Buckle (NYSE: BKE) has reported another month of negative comparable store sales metrics since our last commentary on the company although improved from both the immediately prior month as well as the year before period. The results were roughly in line with our expectations although, as noted below, the critical months of August and September will provide clear indication of whether the company has turned a corner in terms of stabilizing the business. However, despite these short-term results, our expanded analysis of the company’s revenue trends suggest an ongoing improvement.
Buckle’s challenges mirror a significant portion of the retail sector. However, we tend to discount the generic argument that online retail competition is the driving factor behind Buckle’s weakening performance over the last few years. Instead, for a retailer with a specific focus on denim, the primary driver of weakening results was more likely the shift in fashion trends away from denim and towards athletic leisure (or athleisure) and other fashion styles. In fact, Buckle’s revenue trends show a distinct correlation with the shift in fashion preferences between 2011 and 2017, as noted in the following graphic:
Source: Company Financial Reports and Industry Sources
The dramatic shift away from denim fashion, which began in 2011, when sales of higher end designer jeans also peaked for the last time, was bound to negatively impact a company, which generates between 42% and 45% of its revenue from the denim category. In comparison, the reverse was the case during the proceeding boom in denim fashion trends from about 2002 through 2011, which coincided with Buckle’s extraordinary growth in same-store sales over that period despite one of the most severe recessions in history.
It’s difficult to understate the decline in denim as a fashion, which began in 2012 and accelerated into 2014 and 2015. In fact, during this time, mindshare for higher income female shoppers, as measured by a report developed by Piper Jaffray, increasingly tilted towards athleisure styles until athleisure mindshare exceeded denim in the spring of 2014. Indeed, over a similar same period, the revenues of Levi Strauss, the world’s premier manufacturer of denim, declined from $7 billion to $4.8 billion through 2015. The sale of designer jeans, such as True Religion and Rock and Republic, peaked in 2011 and have declined every year since, contributing to the subsequent bankruptcy of True Religion.
The resiliency in denim as a percentage of Buckle’s sales over the last several years despite declining overall sales also suggests the company’s challenges are primarily related to prevailing fashions. The stability in the denim category (and in other categories) indicates that customers who visit Buckle stores remain interested in the company’s general assortment and the decline in transactions is more related to a decline in interest in denim as a fashion versus intense online competition specifically in the denim market.
However, there are indications that the trend against denim may be turning as athleisure fashions become more commonplace. Piper Jaffray, for example, has recently shown a renewed interest in denim versus the prior downward trend. In addition, Levi Strauss reported marginally higher revenues for 2016 and actually raised expectations in its more recent second quarter report, reversing the prior negative trend.
Denim is unlikely to displace athleisure fashion, but after an extended period during which consumer spending was focused on adding athleisure fashions to the closet, a greater balance between denim and athleisure may be on the horizon as consumers replace worn denim fashions.
However, none of this is to say that online competition has not had an impact on the business or that the company need not pursue a more aggressive and robust online strategy. Amazon (NASDAQ: AMZN), for example, has certainly grown its market share in the jeans category and especially in online sales, trailing only Nordstrom (NYSE: JWN) and Gap’s (NYSE: GPS) Old Navy in online sales of jeans. It’s likely that online channels will continue to gain share in denim (and clothing generally) and remain a meaningful competitor.
However, the vast majority of consumers, including those classified as Generation Z, still prefer shopping in physical stores and having the tactile experience with the products belying the oversimplified argument that traditional retail is inevitably dead. In some cases, this is combined with the expectation of the ability to shop in store and purchase online, especially from the same retailer.
In our view, this means Buckle must be more proactive in building the online channel as well as emphasizing differentiating factors to drive traffic online and in physical stores in order to retain consumer purchase decisions. In this respect, Buckle should – must – be more aggressive in marketing the in-store services it provides, such as free in-store alteration, that still require an direct interaction with the customer and which Amazon can’t (at least not yet) provide in an online channel.
