Seeking Alpha
Long/short equity, deep value, event-driven, macro
Profile| Send Message|
( followers)  

Barnes & Noble (NYSE:BKS) has declined by nearly 25% from a peak of $23.3 in May 2013 to $17.6 currently. A steep correction might seem as a buying opportunity. This article discusses the reasons for believing that Barnes will continue to struggle in its operations and hence can be avoided even after the steep correction.

Dismal Fiscal 2013 Results

Barnes financial results for the year ended April 2013 were dismal as the company continues to take a hit on the top-line as well as the bottom-line. Revenue declined by 4.1% to $6.839 million from $7,129 million in FY12. The revenue decline was driven by the retail and the NOOK tablet segment. What is more important to mention here is the operating level profits of the company. For the fiscal year ended 2013, the EBITDA declined by 94.2% to $10.3 million from $176 million in FY12. The EBITDA margin was dismal at 0.2%. In other words, the company has barely managed to remain in profits even at the EBITDA level.

This is certainly a red flag and sustained downturn in the business could potentially mean that Barnes will incur EBITDA level losses going forward. This trend is already visible in the fourth quarter with Barnes reporting an EBITDA level loss of $122 million. This was primarily driven by higher EBITDA level losses in the NOOK segment. However, EBITDA margin continues to decline in the retail segment as well.

Barnes does plan to cut on losses in the digital business (NOOK tablets) by reducing the manufacturing risk and cost. For this, the company intends to tie-up with third party manufacturers for its tablets.

Even if Barnes is able to tie-up with a third party for manufacturing tablets, the problem of competition with giants in the industry will remain. More specifically, Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL) will be hard to beat in the digital market. The differentiation factor and the growth strategy therefore remain uncertain.

After witnessing robust top-line growth in the initial years of operation, the NOOK segment of the company has reported a decline in revenue of 16.8% for the fiscal ended 2013. The decline was primarily due to lower selling volume. The market demand for NOOK readers therefore remains weak and uncertain.

To aggravate problems in the digital segment, Barnes announced the resignation of William Lynch in July 2013. He had been instrumental in launching the Nook's tablet business and the resignation might signal the beginning of the end of a failed venture.

Gloomy Fiscal 2014 Outlook

The initial outlook for 2014 coming from Barnes is negative and certainly does not provide insights for any positive action in the stock. According to the initial guidance -

For fiscal year 2014, the company expects Retail comparable bookstore sales to decline in the high-single digits on a percentage basis. College comparable store sales are expected to decline in the low-single digits on a percentage basis.

The outlook implies that the biggest segments of the company will continue to depress, and it is very likely that there will be a further margin squeeze in the fiscal as sales remain depressed. As mentioned earlier in the article, Barnes might be staring at EBITDA level losses if the current problems are not resolved.

Analyst estimates also points to an impending gloom as earnings growth FY14, FY15 and FY16 are expected to be a negative of 254%, 27% and 87.5% respectively. Even for the fiscal year ended April 2013, the loss per share more than doubled to $2.97 compared to FY12 losses. Considering the outlook given by the company, analyst estimates are in sync with the depressed growth momentum.

Elaborating further on the depressed growth momentum, Barnes retails stores have declined to 677 as of January 2013 from 691 in FY12 and 720 in FY10. The retail sales revenue has also been on a gradual decline over the last few years with the segment revenue declining from $4,947 million in FY10 to $4,568 million in FY13. Leaving aside the past, there are no visible growth driver for this segment even in the future. As mentioned above, the company has already indicated on another dismal year for the segment.

The Barnes college segment had witnessed a significant bump-up in revenue in FY11 compared to FY10, when revenue increased to $1,778 million from $834 million. However, the revenue growth has stagnated since then and FY13 revenue for the segment was $1,763 million. Comparable store sales have been on a decline for the college segment over the last three years and the company expects the downturn to continue in FY14. Therefore, the second biggest segment of the company does not provide any revenue or growth upside trigger.

As stock prices discount the future, it is impossible (at this point of time) to find a revenue and stock upside trigger. On the other hand, the concerns on the downside are plenty.

Inventories Remain Stubbornly High

The company's inventory level, which includes Nook inventory, remained stubbornly high as of 4Q12. The merchandise inventory as of 4Q12 was $1.4 billion. This blocks meaningful cash flows for the company. It is also worth mentioning here that the current inventory level is at the highest in over five years and this is another red flag for investors. Inventory level compared to the past was important to mention as the business does demand a relatively higher level of inventory. However, an increasing inventory with weak sales is a potentially harmful trend.

Besides the Nook tablet inventory, the rising inventory of textbooks indicates a gradually waning demand. Additional inventory charges have also driven up the losses for the NOOK segment and with the inventory level remaining high, additional losses might continue.

Conclusion

With a growing market share of digital book reading, the NOOK segment was the potential game changer for Barnes. Unfortunately, the segment has been struggling with significant losses and is finding it hard to compete with much larger and established players in the market. The retail and college segment for the company has been struggling in the last few years in terms of sales and margins. This trend is likely to continue, and given the company's guidance, losses will further widen in the fiscal year ended 2014. In the absence of any positive trigger, investors can avoid exposure to the stock as the company is most certainly on a long-term downtrend.

Source: Barnes & Noble Will Continue To Struggle