(Published by Nick McCullum on July 11)
Reading the media headlines suggests that the brick-and-mortar retail business model is dying as consumers shift their business to e-Commerce companies like Amazon (AMZN, Financial).
While this market pessimism is weighing on the stock prices of retailers in the short term, it is highly likely that traditional retail shopping will never truly die, which means the current retail downturn could be a buying opportunity.
“The time to get interested is when no one else is. You can’t buy what is popular and do well.” – Warren Buffett
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There is perhaps no company that embodies a victim of Amazon more than Barnes & Noble (BKS, Financial).
After all, Amazon originally started as an online bookstore, and Barnes & Noble sued Amazon for falsely advertising as "the world’s largest bookstore" in the ’90s. The companies settled for an undisclosed amount.
The effect of Amazon on Barnes & Noble’s business has caused its stock price to drop materially, even though Barnes & Noble is a well-known blue-chip stock. The Blue Chip Stocks Excel Sheet contains pertinent investment information on a wide variety of blue-chip stocks (including Barnes & Noble).
More specifically, Barnes & Noble’s stock has lost more than 50% of its value over the past three years.
Barnes & Noble’s stock price suggests that its business is failing. If this is not the case (in other words, if this is a market overreaction), then Barnes & Noble is likely providing a compelling buying opportunity today.
This is especially true for dividend investors. After all, a declining stock price results in a higher dividend yield, all else being equal.
Barnes & Noble’s recent stock price movement has pushed its dividend yield north of 8%. The High Dividend Stocks Excel Sheet contains pertinent investment information on 405 securities (including Barnes & Noble common shares) with 5%-plus dividend yields.
Business overview
Barnes & Noble is the nation’s largest bookstore company. As of April 29 the company operated 633 bookstores in all 50 states.
Barnes & Noble serves 30 million customers, 6 million Barnes & Noble "members" (the company’s loyalty program), and delivers a complete multichannel offering through barnesandnoble.com and its NOOK e-reader platform.
Source: Barnes & Noble Investor Day Presentation, slide 7
Barnes & Noble benefits from being the undisputed leader in the U.S. consumer book market, which is surprisingly large.
It is estimated that the U.S. digital consumer book market generates $3 billion in sales and the U.S. physical consumer book market generates $16 billion in sales, for a total addressable market of $19 billion.
For context, Barnes & Noble has a market capitalization of $532 million.
Source: Barnes & Noble Investor Day Presentation, slide 6
It should be noted that Barnes & Noble has significant insider ownership.
The company’s founder and executive chairman, Leonard Riggio, owned 18.0% of the company’s outstanding common stock as of April 29. At current market prices, this ownership amounts to nearly $96 million.
Current events
Barnes & Noble’s fourth-quarter earnings release was not pretty.
The company reported fourth-quarter and full-year sales declines of 6.3% and 6.5%. This continues a worrying trend as Barnes & Noble has reported declining revenue for five straight years.
Source: Value Line
For many retail companies, declining overall sales are the new normal but are partially offset by rapid growth in online sales.
This does not hold true for Barnes & Noble.
The company’s online sales increased by 2.9% in the quarter and 3.7% for the full year, which certainly does not compensate for 6%-plus declines in overall company sales.
In addition, Barnes & Noble’s NOOK e-reader platform incurred an operating loss of $36.4 million in the most recent quarter.
Considering that NOOK and online sales are expected to be two of the business’ primary growth drivers, this earnings release was poorly perceived by the financial markets.
Growth prospects
Barnes & Noble’s growth is expected to come from three sources:
- NOOK, its e-reader platform.
- Online sales.
- Its Barnes & Noble Member program.
Like most retailers nowadays, Barnes & Noble delivers a truly diverse multichannel shopping experience.
The company has developed NOOK, its e-reader platform, and has a diverse range of titles available on barnesandnoble.com.
Source: Barnes & Noble Investor Day Presentation, slide 15
Neither of these initiatives are proving capable of restoring Barnes & Noble to companywide growth. Barnes & Noble’s online sales are only growing at low-single-digit rates, and its NOOK device is currently operating at a net loss.
This leaves the company’s membership program as its only real growth catalyst.
To be a Barnes & Noble member, you must pay a $25 annual fee. In exchange, you receive 40% off hardcover bestsellers, 10% off "almost everything else" and free express online shipping.
Source: Barnes & Noble Investor Day Presentation, slide 18
Barnes & Noble’s members are some of the company’s best customers.
These consumers spend roughly twice as much per visit as the average Barnes & Noble customer and have a reasonably high retention rate – over 70%.
Source: Barnes & Noble Investor Day Presentation, slide 19
While Barnes & Noble’s membership program is promising, it does not compensate for the lack of performance in the company’s online channel or its NOOK operating loss.
All said, Barnes & Noble appears to have weaker growth prospects than many of the companies covered on Sure Dividend.
Competitive advantage and recession performance
Barnes & Noble’s competitive advantage comes from being the largest and most well-known provider of books in the U.S. Simply put, consumers are likely to seek out a Barnes & Noble when book shopping because of its exceptionally high brand awareness.
The company also benefits from its customer demographic.
Barnes & Noble’s customers are young, educated and earn a high income, which suggests they are more apt to continue shopping through recessions.
Source: Barnes & Noble Investor Day Presentation, slide 12
With that said, the company is not very recession resistant. Barnes & Noble’s earnings were crushed in the period following the Great Recession of 2007-2009. The company’s adjusted earnings per share during that period can be seen below.
- 2007 adjusted earnings per share: $1.85.
- 2008 adjusted earnings per share: $1.56.
- 2009 adjusted earnings per share: 39 cents.
- 2010 adjusted earnings per share: -$1.19.
- 2011 adjusted earnings per share: -$1.41.
- 2012 adjusted earnings per share: -$3.02.
Barnes & Noble’s earnings declined for five straight years following the Great Recession.
Barnes & Noble’s business model (sales of non-necessary books) and poor historical recession performance suggest that there are far superior alternatives for investors looking to build a defensive investment portfolio.
Valuation and expected total returns
Because of its recent stock price decline, one would think that Barnes & Noble is currently trading at an appealing multiple of earnings.
This is not the case.
Since Barnes & Noble’s earnings have declined faster than its stock price, the company’s price-earnings (P/E) ratio has actually expanded.
The company recently reported 2017 full-year adjusted earnings per share of 30 cents. Barnes & Noble’s stock price of $7.20 results in a P/E ratio of 24.
A P/E ratio of 24 is much too high for a company that is experiencing negative revenue and earnings growth. Thus, the company’s valuation suggests investors should avoid this stock.
But what about its exceptionally high dividend yield?
Barnes & Noble pays a quarterly dividend of 15 cents per share which yields 8.3% on the company’s stock price of $7.20.
The company’s dividend yield is appealing, but it is a yield trap. Barnes & Noble is paying 60 cents of dividends on 30 cents of earnings for a payout ratio of 200%.
Unless business conditions improve dramatically, a dividend cut is imminent, which would trigger an automatic sell using The 8 Rules of Dividend Investing.
Thus, investors should look elsewhere for high-quality exposure to the retail shopping sector.
Final thoughts
Barnes & Noble’s stock price has declined meaningfully in recent times, which naturally catches the eye of the opportunistic value investor.
“The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.” – Warren Buffett
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Further due diligence reveals that Barnes & Noble is not really an attractive value based on its current earnings. Further, the company is paying an unsustainable dividend.
This leads us to recommend avoiding this stock for the time being.
Disclosure: I am not long any of the stocks mentioned in this article.