It’s arguable that for a smaller retailer such as Buckle, the online channel actually offers a far more cost effective way to bring its products to a much broader audience than the traditional development of an expanded store footprint. Buckle remains a surprisingly regional retailer with essentially no (or very limited) presence in such major markets as California, New York, and Massachusetts (or for that matter the entire Northeastern United States).
Buckle has nearly as many stores in Kansas as it does in all the states north of Pennsylvania, including New York, and has more stores in Iowa than in California. The online channel may offer the company the opportunity to expand its geographic and market reach in the most cost effective manner with selected geographic physical locations designed to reach the largest possible audience for the tangible experience.
So, are there indications in Buckle’s revenues that denim may be stabilizing (as reflected in the Piper Jaffray findings) or regaining mindshare among consumers? The answer – so far – is a highly conditional yes.
We were somewhat disappointed by the company’s revenue results for the month of May. However, revenue trends returned to the range of our expectations for the month of June and we expect July will come in roughly proximate to the results from June. However, the critical period will be revenue performance in August and September when the company begins to lap the accelerated collapse in revenue, which began in August of the prior year and continued through the holiday season.
The back to school period is important for two reasons: first, August and September are higher revenue months which will provide a basis for assessing whether the company is on track to improving the comparable store change in revenues, and, second, the back to school season over the last several years has been highly indicative of revenue performance during the following peak period in December.
In the event the company is stabilizing the business, it’s possible that the company could report negative same-store sales comparisons in the low-single digits and even slightly positive same-store sales results in the fourth quarter. The cumulative trend in comparable store revenue results during the prior two months of March, April, May, and June (i.e., the combined revenue performance in June of 2017 and 2016), average roughly -18% for each pair. The August 2016 result was -14.8%, which could result in performance for August 2017 in the range of -3.2% assuming stabilization.
We extended our earlier revenue analysis to include the most recent monthly revenue reports and include data showing the trailing six and twelve-month average monthly percentage change in revenues on a comparable store basis, as shown in the following chart:
Source: Buckle Monthly Revenue Reports
The blue line represents monthly results, the orange line represents average monthly results for the trailing six months, and the purple line represents monthly results for the trailing twelve months.
The trailing average monthly change information is interesting because it clarifies the noise in the monthly figures and clearly shows the rather smooth and pronounced downward trend in the change in revenues over the last two years.
However, equally interesting is the reversal of this trend over the last few months (suggesting greater traction in denim among other factors) after bottoming with the collapse in revenues in February of 2017. The information available to date is not sufficient to call a bottom or clear upward trend (although still negative and from a very low base), but the trend so far has clearly shifted for the moment in a positive direction.
Buckle, in our view, has never been a likely acquisition candidate and our assessment of the company does not include any potential acquisition by another company. The existing insider ownership would represent a challenging hurdle for an outside acquirer.
However, we do consider a potential management buyout of the company to be possible, especially since management’s current holdings would allow a buyout using the company’s existing excess liquidity of around $200 million and a very modest level of debt at the current share price. In fact, under even pessimistic operating assumptions, the company will generate $50 million-$75 million in annual free cash flow, allowing repayment of the necessary debt in as little as 3-5 years.
Buckle, in our view, remains undervalued despite the challenging market conditions. The company certainly has work to be done. Management must better communicate its priorities to demonstrate that it is engaged and proactively addressing the challenging retail environment while focusing on a more robust combined online and physical store strategy. The company should also refresh the board of directors and effectively deploy its significant excess cash and equivalents for shareholders. Unfortunately, it’s not yet clear that management fully understands these expectations.
However, the recent trends in monthly revenue performance suggest that the company may be in the process of stabilizing the business. The recent research concerning fashion trends and the recovery of denim is encouraging.
In addition, the company’s significant excess liquidity, lack of debt, ongoing positive free cash flow, and high insider ownership add significant backstops for the company’s valuation, as does management’s potential ability to purchase the entire public float utilizing the company’s existing excess liquidity and modest leverage. We see relatively limited downside risk barring a renewed significant downturn in revenues with significant long-term potential if management can execute within the business.
Disclosure: I am/we are 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.