Monday, September 11, 2006

The Buckle Inc. (BKE) at $35.10

Step 1: Do you understand The Buckle Inc.’s business?
Incorporated in Nebraska in 1948, the Company commenced business under the name Mills Clothing, Inc., a conventional men's clothing store with only one location. In 1967, a second store, under the trade name Brass Buckle, was purchased. In the early 1970s, the store image changed to that of a jeans store with a wide selection of denims and shirts. The first branch store was opened in Columbus, Nebraska, in 1976. In 1977, the Company began selling young women's apparel as well and opened its first mall store. The Company has experienced significant growth over the past ten years, growing from 164 stores at the start of 1996 to 338 stores by the close of fiscal 2005. The Company changed its corporate name to The Buckle, Inc. on April 23, 1991.

The Buckle, Inc. is a retailer of medium to better−priced casual apparel, footwear and accessories for fashion conscious young men and women. The Company markets a wide selection of mostly brand name casual apparel including denims, other casual bottoms, tops, sportswear, outerwear, accessories and footwear. The Company emphasizes personalized attention to its customers and provides customer services such as free alterations, free gift−wrapping, easy layaways, The Buckle private label credit card and a frequent shopper program.

Most stores are located in regional, high−traffic shopping malls, and this is the Company's strategy for future expansion. All of the Company's central office functions, including purchasing, pricing, advertising and distribution, are controlled from its headquarters and distribution center in Kearney, Nebraska.

Throughout the years many changes have occurred in fashion, retail, and within the company but one constant has driven Buckle’s success…..the mission "to create the most enjoyable shopping experience possible for our guests".

The Company provides merchandise designed to appeal to the fashion conscious 12 to 24−year old. Denim is a significant contributor to total sales (42.7% of fiscal 2005 net sales) and is a key to the Company's merchandising strategy. The percentage of net sales contributed by denim has increased from 36.2% (2003) to 42.7% (2005).

The average store is approximately 4,900 square feet (of which the Company estimates an average of approximately 80% is selling space), and stores range in size from 2,600 square feet to 8,475 square feet.

The top four members of this buying team combined, have over 90 years of experience with the Company. The experience and leadership within the buying team contributes significantly to the Company's success by enabling the buying team to react quickly to changes in fashion and by providing extensive knowledge of sources for branded and private label goods.

As of April 11, 2006, the Company operated 341 stores in 38 states, including 4 stores opened and 1 closed during fiscal 2006. The existing stores are in 4 downtown locations, 11 strip centers, 16 lifestyle centers and 310 shopping malls. The Company anticipates opening approximately 17 new stores in fiscal 2006. For fiscal 2006, nine of the new stores are expected to be located in higher traffic shopping malls and eight of the new stores are expected to be located in lifestyle centers.

As of January 28, 2006, the Company had approximately 6,500 employees − approximately 1,227 of whom were full−time. The Company has an experienced management team and substantially all of the management team, from store managers through senior management, commenced work for the Company on the sales floor. None of the Company's employees are represented by a union.

Step 2: What are the potential risks of owning BKE?
The men's and women's apparel industries are highly competitive with fashion, selection, quality, price, location, store environment and service being the principal competitive factors.

The Company's success is largely dependent upon its ability to gauge the fashion tastes of its customers and to provide merchandise that satisfies customer demand in a timely manner. The Company's failure to anticipate, identify or react appropriately and timely to the changes in fashion trends would reduce the Company's net sales and profitability. Misjudgments or unanticipated fashion changes could have a negative impact on the Company's image with its customers, which would also reduce the Company's net sales and profitability.

Many of the Company's competitors are considerably larger and have substantially greater financial, marketing and other resources than the Company, and there is no assurance that the Company will be able to compete successfully with them in the future. Furthermore, while the Company believes it competes effectively for favorable site locations and lease terms, competition for prime locations within a mall is intense.

The distribution function for all of the Company's stores is handled from a single facility in Kearney, Nebraska. Any significant interruption in the operation of the distribution facility due to natural disasters, system failures or other unforeseen causes would impede the distribution of merchandise to the stores.

Net working Capital (NWC) / Sales has been increasing slowly over the years. Other competitors such as Abercrombie & Fitch (ANF) (11.4%), American Eagle Outfitters (AEOS) (4.4%) and Limited Brands (LTD) (8.3%) have better NWC / Sales.

