LVMUY - The Buckle: Solid Discount Despite Best-In-Class Financials

Summary

• The net sales decline is probably due to the high base effect rather than weak demand.
• The Buckle demonstrates impressive inventory stability, generates solid cash flow, and delivers best-in-class margins.
• The company provides a solid dividend yield, which will support the stock price even if macroeconomic factors worsen.
• Special payments in the fourth quarter could be a stock revaluation catalyst.
• Our model shows that current challenges are already priced in.

Investment Thesis

Until recently, Buckle ( BKE ) has shown solid financial performance, with the net sales decline in February likely driven by last year's strong base. Buckle demonstrates impressive inventory stability, generates solid cash flow, and delivers best-in-class margins. The company provides a solid dividend yield, which will support the stock price even if macroeconomic factors worsen. In addition, special payments in the fourth quarter could be a stock revaluation catalyst. Our DCF model shows that current challenges are already reflected in the price. Although the company has the best fundamentals among its peers, Buckle trades at a discount to the industry average, which is not justified. We rate shares as a Buy .

Company Profile

The Buckle dates back to 1948 when David Hirschfeld opened a menswear store Mills Clothing in Kearny, Nebraska. In 1967, the company bought the Brass Buckle store and became a dedicated shirt and jeans retailer. In the 1970s, the company opened its first branch, began selling women's clothing, and opened its first mall store. At the same time, Dennis Nelson, the current CEO, joined the team. The Brass Buckle changed its name to The Buckle in 1991 and has since expanded rapidly. From 1992 to 1998, the company doubled its stores to 200 in 29 states.

Today, Buckle offers mid- to high-end casual wear, footwear, and accessories under its own and third-party brands. The company is represented in 41 states and operates 441 stores located in regional shopping malls and lifestyle centers. Like 50 years ago, most of Buckle's revenue comes from denim, the second most important merchandise group is tops and sweaters.

Buckle offers clothing under iconic brands including Levi's, Crysp, Preme, and Wrangler. The company's private labels include names such as BKE, Buckle Black, Daytrip, Gilded Intent, Gimmicks, Willow & Root, FITZ + EDDI, and Outpost. Private labels provide 46% of total revenue.

Business Sustainability and Macro Headwinds

The last month has been quite difficult for apparel companies . In February, Canada Goose ( GOOS ), Under Armor ( UAA ), and even Capri Holdings ( CPRI ) missed the Street's expectations and lowered their guidance. Since the beginning of February, the SPDR S&P Retail ( XRT ) index has lost about 11%. Buckle's recent February sales announcement also disappointed investors. Comparable store net sales decreased by 6.9%, net sales decreased by 6.1% YoY.

Until recently, Buckle has shown excellent financial resilience. In December 2022, the company's comparable sales increased by 7.9% year-over-year . In January, the indicator grew by 6.1% . Why did February sales drop? The decline is probably due to the high base effect rather than weak demand. Last February comparable net sales rose a whopping 32.9% year-over-year, while in December and January, the figure rose by 17.3% and 2.9% , respectively.

Although denim is a Consumer Discretionary product, it is considered less susceptible to economic cycles than other apparel. Denim was one of the few clothing categories that saw growth during the Great Recession . Indeed, jeans are an indispensable piece of clothing for every person's wardrobe; if your old pants are worn out, you are likely to fork out for a new pair, even if your real income is down.

It should be noted that Buckle confidently overcame the crisis of 2007/09. The company's sales grew at a double-digit pace. This was partly due to the rapid growth in the number of open stores. However, the average revenue per store was also growing.

The Achilles' heel for most retailers in 2022 has been excess inventory, which has grown by leaps and bounds amid declining demand and supply chain problems. Buckle has demonstrated and continues to demonstrate impressive stability in inventories. Take a look at a comparison of changes in net working capital over the past three years.

Although inventories rose slightly in the last quarter, they are still at a healthy level of 11.5% of trailing twelve months revenue. For comparison, in 2019 the figure was 14.1%. Inventories are a good indicator of future demand.

Growth Drivers

Of course, Buckle is not a growth story. The potential for further expansion is too limited. The company is actively closing the least efficient stores, reducing their number from 467 in 2017 to 441 in the last quarter. However, Buckle has several growth points, thanks to which the firm can surprise the market.

Firstly, the company's online sales are growing faster than overall revenue. In the third quarter, online sales grew by 8.8%, while total sales increased by 4.0%. At the same time, the share of e-commerce over the past nine months is 16.5% (16.2% a year earlier), which is below the industry average of 23.4% . Thus, Buckle has the potential for catch-up growth.

