BBW - Build-A-Bear Workshop Stock: Quietly Transforming Into A Powerhouse

2023-08-21 13:31:43 ET

Summary

• Build-A-Bear Workshop has been a defensive stock during a turbulent summer market.
• The author noticed high demand at a new Build-A-Bear during a family vacation, suggesting potential investment opportunity through the lens of Peter Lynch's advice to invest in what you know.
• Build-A-Bear's valuation looks attractive.
• The company is also returning capital to shareholders.

It may be hard to believe that a store that sells teddy bears and a wide variety of other stuffed animals would be a particularly defensive stock, but believe it or not, Build-A-Bear Workshop ( BBW ) has been a veritable port in the storm during a turbulent summer market. After a strong start to the summer, the S&P 500 and NASDAQ have lost some momentum, and are now down 3.5% and 6.5% respectively, over the past month. Meanwhile, Build-A-Bear just keeps chugging along, to the tune of a cool 11.7% gain over the same time frame. An environment where consumers are concerned about inflation, rising interest rates, and an uncertain economy certainly seems like an odd backdrop for a company like this to thrive in, but Build-A-Bear is firing on all cylinders. In 2022, the company posted the highest profit in its 25-year history, and in the first quarter of 2023, it reported record first-quarter EPS.

How did Build-A-Bear become a powerhouse that has defied a choppy market, and why does it still look like a compelling buy, even as shares continue to climb? Let’s take a look below.

What is Build-A-Bear Workshop?

Build-A-Bear Workshop was founded in 1997 and “operates as a multi-channel retailer of plush animals and related products in the United States, Canada, the United Kingdom, Ireland, and internationally.” Based in St. Louis, Missouri, this is a small company with a market cap of just $350 million. You may be familiar with it if you have kids (or if you went to one when you were a kid), or you may have seen one of its locations at the mall (although there is more to the company than just the mall, which we’ll discuss shortly).

Channeling Peter Lynch

There is of course a lot more to investing than this, but Build-A-Bear resurfaced on my investing radar when I took my family on vacation to a Kalahari Resort earlier this summer. I couldn’t believe the demand at the Build-A-Bear location on-site at Kalahari, which was not there when we had visited the previous summer, and turned out to be newly opened.

There is of course more to making an investment decision than just saying, “Hey this place is crowded.” That being said, Peter Lynch, who soundly beat the market for 13 years as the portfolio manager of Fidelity’s Magellan fund, averaging a stellar annualized return of nearly 30% in the process, championed the idea that investors should 'invest in what they know' and utilize 'local knowledge'. Lynch discussed the fact that he made a very profitable investment in Dunkin’ Donuts, which surfaced on his investing radar based on the fact that he enjoyed their coffee and because he noticed that their locations near him were always crowded, so there is something to be said for this simple approach.

Beyond the Mall

Back to my previous point about the mall -- I suspect that many investors have looked past the Missouri-based company in recent years because they associate it with mall-based retail, which is seen as an industry in secular decline.

However, there’s much more to Build-A-Bear than mall locations. The company has pivoted towards more dynamic locations, like the one that I visited at Kalahari and other ‘destinations’ such as Great Wolf Lodge or other hotels and resorts. The location I visited turned out to be one of four new locations opened in partnership with Kalahari (in Ohio, Pennsylvania, Wisconsin and Texas). This seems like a prudent move by Build-A-Bear as people going to these resorts with their families are already in a good mood and splurging on the vacation, so they’re more likely to spend a few extra bucks on a stuffed animal for their kids than they would be during a normal day of running errands at the mall when they probably just want to get in and out.

I certainly wasn’t planning on visiting it or shopping there, but the store was friendly, vibrant and inviting, my kids were excited about it, and I ended up buying them both new stuffed animals. It was a great experience as they enjoyed picking out the animal, putting in a “heart” so they could hear its heartbeat, and using Build-A-Bear’s machine to fill it with stuffing, not to mention interacting with the friendly and engaging staff.

In 2022, , Build-A-Bear reported that about 35% of its locations are now off-mall, so the company is continuing to make progress on reducing its exposure to mall-based retail.

In addition to pivoting towards these types of destinations, Build-A-Bear has also reduced its dependence on mall-based locations by selling online to become a true omnichannel retailer. The company reports that digital demand has grown over 135% since pre-pandemic levels.

Build-A-Bear also has significant opportunity to ink licensing deals that capitalize on trends in popular culture and draw in older consumers -- for example, in May, Build-A-Bear took advantage of the renewed popularity of Dungeons and Dragons to release its first Dungeons and Dragons collaboration . The company says that 40% of its sales now come from teens and adults, so its customer base isn't limited to parents buying stuffed companions for their kids.

By upgrading its physical footprint to more locations like Kalahari Resorts and driving more sales online, Build-A-Bear is shedding its reputation as a mall-based retailer, although the market doesn't seem to be giving it much credit for this yet, which brings me to my next point.

Valuation

Despite Build-A-Bear's record profits in 2022 and record first-quarter earnings (not to mention the company's nine consecutive quarters of year-over-year revenue growth) it still trades for just 7.2 times earnings , and an even cheaper 6.7 times forward earnings. You likely don’t need me to tell you that this is a substantial discount to the broader market (the S&P 500 trades for approximately 20 times earnings).

While some discount to the broader market is perhaps warranted as Build-A-Bear is still a "show me" story for many investors, this wide of a discount seems way too cheap for a company that is growing revenue and earnings on a consistent basis.

In addition to this cheap valuation, Build-A-Bear is also doing a great job of returning capital to shareholders via both share repurchases and special dividends. In April, the company rewarded shareholders with a special dividend of $1.50 per share.

Build-A-Bear has also been buying back shares; the company has a $50 million share repurchase program with $36.4 million still available, which is not a trivial sum for a company with a $350 million market cap like Build-A-Bear.

Looking Ahead

Build-A-Bear has quietly turned around its business in recent years, and now is in the early stages of operating as a multichannel, experience-driven retail powerhouse, as opposed to the one-dimensional mall-based retailer some investors still think it is.

In addition to this dynamic turnaround, Build-A-Bear shares are attractively valued at just 7.2 times earnings and 6.7 times forward earnings, and the company is rewarding its investors with shareholder returns in the form of buybacks and special dividends, making Build-A-Bear stock a strong buy in my view. I purchased the stock this year and it has become one of my top holdings.

Build-A-Bear will report second-quarter earnings this week on August 24th. While we don't yet know what the company will report, I expect earnings to be strong as the company has enjoyed considerable momentum, reporting record first-quarter earnings results in May and reiterated its strong fiscal 2023 guidance. The market's reactions to earnings reports can be unpredictable, and if the stock does sell off after earnings, my plan is to add to my position, unless something material changes about the company. This still looks like an undervalued, long-term growth story in the early stages of a compelling business transformation and I look forward to being a long-term shareholder.

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