Year Net Working Capital / Sales (%)
01/06 12.5
01/05 12.2
01/04 12.0
01/03 12.0
01/02 11.7
01/01 10.9
01/00 11.4
01/99 10.8
01/98 10.2
02/97 11.2

Inventory increased by 32% over the last quarter from $68.7M to $90.9M. However, in comparison to 2nd Quarter last year, the inventory level was actually lowered ($100.9M 2nd Qtr 2005).

Step 3: Insider Holdings
Insiders hold significant amount of stocks, approximately 55%. The Chairman and founder’s son, Daniel Hirschfeld, holds 9.4M of shares, which are equivalent to about 48% of the company. Dennis Nelson, who is the Chief Executive Officer, owns approximately 1.79M shares or about 5% of the shares outstanding.

It has been shown that companies with significant insider holdings, especially with the presence of founders, flare better over long term.

Step 4: Is BKE a good Company?
A good company is a company that has high return on invested capital (ROIC) and performs consistently over a long period of time. Looking at BKE, it is an excellent company despite in an extremely competitive industry. Net income compounded at 16% and 8.3% for 9 years (1997 – 2006) and 5 years (2001 – 2006) respectively.

Year Sales (m) Net Income (m)
01/06 501.1 51.91
01/05 470.94 43.23
01/04 422.82 33.68
01/03 401.06 32.08
01/02 387.64 32.64
01/01 393.25 34.8
01/00 375.53 34.03
01/99 337.92 34.03
01/98 267.92 23.33
02/97 206.39 13.62

Return on equity (ROE) and return on asset (ROA) are good.

Year ROE(%) ROA (%)
01/06 17.3 13.9
01/05 13.0 10.7
01/04 11.5 9.5
01/03 12.3 10.1
01/02 14.0 12.3
01/01 17.9 15.1
01/00 22.9 18.8
01/99 23.3 18.3
01/98 21.6 16.1
02/97 17.5 13.4

Net profit margin is impressive with most current one over 10%.

Year Net Profit Margin (%)
01/06 10.4
01/05 9.2
01/04 8.0
01/03 8.0
01/02 8.4
01/01 8.8
01/00 10.0
01/99 10.1
01/98 8.7
02/97 6.0

BKE has solid balance sheet; net cash/equivalent of $123M on April 2006. It is a great cash machine; earning free cash flow of $50.5M (2006), $55.9M (2005) and $37.6M (2004).

Step 5: Is BKE management shareholders-orientated?
Of course BKE management is shareholders-orientated, especially when founder’s son and current Chairman, Daniel Hirschfeld, owns approximately 48% of the company. Dividend payments almost tripled in 2 years from $4.3M (2004) to $11.8M (2006). BKE has also repurchased significant amount of shares last year; totally $82.4M, which is more than 10% of its market capitalisation.

BKE is led by dedicated management; Daniel Hirschfeld has been with the company since 1965 while Dennis Nelson (President and CEO) has been with the company for over 30 years. He began as a part-time salesman while he was a college student and continued full time after graduation. He has helped lead the company to over 300 stores and is actively involved in all phases of the company’s operations. Executive Vice President, Jim Shada has been with the company 25 years. Kari Smith, Vice-President of Sales, has been with the company for 25 years.

Step 6: Does BKE have a Moat?
Unfortunately, no.

Step 7: Does any superinvestor invest in BKE?
Third Avenue Management LLC holds 1.5% of the company.

Step 8: Is BKE undervalued?

Method 1 (EV/(EBIDTA – MainCapex):
Price per share = $35.10
Enterprise Value (EV) = $563M
EBIDTA – Maintenance Capital Expenditure (EBIDTA – MainCapex) = $54.3M

Thus, EV/(EBIDTA – MainCapex) = 10.4X

Method 2 (Adjusted FCF yield vs. Treasury yield (30 years):
Free Cash Flow (FCF) = $50.5M
Adjusted FCF = $48M
Adjusted FCF is calculated by deducting after tax interest income from FCF.

Thus, adjusted FCF / EV yield = 8.5%
Treasury yield (30 years) = 4.92%

The Buckle Inc (BKE) is an interesting retailer with excellent management, solid balance sheet and undervalued. Current pessimism over sales, net profit margin and comparable sales declines provides opportunity for long-term value investors to invest.

To conclude, let me quote our famous investor, Warren Buffett… “The most common cause of low prices is pessimism -- some times pervasive, some times 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.”

Happy investing,
Dah Hui Lau (David)

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