2023-06-16 13:02:18 ET
Summary
- Winmark Corp. has outperformed the market and its peers in the last five years, with a total shareholder return of 182% compared to 78% for the S&P 500.
- The company's strong performance is attributed to its profitability, asset-light franchise model, and ability to grow dividends, supported by its free cash flow generation.
- However, Winmark's current valuation and free cash flow yield make it unattractive as an investment possibility compared to its peers and the market.
Winmark Corp. (WINA) has been a stock market winner in the last five years, with total shareholder returns (TSR) of nearly 182%, compared to 78% for the S&P 500. Part of the reason for this has been the firm's ability to grow dividend payouts, an ability that remains thanks to the enormous free cash flows ((FCF)) that it has generated, earning 15.5% of its market cap in FCF since 2018. The other reason is that, quite simply, Winmark is a very profitable firm, due to the successful franchise model, that allows it to reduce its asset base while continuing to grow profits at a faster rate than revenue. Nevertheless, with a price/earnings (P/E) multiple of 33.95, and an FCF yield of just 3.47%, the firm does not appear to be attractive at the moment.
Winmark's Exceptional Stock Performance
In the last five years, Winmark's share price has appreciated by nearly 157%, compared to more than 14% for the iShares Russell 2000 ETF ( IWM ), which tracks the Russell 2000, nearly 62% for the SPDR S&P 500 ETF ( SPY ), and over 37% for the SPDR S&P Retail ETF ( XRT ), which tracks the retail industry's performance. The company's peer group average share price appreciation over that period was 143.78%. The peer group consists of The Buckle, Inc. ( BKE ), The Gap, Inc. ( GPS ), The Children's Place, Inc. ( PLCE ), Chico's FAS, Inc. ( CHS ), Dick's Sporting Goods, Inc. ( DKS ), and Abercrombie & Fitch Co. ( ANF ).
Winmark's TSR for the period was nearly 182%, while the iShares Russell 2000 ETF had a TSR of more than 23%, the SPDR S&P 500 ETF scored a TSR of just over 78%, and the SPDR S&P Retail ETF had a TSR of more than 49%. Winmark's peer group average TSR over that period was 193.07%.
Source: Morningstar
FCF Generation Supports Dividends
Given how dividends played such an important role in widening the firm's performance lead over the market and its peers, it's important to understand if that lead is supportable. In other words, can Winmark continue to pay out dividends, or even increase dividends going forward?
In the last five years, Winmark has grown FCF from $11.14 million in 2018 to $43.66 million in 2022, compounding FCF at 31.4% a year. In 1Q23, the firm generated $13.85 million in FCF, compared to $13.33 million for the same period in the year prior. Since 2018, the firm has generated $197.24 million in FCF, or 15.5% of its market cap. In that time the company has grown annual cash dividends per share from $0.56 in 2018 to $2.55 in 2022, compounding at over 35% a year. In 2023, management announced a quarterly dividend of $0.70, with the first payment made in 1Q23, raising the annual dividend per share to $2.80. Since 2018, the firm has paid out $74.69 million in dividends. The gap between FCF generation and dividend payments provides ample support for future dividend payments and growth of those dividends.
Source: Winmark Corp. Filings and Author Calculations
Peer-Leading Profitability
Between 2018 and 2022, Winmark grew revenues from $72.51 million to $81.41 million, compounding at just 2.34% a year. Growth has clearly not been very strong. In 1Q23, the firm had revenues of $20.52 million, compared to $20.05 million in 1Q22. The firm's profitability has improved at a higher rate than revenue growth. In that 5-year period, operating income rose from $41.8 million to $53.55 million, compounding at nearly 5.1% a year. This was boosted by operating margins rising from 57.65% in 2018 to 65.78% in 2022. In 1Q23, the operating margin was 60.34% compared to 66.98% in 1Q22. Winmark's operating margin is higher than the peer group average of 8.88%. Net income rose from $30.13 in 2018 to $39.42 million in 2022, compounding at 5.5% a year, while profit margins rose from 41.55% in 2018 to 48.43% in 2022. Net income in 1Q23 was $8.94 million, compared to $9.85 million in 1Q22.
