Buckle: A Long-Term Gem

| About: The Buckle, (BKE)
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Buckle (NYSE:BKE) is a retailer of trend fashions focused primarily on a college age customer base with a target age range of 15-30. A common challenge with retailers, especially fashion retailers of this type, is assessing the long-term growth potential and the resulting investment potential in light of regularly shifting fashion trends than can quickly consign once popular retailers to relative irrelevance. The problem of assessing long-term market and fashion potential often makes these retailers relatively unattractive investments except when exceptionally mispriced by the market. However, Buckle represents a relatively unique opportunity with a model that mitigates many of the common risks in the industry while providing strong long-term growth prospects.

The following analysis focuses on assessing the long term potential of the business. In doing so, models which rely on precise estimates of performance over extended periods of time - which are inherently inaccurate and more often than not yield results which provide a false sense of precision and security - are eschewed in favor of estimating the company's total market potential by using a handful of key metrics which limits the opportunity for gross inaccuracy. The basic framework of assessing the company's long term potential relies on an analysis of its potential store base and using this information to evaluate the company's potential revenues, net income, etc., to gain an overall sense of the potential investment opportunity.

Assessing Company Potential

Buckle's current 440 stores (as of the end of the prior fiscal year) are distributed across the country with concentrations in the central United States and the southeastern United States. The company has yet to enter or establish a meaningful presence in many major markets so many of the largest potential markets - including many of the largest states - remain relatively untapped at this point. For example, the company has more stores in Kansas than in any of New York, Pennsylvania, Arizona, Washington, Massachusetts, Connecticut, New Jersey, or Maryland and California had only one more store than Kansas at the end of the most recent fiscal year. Moreover, Texas has more stores than the combined total in California, Florida, and New York. This distribution suggests that Buckle likely has substantial opportunity for long-term growth with its existing brand.

The potential opportunity can be assessed by estimating the maximum probable concentration of stores throughout the country based on population. The greatest concentration of the company's stores is in the company's home state of Nebraska with one store per 142,000 residents. The second most concentrated state is Kansas with one store per 170,000 residents. These figures can be used as a baseline with other potential concentrations to estimate the maximum potential "saturation" store count, as shown in the following table:

Potential Store Count (Maximum)

Population per Store

Stores (U.S. Only)

Stores (U.S. and Canada)

145,000 (Nebraska)

2,165

2,396

170,000 (Kansas)

1,847

2,044

200,000

1,570

1,737

250,000

1,256

1,390

The company does not currently operate in Canada but, under similar conditions, could potentially increase its maximum potential total store count by approximately 12% by expanding into the Canadian market in the future.

The maximum store count figures based on population can then be used to create a matrix of potential revenue outcomes using a few assumptions about the company's longer term performance and incorporating a multiplier to reflect online sales. The estimates are, of course, inherently uncertain, but the objective is not to identify an exact value but to develop a conceptual range of potential values which represents the company's maximum potential and then evaluate our level of confidence in those estimates.

In this analysis, let's assume no future expansion into Canada and relatively conservative estimates by using current performance values. In this case, the assumptions would be that long term average revenues per store will not exceed the $2,500,000, that online revenues will continue to represent roughly 8.0% of store revenues, and that net profit margin will remain unchanged over time at 14.6%. The following table provides the maximum potential revenue and profits based on these assumptions using the current share count:

Potential Revenues and Profitability (U.S. Only)

Population per Store

Revenues

Net Income

EPS

(Millions)

(Millions)

145,000

$5,845.50

$853.44

$17.78

170,000

$4,986.90

$728.09

$15.17

200,000

$4,239.00

$618.89

$12.89

250,000

$3,391.20

$495.12

$10.31

In general, these estimates represent a rather conservative approach by assuming no long-term growth in average revenue per store (unlikely), no long-term expansion of margins due to leveraging fixed expenses over a growing store base (unlikely), no expansion into adjacent markets (unlikely), and no share growth in online sales (unlikely). In addition, the maximum store count calculation assumes no population growth - a certain inaccuracy. The greatest potential risk to these estimates, in fact, is that the market will not, in fact, support as many stores as estimated (as discussed below), but even under the worst-case scenario - a long-term market for 1,250 domestic stores - yields respectable long term growth potential in earnings (and thus share valuation) and - as noted below - in dividends.

