Tandy Leather Factory (TLF) is an unheralded small cap company engaged in retailing and wholesaling leather and leather craft items. The company operates 110 outlets, including 78 retail stores and 29 wholesale stores in the US and Canada. Over the past few years the company has expanded internationally and now has a combination wholesale and retail store in the United Kingdom, Australia, and Spain.
I have been a follower of the company for many years and occasional investor. I like the company because of its strong earnings and sales growth history, the strong balance sheet, the steady growth strategy, and the low valuation relative to the company's earnings and balance sheet metrics. Since my first article on Tandy, the share price has advanced 26% from $5.55 to $7.00 a share as of the May 8th, 2013 close. The May 9th release of April sales and the pending May 13th earnings release are both possible catalysts to get the share price moving to the upside, with plenty of built up potential.
A STRONG EARNINGS HISTORY
When I first wrote about Tandy Leather Factory, the company's history showed earnings increases in 12 of the last 14 quarters, while the remaining two quarters had flat earnings, year over year. Since then, the company has reported two additional quarters of earnings growth, bringing the record to 14 of 16 quarters. This period even covers part of the Great Recession in 2009. The following table shows the progress the company has made from $0.24 a share in EPS for fiscal 2008 to $0.62 a share for fiscal 2012.
|Year Over Year Comparisons|
|EPS||EPS Previous||% Change||Sales % Change|
Source: Company Press Releases
One must include a special note for this table. In the third quarter of 2012, Tandy Leather Factory took an approximate $1 million charge related to a settlement reached with the company's current and former employees. As a group, these employees sought compensation for past wages earned, which they alleged were not paid in full under various state and federal laws. Although the company did not admit guilt, certainly one can conclude some fault if Tandy Leather Factory decided to settle instead of fight the claim. As such, I adjusted the quarter three results from $0.03 per share to $0.10 per share based on a tax rate of 37.5% and assuming the settlement had not been reached.
Also, past earnings would have been lower had the company paid the employees the correct amount when the wages were earned, instead of in a lump sum settlement. With this behind the Tandy Leather Factory, I see no issues with evaluating the company based on earnings being reported going forward and the most recent balance sheet. In the past, I had a lot of trust in the company's management. The company had reported steady earnings growth, had not tried to over expand itself by opening too many stores a year, and had yet to bring up any real red flags to deter a positive evaluation. Now, one has to at least keep this as a mental note for looking at Tandy or any investment.
FUTURE EARNINGS GROWTH
Nastiness aside, Tandy Leather Factory has reported very consistent earnings growth over the past four years. Ranging from 15% to 32% on an annual basis, even during a rough 2009, the company has continued to support long term holders. In the first quarter of this year, based on the monthly sales reports on the company website, sales grew 7%. This supports yet another quarter of good earnings growth to be reported on Monday. If the company were to continue a trend of expanded net margins to 9% for the quarter, this would lead to a report of $0.17 a share in earnings, a 13% increase. This is also about the mid-range of the company's own guidance of 11% to 16% EPS increase for the year, as shown in the 2012 year end press release.
While the first quarter sales and earnings numbers may not be as spectacular as was seen last fiscal year, the second quarter is off to a promising start. Today the company announced a 23% gain in April sales. Results were driven by the company's annual open house event, which saw 53% sales gains. In the release, the company's chief financial office, Shannon L. Greene, commented:
"Excluding the gains from the open house and the extra selling day this month, we still ran a 10% sales gain, which is great. We are investing heavily in advertising internationally in order to continue the growth of our international customer base. So far, the sales generated in our three international stores suggest a solid return on that investment as their sales, compared to last year, were 82% higher in April and 42% higher year to date."
The second quarter is off to a bright start and the company is on track to meet or exceed the guidance issued for 11% to 16% in annual earnings gains in 2013. Overall the company's earnings history and earnings future can be considered two check marks in the plus column when evaluating the viability of a potential investment.
A STRONG BALANCE SHEET
Earnings and sales growth can make a company look strong, but the truly stellar investments also back this growth up with a strong balance sheet. What I like in a strong balance sheet is a strong current ratio, growing equity, shrinking or stable liabilities with few long term liabilities, and growing current assets, especially cash. Although Tandy Leather does not encompass all of these criteria, it does well on the balance sheet.
|Weighted average diluted shares||10.178 million||10.166 million|
|Balance sheet items per share:|
Source: Fiscal 2012 Earnings Release
Tandy Leather Factory has maintained a strong current ratio, despite having a $0.10 a share charge and paying a $0.25 a share dividend in 2012. At $7 a share, the company is trading at less than twice equity. Liabilities outside of the usual operating liabilities are small and intangibles plus other assets are less than 3% of total assets. In other words, the balance sheet for Tandy Leather Factory is very clean, has room to support growth, and should improve further as sales are realized.
Of important note on this balance sheet is a 29.7% increase in inventory. The company's strategy for years has been to stock up on inventory when prices are right and maintain high gross and net margins. With a 23% increase in April sales and a 7% increase in first quarter sales, one can see the company is burning through this inventory. If sales gains should falter, one could worry about the inventory build up, but for now there is nothing of great concern. If the company reaches its stated sales goals for the year, the amount of inventory on hand will turn over around 3 times for the year. Although not stellar, this is consistent with the company's past success in maintaining high gross margins by buying cheap and concentrating on keeping stores profitable.
VALUING THE COMPANY
Lately, when I value a small cap company I calculate two numbers to see if there is any room for growth in the share price. For Tandy Leather Factory I have to remember the company has not been in any hurry to grow over the past several years, but instead focuses on a "slow and steady wins the race" type of mentality. This is one reason the company was able to grow earnings in the middle of the Great Recession.
With this in mind, I would state a reasonable, fully valued, forward PE for Tandy Leather Factory to be somewhere around 14. According to finviz.com's screener, a forward PE of 14 would be around the median for Tandy Leather Factory's industry. The company's own estimated range for 2013 was $0.69-$0.72 a share in earnings. Assuming the high end of this range, we have $0.72 X 14 = $10.08 a share for a reasonable valuation.
A second method I have been using lately is to look at the company's current equity per share, $3.69, and add an approximation of the next five years worth of earnings. For this calculation I will use the 29%, 32%, 15%, and 32% earnings growth of the last four years, plus the 16% high end estimate for the company in 2013. The average of those five percentages is 25%. Using the $0.72 as a solid number for 2013 and then growing the next four years by 25% yields additional earnings over the next five years of $5.91 per share. Added to the $3.69 a share in reported equity, the valuation would be $9.60 per share.
Lastly, I have taken the midpoint of those two numbers to give a reasonable estimate of the company's current valuation. This puts Tandy Leather Factory at $9.84 per share, or 41% higher than Wednesday's close. If I had the cash to buy shares of Tandy Leather Factory, I would not be shy in buying before the earnings report on Monday or any time in the near future, as long as the company is still trading in the single digits. I see significant upside potential for the company over the next year. However, buying any stock before earnings is definitely a gamble. One wrong word in the press release, one miss of an estimate, or one bad call by an analyst could cause the shares to drop drastically.
In the long run, I see Tandy Leather Factory as a very safe buy, with much upside potential. Even if the stock should drop on the earnings report, there is still a good basis for holding out to realize the potential gains of a bright future. As long as the company continues to report monthly and quarterly gains, long term holders should be rewarded.