The best investments are often found among unwanted and unloved stocks. Unfortunately, this means that you'll rarely buy the best performing stock or the stock that everyone talks about at cocktail parties. Sometimes, good investing may even lead you to stocks that EVERYONE "knows" is a terrible investment.
Barnes & Noble (BKS) might just be one of those stocks, so let's hold our noses and take a closer look.
CONSENSUS BEAR OUTLOOK
- The brick and mortar bookstore business model is dead (see: Borders (BGPIQ.PK))
- Barnes & Noble's dividend cut is an ominous sign
- It's cheaper to buy books online (Amazon.com (AMZN))
- Barnes & Noble is hopelessly behind the eReader curve (Kindle, iPad, Wal-Mart (WMT) eReaders)
The brick and mortar bookstore model is clearly in a secular decline, but the Borders bankruptcy may have created a misconception about the speed at which the model is changing. Borders' struggles are the result of both industry trends and company specific problems. The media outlets have attributed much of Borders' problems to their delayed entry into electronic books, but the much bigger issue was their over expansion and above industry average overhead. The aggressive expansion led to expensive long term leases that destroyed the company's ability to adjust to the recession and industry trends. As of their last 10K, 72.6% of Borders store leases expired in 2017 or later.
Barnes & Noble has been adversely affected by the trends in eBooks, but their decline in store sales have been nowhere near as severe at those seen at Borders. For example, Barnes & Noble's store sales per sq. ft have declined from $244.33 in fiscal 2004 to $231.03 in fiscal 2010, though it's unclear how much of the decline was due to industry trends and how much was due to the economic downturn. Same store sales for the latest quarter increased +7.3% and online sales increased +64%. Barnes & Noble college, which contributed $836 million in sales during fiscal year 2010 should continue to supplement total sales. In the quarter ending October 30, 2010, B&N college reported sales of $798 million.
Books-A-Million (BAMM) is another brick and mortar bookstore that has held its own amid serious headwinds. During the 9 months ending in October 31, 2010, sales declined around 3% while net income remained roughly the same year over year.
The dividend cut is not necessarily a sign of poor earnings. As a shareholder, you can only hope that the management uses capital to achieve the best possible results. If this means cherry picking prime Borders locations or investing in the eBook business, so be it.
Amazon is cheaper than brick and mortar stores. There's no debate here. But it may be useful to point out that brick and mortar stores offer instant gratification to shoppers. Also, in the future, if states have their way and internet retailers lose their tax free status, it could eliminate a price arbitrage between online retail vs brick and mortar retail.
According to Barnes & Noble, the company's Nook has 25% market share of the US eBook market. This share could grow as they continue to exceed expectations with their Nook. The color Nook has received positive feedback.
The Barnes & Noble bears are right. The industry is in decline, but the stock market is punishing BKS as if it were on its last leg. For a company that had consistently produced 3-5% operating margins (BAMM was closer to 3-4%), the current stock price seems like a reasonably priced bet on growth in B&N college, industry stabilization and cost reductions with a call option on success in the eBook arena.
For investors with an open mind, Barnes & Noble might be worth a look.
Disclosure: I am long BKS.