It's also worthwhile to recalculate the above table using different values for all of the key factors as a means of sensitivity testing the results presented in this table. If, for example, the assumption is that the long term sustained average revenue per store is a marginally higher $2.75 million, the online business grows to 10% of store sales, and the net profit margin will expand to 15.0%, the results are presented in the following table:

Potential Revenues and Profitability (U.S. Only)

Population per Store

Revenues

Net Income

EPS

(Millions)

(Millions)

145,000

$6,549.13

$982.37

$20.47

170,000

$5,587.18

$838.08

$17.46

200,000

$4,749.25

$712.39

$14.84

250,000

$3,799.40

$569.91

$11.87

A number of scenarios can - and should - be calculated to provide a basis for understanding the factors which drive the company's results. Of course, at a growth rate averaging only 10-20 new stores per year, reaching these revenue and earnings figures could be a very long-term process. However, it nonetheless illustrates that Buckle has an extraordinary market opportunity ahead of it simply by continuing to build on its existing brand and executing on its current growth strategy.

Assessing the Assumptions and Risks

The second aspect of the analysis is assessing whether the assumptions made, on a quantitative and qualitative basis, are reasonable. In this case, the most subjective figure is the estimate of the total number of potential stores the market will support. The assumptions used above for calculating future potential revenues, earnings, and profit margins are already conservative and reflect relatively little growth in the established core business.

In comparison to peers, however, the maximum potential store counts may actually be somewhat aggressive at the upper end of the range. In most cases, major competitors such as Aeropostale (NYSE:ARO), American Eagle (NYSE:AEO), Abercrombie and Fitch (NYSE:ANF), and Gap (NYSE:GPS) all have store counts in the range of 1,000 locations in North America, suggesting that this may be a reasonable estimate of the current maximum market potential for Buckle. In this case, the revenue and earnings assumptions for store counts in states with population densities of 145,000 or 170,000 per store may not reflect the overall average achievable in larger states and the estimate of potential store count based on 250,000 residents per store, over the long term, may be more accurate. In this case, the investment opportunity should be assessed on the more reasonable figures which, while certainly less than those based on a more dense store footprint, still suggest substantial potential growth for the company. The store count calculation also assumes no long term growth in population which is an obvious inaccuracy weighted towards a conservative figure.

A second key implicit assumption is that the company's fashions will gain traction in the relatively underpenetrated coastal markets. We don't believe this is necessarily a foregone conclusion and the company's ongoing expansion into the Northeast will provide an ongoing assessment of whether the company's fashions can succeed in these new markets. However, there is little immediate indication that the company's fashions will not gain traction in new markets and the company's distribution system, which incorporates holding back inventory to allocate to stores with greater sell through of specific styles, tends to mitigate the inherent risk in regional fashion preferences.

In addition, there are a number of positive qualitative aspects to the company. The company's management and area and district managers are almost all former sales people and the company is focused on developing internal talent to manage expansion instead of hiring individuals who have no prior experience with the company simply to accelerate growth in the store count. The benefits of this approach are further discussed below. The company's shareholders list is also relatively short with substantial insider ownership - current officer and directors own nearly 42% of the company's outstanding shares, virtually all of which are actual shares (i.e., personal wealth) rather than shares which may be acquired through stock options. The company's measured growth and consistent emphasis on returning cash to shareholders rather than retaining it as excess cash ensures a focus on the core brand rather than incentivizing adventures into other businesses. Finally, the company occupies a relatively unique market position by generating brand loyalty through its internal brands (which consistently represent roughly a third of total revenues) and most locations employ an in house alterations person to tailor clothes to the individual customer. In combination with the focus on developing and growing internal talent for management, this model creates a customer experience which is relatively difficult to replicate, especially for other popular and fast growing but otherwise commodity fashion competitors.

This last consideration is a particularly important aspect relative to the company's measured growth. A common unifying theme amongst many fashion retailers serving similar or adjacent markets which have run into challenging times (even before the recession) - such as Pac Sun (NASDAQ:PSUN), Wet Seal (NASDAQ:WTSL), and Hot Topic (NASDAQ:HOTT) - is that all were expanding at a breakneck pace. In many cases these companies were adding 60-100 new stores a year, thus sacrificing customer service to capture raw market share. As a result, once revenues began to slow due to misjudging the market or fashion cycle, the aggressive expansion saddled each company with a large number of relatively unproductive new stores (and the associated overhead expense) at the worst possible time and aggravated management's challenge of dealing with the fashion issues in a quick and effective manner. Buckle's approach mitigates some of this risk by ensuring critical consistency in customer experience and stability and continuity in management in the face of intermittent challenges.

