Zumiez: The One That Mr. Market Got Right

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About: Zumiez Inc. (ZUMZ)
by: ThreeThree Capital Research
Summary

With the retail industry out of favor, many value investors have flocked to it looking for value plays - Zumiez is NOT one of them.

Potentially nearing the end of an economic cycle, a downturn in the economy, reduced consumer spending would be detrimental for Zumiez and its stock.

At today's prices, Zumiez is fairly valued and does not provide an intriguing investment opportunity.

Zumiez, Inc. (ZUMZ) is a specialty retailer specializing in street clothing, skateboarding and snowboarding apparel. Although there are numerous other retail stores with a similar description, many of them have branched out to general or athleisure wear so as to tap into a greater market. However, Zumiez’s main focus is still on extreme sports, with most of their collection tapping into this specific niche.

Image result for zumiez

Source: Zumiez website

Zumiez offers products by some of the largest brands in sports including Santa Cruz, Nike SB (NKE), Adidas (OTCQX:ADDYY), and Vans. Zumiez currently operates a total of 707 stores in 4 countries, although the vast majority (608) of these stores are in the United States.

The retail sector has piqued the interest of value investors due to the current unfavorable market outlook towards it. However, Zumiez’s falling share price and the decline in interest from institutional investors is worrisome. We dove into the company’s latest annual report to help you value Zumiez accurately and decide whether or not it is worth your money at today’s prices.

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Zumiez Has a $75M Stock Buyback Plan

Zumiez disclosed on December 13, 2018 that it plans to purchase $75M of its common stock between now and February 2020. The time frame of this plan can be shortened or elongated at the discretion of the Board of Directors, but overall, we expect this plan to be a wise capital allocation decision. Dividends and share buybacks are two of the most common ways through which companies give back to their stockholders. Zumiez does not offer a dividend despite its large cash and marketable securities holdings, so share buybacks are currently being used to compensate stockholders and increase shareholder value.

Although share buybacks are generally considered positive, it is important to remember that the company can also use the cash for other purposes. For example, Zumiez currently operates only 8 stores in Australia and 41 stores in Europe. These are potentially profitable markets and it might have been better for Zumiez to invest its cash in as opposed to buying back its own shares.

Generally, the stock price of Zumiez should benefit from the buybacks, but Zumiez is a relatively small retail chain when compared to some of its competitors. This calls into question whether this is a correct decision by the management since the $75M could have been used to pursue aggressive growth in markets currently untapped by Zumiez.

A Class-Action Lawsuit Currently Threatens Zumiez

A class action lawsuit has been filed against Zumiez. Alexia Herrera is the lead plaintiff, who alleges breach of various Californian wage and hour laws along with allegations of failure to pay reporting time. Oral arguments have been heard on this case, but no judgment has been made as of yet.

The company claims that it failed to pay some of its workers due to failure to report for work. According to the recent 10-K filed by Zumiez, it is unable to estimate the amount or range of loss that it would experience if the outcome favors the plaintiffs.

While the majority of the details of the case have not been made available to the public, it is expected that this lawsuit could yield a considerable amount in damages if the outcome proves to be adverse for Zumiez.

Valuation

Zumiez’s stock price has gone through many different ups and downs over the last few years. However, their current stock price is pretty similar to what it was 5 years ago. At this rate, Zumiez should be undervalued. However, that is not the case. Please note that Zumiez was trading at $24.68 when the following valuation was performed.

If we use DCF analysis with extremely conservative figures, it seems as if Zumiez is currently overvalued. If we assume no growth over the next 10 years, a TV multiple of 8 and a discount rate of 10%, the intrinsic value of the share comes out to be only $15.89. This leaves a lot to be desired and may be one of the reasons why the price of Zumiez has not experienced any significant rise over the last few years.

If we use figures which may prove realistic, but also optimistic, we find the shares to be fairly valued at this time. For this calculation, we are assuming a growth rate of 5% for the next 5 years, which is roughly the growth in sales that the company has experienced over the last 5 years, followed by a growth of 2.5% for the next 5 years. Along with this, we are using a TV multiple of 14. Here, we found the intrinsic value of the stock to be $25.21.

Although this may seem like the stock is slightly undervalued at this time, do remember that the growth rate assumption is based on averages. In reality, Zumiez has performed fairly inconsistently over the last few years and has failed to translate their increase in sales into cash flow. Based on this, we believe that the current valuation of Zumiez is accurate and does not provide an opportunity for outsized returns at today’s prices.

Risks

Due to Zumiez relatively small size, it is possible for Zumiez to be outmatched on pricing by larger retail store chains. Although Zumiez has done well to combat this by specializing in the extreme sports niche, it is possible for a larger chain to offer similar depth in their collections simply due to their larger size, scale, and resources. Combine this with the online presence of growing e-commerce businesses and Zumiez is in a very competitive industry with little to differentiate itself.

The biggest risk for Zumiez currently is the pending litigation. Some of the claims made by employees include the company not paying minimum wage. If Zumiez concedes the lawsuit, it is possible for similar lawsuits to spring up in other places. We are also currently unable to estimate the damages that the company would have to pay in such a scenario, leaving us in further uncertainty as to the future of the company.

The Bottom Line

The company is showing some signs of growth and the share buyback program should help the stock price, but the lack of interest from institutional investors, pending litigation, and low free cash flow leads to a gloomy outlook for the company. While many value investors are finding “good bargains” in the retail space, Zumiez's valuation does not lend itself to those characteristics. In terms of valuation, there are much better “value investment” opportunities in the retail space currently, and therefore we recommend investors to avoid Zumiez (or sell if already a shareholder) and seek out companies with a better outlook and expected yield.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: Although we do significant research and due diligence, we are not always right with our predictions or recommendations. This also applies to our grammar; please excuse any typos you may find. This article is free to readers with the purpose of assisting with research, while also providing a forum for second-level thinking and discussion. This article is for educational purposes only; we have not considered your specific situation and we are not your investment fiduciary.