see with our own eyes that they have fierce fashionistas working at the bottom, and we can then safely imagine that all of the levels in between must also be streamlined accordingly. This is why, when you compare them to the competition, they (by far!) run the leanest, meanest, and most profitable operation in the industry. It also helps that they have considerable insider ownership at 42% of shares outstanding. Their 14% profit margin represents profits powered by elbow grease, an environmentally-friendly renewable resource, and it sets the bar for what the rest of the industry would otherwise be capable of accomplishing, but they do not.
The chart above is ordered by the Operating Margin column on the right. We can see that the next competitor is about half of their margin at 11.5%, and this also the same with Net Profit Margin. Is this a temporary anomaly? In light of what we now know, it appears not. And with them being compensated accordingly to both grow earnings and cut costs, their expanding profit margin % now begins to make sense. Is a 14.2% profit margin the peak potential for a clothing retailer?
Year Net Profit Margin
With a look at PE ratios, can also see there is an anomoly here where this company is well-underbet compared to others in the industry.
Normally, with them being so undervalued compared to the others, I would have to consider that there is something going on here that I am unaware of. Maybe this is the case, however, despite having years upon years of good results, their growth has been consistently doubted for quite some time.
Low PE + high growth looks more like the working of a neurotic Mr. Market. Their current PE ratio of 11.64 essentially represents an assumption of having no long-term future growth, and the markets have already been consitently wrong about this. So what do we know anyway? We are just a bunch of frumpy investors, too scared to go into the business of retailing fine fashions. Ten years ago the investing world was assuming a low-growth scenario, but Buckle's target consumer group at that time has grown up, long flown the coop, and been replaced with an entirely different population of customers - and the company is still keeps on growing. Bottom line here is they sell (mostly) jeans and shirts. Perhaps the cut and the style varies from year to year but the products in themselves are timeless, it's not like these are pet rocks or Troll dolls. Considering how well they have performed in the past, and that their compensation policies are designed for them to continue performing well in the future, it looks more likely than not that they will be able to continue overcoming any future obstacles that get thrown in their way. Recent releases are showing that their SSS, although they are not yet decreasing, are not increasing as robustly as they have in the past, but this is happening to a lot of companies lately, so its not necessarily a red alarm as far as these guys are concerned.
Therefore, at today's price of $38, this company is a buy and hold until:
A. They start to hit an unjustifiable PE of greater than 15 or 20, that would be $50 or $60 at today's earnings.
B. They reach 1,000 store locations, this is a long time from now.
C. Something else comes up to materially change their situation or disprove this thesis, for example, an investor-unfriendly change in their compensation policies, but not something like a change in the overall economy.
*(Their net cash balance = cash + short term investments + long term investments - total liabilities.)
This is not an investment recommendation but an analytical investigation into a company. Do not be silly enough to take anyone's perspective as infallible, certainly not mine, but make sure to do your own independent research and verification. I own shares in Buckle.