Winmark's profitability is peer group leading. Its gross profitability (gross profits/total assets), is 1.93, compared to the 0.33 threshold established as attractive by Robert Novy-Marx, and compared to the 0.52 peer group gross profitability. Return on invested capital ((ROIC)) has risen from 54.4% in 2018 to 66.6% in 1Q23, higher than the peer group ROIC of 14.57%. The excellent ROIC demonstrates management's superior capital allocation and the strength of the underlying, asset-light business model.
Company | Ticker | Gross Profitability | ROIC | Operating Margin |
Winmark Corp. | WINA | 1.93 | 66.60% | 64.13% |
The Buckle, Inc. | BKE | 0.77 | 50.00% | 23.41% |
The Gap, Inc. | GPS | 0.50 | 1.10% | 0.77% |
The Children's Place, Inc. | PLCE | 0.46 | -6.60% | -3.05% |
Chico's FAS, Inc. | CHS | 0.72 | 12.90% | 7.03% |
Dick's Sporting Goods, Inc. | DKS | 0.48 | 17.10% | 11.37% |
Abercrombie & Fitch Co. | ANF | 0.85 | 5.00% | 3.67% |
Peer Group Average | 0.52 | 14.57% | 8.88% |
Source: Company Filings and Author Calculations
An Asset-Light Business Model
Winmark's gross profitability hints at the asset light nature of the business. Winmark generates more in gross profits per year than it holds in assets. This is a consequence of the franchise model that the firm deploys. Winmark's award winning resale franchises, Plato's Closet, Once Upon A Child, Play It Again Sports, Style Encore and Music Go Round, are sold through 1,297 franchises in the United States and Canada and over 2,800 available territories. System-wide sales have grown from $1.14 billion in 2018, to $1.53 billion in 2022. As a franchisor, Winmark clearly creates more economic value than it takes in the form of profits.
Because Winmark is a franchisor, the costs of building and operating stores are shifted to the entrepreneurs who are attracted by the chance to earn economic profits within the Winmark system. This decreases the risk on Winmark's part, and makes it easier for it to grow quickly. Given that managers tend to raise too much capital and invest too heavily, during growth periods, being a franchisor means Winmark can do something else: reduce its investments. Between 2018 and the trailing period, Winmark's assets were reduced from $46.66 million to $39.75 million. This means that the firm can tolerate tepid revenue growth and still grow profits.
Valuation
Winmark has a P/E multiple of 33.95 compared to 1.22 for its peers, and 25.62 for the S&P 500. The firm is clearly unattractive relative to its peers and the market. Winmark's FCF are trading at a 3.47% yield, compared to 7.28% for its peers, and 2.3% for the market. The firm's FCF are also trading at an unattractive level. So, although the company's profitability is attractive, as represented by its gross profitability, the market seems to have understood what a great business Winmark is and priced it accordingly.
Company | Ticker | P/E Ratio | FCF Yield |
Winmark Corp. | WINA | 33.95 | 3.47% |
The Buckle, Inc. | BKE | 6.99 | 12.90% |
The Gap, Inc. | GPS | -60.61 | 17.10% |
The Children's Place, Inc. | PLCE | -7.38 | -11.66% |
Chico's FAS, Inc. | CHS | 5.73 | 19.82% |
Dick's Sporting Goods, Inc. | DKS | 11.53 | 4.80% |
Abercrombie & Fitch Co. | ANF | 51.77 | 1.89% |
Peer Group Average | 1.22 | 7.28% |
Source: Company Filings and Author Calculations
Conclusion
In the last five years, Winmark's share price and TSR have outpaced the market and its peers. This is due to the firm's underlying profitability, the asset light franchise model, as well as its ability to grow dividends. However, the firm's relative valuation exceeds that of its peers and the market, and its FCF yield trails that of the market. In other words, as excellent as the company has been, the market has priced it out of contention as an investment possibility.
For further details see:
Winmark: An Attractive Company Richly Priced