Secondly, private label sales are also growing, and their share in total revenue increased from 39% in 2019 to 46% in the last quarter. Through private labels, a company can reach a new level of recognition, provide deeper customer loyalty and gain greater price flexibility.

Thirdly, today Buckle works only in the USA. Although the management does not declare plans for international expansion, this possibility remains and must be considered when assessing the company's prospects.

Impressive Profitability

Although Buckle operates predominantly in the mid-price category, the company demonstrates extremely high margins and outperforms competitors from the premium price segment. At the end of the last reporting period, the operating margin stood at 24.75% and the net margin at 18.93%. The closest peer in terms of profitability is Capri Holdings, which owns names such as Versace, Jimmy Choo, and Michael Kors.

Premium brands have less price elasticity and therefore show better profitability. By comparison, luxury giant LVMH Moët Hennessy Louis Vuitton ( LVMHF ) has the net margin of 17.79%.

Robust inventory levels ensured high asset utilization of 1.56x. Buckle delivers best-in-class return on assets and equity thanks to high margins and utilization.

Buckle's margins are likely to come under pressure as consumers increasingly prefer to visit stores after lockdowns are lifted. Last year, the payroll at the store level was minimal. The company's management notes an increase in labor costs in physical stores. However, this is a problem that all players in the industry face, and Buckle is best suited as high margins provide it with a margin of safety.

Capital Allocation

The Buckle has regularly rewarded shareholders with dividends since 2006. The company's dividend policy includes fixed payments for four quarters and a special payment at the end of the year.

According to Seeking Alpha , the forward dividend yield is 3.4% with a payout ratio of 27.67%. However, the aggregator takes into account only fixed quarterly payments. The actual dividend yield may exceed 10%.

Dividend history testifies to Buckle's commitment to paying out all of its net income to shareholders.

According to the Wall Street consensus, EPS this year will be $4.99. Given that the company has been steadily beating the consensus over the past three quarters, EPS will likely exceed $5.

We do not see objective reasons to retain earnings. Buckle generates solid operating and free cash flow. In addition, the company has a strong and fairly liquid balance sheet.

Buckle has no leverage (except operating lease liabilities, which include fixed payments for rent, real estate taxes, insurance, and common area maintenance), cash equivalents and short-term investments account for $325 million, or 36.8% of total assets. Thus, capital allocation can support the share price and become a revaluation catalyst.

BKE Stock Valuation

Our DCF model is built on some assumptions. Considering monthly sales in November, December, and January, we determined that quarterly revenue would be $401.8 million. Thus, according to the results of FY 2023, revenue will grow by 3.9% YoY.

We extrapolate the February results and assume that FY 2024 revenue will decrease by 6.1%. Although this assumption is very approximate, it does allow for a trend. It is also more pessimistic than the Wall Street consensus. We further assume that revenue will grow in line with the Fed's inflation target of 2% until the end of the forecast period.

The gross margin for nine months was 49.07%. We assume that this indicator will remain until the end of the forecast period. We expect operating expenses as a percentage of revenue for the year to be 75.25%, in line with the last 12 months. Further, we expect the indicator to rise to 79.02%, the five years average.

We expect DD&A expenses as a percentage of revenue to be at 2.6%, in line with the average over the past five years. The company's management forecasts capital expenditures of between $26 million and $30 million in 2022. In our model, we include CapEx at the upper end of the forecast range. Further, we expect that by the end of the forecast period, CapEx as a percentage of revenue will be in line with the five years average of 1.1%.

Our assumptions are presented below:

With the cost of equity equal to 11.27%, the Weighted Average Cost of Capital [WACC] is 13.3%.

With a Terminal EV/EBITDA of 7.57x, our model projects a fair market value of $2.68 billion, or $53 per share. The upside potential we see is about 42%.

You can see the model here

Despite best-in-class financials, Buckle trades at a discount to the industry average.

Source: YCharts

As a rule, companies with high margins trade at a premium to their less efficient counterparts. High margins make net income more predictable and provide a margin of safety in case of rising costs. Thus, Buckle deserves a premium to peers.

Conclusion

The Buckle is well-adapted to the headwinds the retail industry goes through, and it can overcome storms with minimal loss. The February drop in net sales was likely due to the high base effect rather than weak demand. Buckle is an example of a highly efficient business. It has the best margins in the industry. Although Buckle is not a growth company, it still has several drivers to sustain revenue. The firm deserves a premium valuation relative to peers but trades at a discount to the industry average. The catalyst for stock revaluation could be special dividends that provide solid returns.

For further details see: