TLF - Tandy Leather Factory: A Hidden Gem That Cannot Be Ignored

Summary

• Tandy Leather Factory is a tiny company that has 104 stores selling leather crafting products.
• The profitability of the business has been improved. The sales performance is not performing as badly during recent macro headwinds.
• As more buybacks coming, the value of owning the stock can only be higher.

Tandy Leather Factory, Inc. ( TLF ) is a leathercrafting company based in Fort Worth, Texas. It sells leather products such as leather, tools, hardware, supplies, and kits. It also offers teaching materials and workshops in its stores. Founded in 1919, Tandy is a quality brand in its niche Leathercrafting space with a 100+ year heritage. In the last five years, the company has faced some challenges from the competition of eCommerce. The stock hasn't performed well for a long time. However, I felt the business has improved a lot and is definitely worth taking a serious look at.

The Unit economics become better

As of May 1, 2018, TLF had 115 company-owned stores located in 42 U.S. states and 7 Canadian provinces. This quarter , TLF reduced its store count to 104 with 93 stores in the United States and ten stores in Canada and one store in Spain. However, if you look at the total annual revenue, TLF even increased from $74.92M in 2018 to the current TTM of $81.39M which indicates a 20% comp at per store basis.

This is achieved without raising any long-term debt and share dilution. In fact, there is almost no long-term debt in the book. And the company has been buying back shares and the share count has been reduced from 9.25M to 8.24M. This quarter the board just approved a $5M buyback program expiring in 2024.

The business has made transformations in its operational structure

Since 2018 , the company has gone through a series of transformations after it realized the challenges of online retailers such as Amazon and Etsy. The management starts to work on the flexibility and nimbleness of its operations. They are very cautious about leverage and operational costs. Fast growth is not the goal anymore. Profitability and stability become the focus. They made some investments in talent and technology and developed a new operating model and infrastructure.

TLF is in the process of closing all stores with negative cash flow after their leases expire. The 2022 Q3 has closed three high rents and underperforming stores which affect sales but improve profitability. As a result, 2022 Q3 sales were down 1.2% while the gross margin improved by 300 basis points to above 60%. The retail channel remained flat year-over-year while e-commerce grew (counts 18% of sales). Commercial sales declined. This showed some resiliency given external headwinds at play, especially for commercial customers who are mostly small to medium businesses.

The growth perspectives

TLF operates in a niche space where it is difficult to estimate how large the TAM or target population is. However, I think the management’s long-term target of $100M revenue and $10-20M operational profit is definitely an achievable baseline. CEO Carr has also confirmed the long-term positive trend for crafting products in general. Of course, this is not an industry with explosive growth like cloud and AI. But a growth rate similar to GDP or inflation rate should be expected.

Another aspect is that the management had the plan to expand their store count to 150 in 2018 . Although TLF’s strategy is closing stores right now, there should be still space for them to open new stores.

The new store in the military base at Fort Bragg this quarter is a good sign. It is a very low-cost model with rent linked with sales (8%). It is highly likely this kind of investment will increase earnings. The CEO has also revealed that other military bases have shown interest to include new stores.

Risks

TLF should have no bankruptcy risks given the strong balance sheet. However, the stock hasn't been trending downward since 2014. It is possible that the market continues to punish TLF if it fails to show sustainable improvement on profitability or sales. Ecommerce and online marketplaces such as Amazon and Etsy will continue to compete market shares with TLF. TLF's business may deteriorate if another large brand emerges. Running physical stores require large amount of fixed costs, therefore, TLF might easily get hurt by inflation and labor costs. Its SG&A costs are at an all-time high, they must go down in order to improve earnings. Finally, the leather crafting business is tough, you don't have lots of consumers but you still need to offer plenty of product selections for them. To keep customers happy, TLF has to continue innovating on its product quality and assortment.

Valuation

TLF is currently making a $1M operating profit and $1.5M EBITA for the quarter. Assuming a $6M EBITA, the stock is very cheap at $44.7M enterprise value with only 7.45x EV/EBITA multiple (the industry median is 9.5). While the gross margin reached the highest level in the last 4 years, current operating margin of 5% is still low compared to historical rates (2012-2017) of 10%+. I think the company will continue to improve profitability in future quarters while it is also in the process of hiring a new CFO. Therefore, the stock will be more undervalued in the future at the current stock price.

Bottom Line

The company management owns 47.7% of the stock. The chairman of the board of directors Jefferson Gramm has the most ownership of the company with 33.3% of the stock. CEO Carr owns 3.6% of shares and she could receive 92k RSUs if the company’s operating income exceeds $12M for two years in a row or $14M for one year. So it is clear that the management has all the incentives to reward shareholders because they own most of the shares. And 10-20 operational income is clearly the expectation. I think TLF will continue to allocate capital carefully and protect shareholders. After all, this is a company with only a $35M market cap with $80M sales and zero long term debt. Any future improvement in profitability will reward investors tremendously.

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