The greatest risk for Buckle - as with all fashion retailers - is that the company will not remain relevant to its target market and continue to execute on fashion trends over the long term. In retail this risk is inherently unavoidable - Buckle has and will from time to time misjudge trends - but the company's approach to management, growth, and product mix tends to mitigate the potential severity of such events. In addition, the company's focus on denim, a segment which tends to be less affected by shifting fashion trends and enjoys greater customer loyalty, offsets the risk associated with fashion trends in other categories. Denim represented 46.4% of the company's revenues for the most recent fiscal year, a far greater share of revenues than most peers.

Prospective Ongoing Dividends

Buckle also has an established record of returning excess cash to shareholders rather than retaining those funds for corporate purposes, especially in light of the company's measured expansion strategy. In the last five years the company has paid substantial year end special dividends in addition to its regular annual dividend of $0.80 - a total of $16.98 in dividends over the period - thereby establishing an unusual track record. In the meantime, the company has maintained a relatively consistent shareholder's equity position of about $337 million to $363 million with the exception of 2012 when shareholders equity fell to $290 million due to an exceptionally large special dividend. In fact, over the last five years, annual dividends paid have nearly equaled or exceeded reported diluted earnings per share.

The company's consistency over time and steady cash flow makes it relatively simple to estimate what the company's ongoing special dividends may be from year to year. If we assume that the company will continue its measured growth, continue to pay out excess cash as special dividends, and maintain shareholders equity at historic levels, future special dividends can be estimated as follows based on a marginal annual net income growth rate of 5% (slightly higher than current market expectations):

Potential Cash Flow and Dividend Analysis

(Fiscal Year)

2014

2015

2016

Net Income

$172,515

$181,141

$190,198

Depreciation and Amortization

$34,000

$36,000

$38,000

Amortization of Stock Options

$9,000

$10,000

$11,000

(Increase)/Decrease - Inventory

($5,000)

($6,000)

($7,000)

(Increase)/Decrease - Payables

$2,000

$2,400

$2,800

Increase/(Decrease) - Gift Certificates

$2,000

$2,000

$2,000

Increase/(Decrease) - Taxes Payable

($10,000)

($4,000)

$0

Cash Flow from Operating Activities:

$204,515

$221,541

$236,998

Less: Capital Expenditures:

($38,000)

($41,000)

($44,000)

Less: Earnings Retained for Equity:

($55,000)

($10,000)

($10,000)

Net Cash Available for Dividends:

$111,515

$170,541

$182,998

Potential Annual Dividend per Share:

$2.32

$3.55

$3.81

The above analysis obviously represents a simplification of the calculation of cash flows and eliminates a number of smaller line items that have historically been immaterial to overall cash flows and/or have balanced over the long term so as not to meaningfully impact cash flows over time. In this analysis, even with growing capital expenditures for accelerating growth and contributions to equity through retained earnings, the company will still be well positioned at very moderate growth rates to pay substantial special cash dividends in the future - as much as a 6.6% yield in 2015 at the current market price per share.

Conclusion

Buckle holds substantial long-term growth potential that is relatively simple to recognize using a handful of assumptions. In addition, the company will likely continue to pay shareholders substantial cash dividends while pursuing a measured growth strategy that has served the company well for many years.

However, the company's shares - currently valued at roughly 16 times projected earnings - reflect a fair amount of this potential growth and may represent only a decent (versus an extraordinary) opportunity. On this basis, the recent shift in sentiment by some analysts to "sell" ratings based on valuation is understandable but nonetheless misguided when focusing on the next ten years instead of the next ten weeks. We are not presently adding to existing positions at the current price but, in light of the long term growth potential and ongoing dividends which may exceed an 8% yield, would not hesitate to add shares in the event of a substantial pull back in the share price, especially to around $40 or less, in the absence of other material issues. Speculators looking for short term gains will not find Buckle of very much interest but investors seeking consistent returns with growth opportunities over the long term should consider shares of Buckle.

Disclosure: I am long BKE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Buckle (BKE) is held in client portfolios.