- The Birks Group is a top-tier jeweler flying under the radar and one of my favorite deep value opportunities of 2021.
- Investors are encountering a unique opportunity as this company is extremely undervalued and poised to soar due to the ongoing economic reopening.
- Most risks are related to Birks' illiquidity as the company has enough liquidity and balance sheet strength to withstand prolonged periods of distress.
All financial numbers in this article are in CAD except when noted differently.
After discussing a number of dividends opportunities this year, it is time to focus on deep value trades/investments again after my recent Marathon Oil (MRO) article resulted in a lot of requests. It is also an article I compare to the deep value play published in May of 2020 that resulted in capital gains of more than 200%. In this article, I am going to discuss what I consider to be one of the best value opportunities I have ever covered on this website. The Birks Group (NYSE:BGI) is a micro-cap opportunity, that despite an impressive YTD performance, can still be considered to be significantly undervalued. In this article, I am going to tell you why you don't want to miss this opportunity.
Source: Birks Group
A Short Overview Of The Company
The Birks Group is a leading designer of fine jewelry, timepieces, and gifts. The company operates a number of jewelry stores in Canada, with wholesale customers in North America and the United Kingdom.
Source: Birks Group Form 20-F
The company's expertise goes back all the way to 1879 when Birks' predecessor company was founded. Its rich history has moved the company well beyond being just another jewelry retailer as its brand has become a staple in Canada and beyond. This success was mainly built on the company's advanced jewelry designer skills and the fact that the company's distinct design and brand name sets it apart from its competitors.
Birks was purchased by the Borgosesia Acquisitions Corporation in 1993, a predecessor company of Regaluxe Investment S.á.r.l. Effective March 28, 2006, Regaluxe was acquired through a merger with Iniziativa S.A. As of May 31, 2007, and June 4, 2007, respectively, following a reorganization, Iniziativa, and Montrolux S.A. transferred all of the shares they respectively held in the Company to their parent company, Montrovest B.V. Following the 1993 acquisition of Birks, Birks’ operations were evaluated and a program of returning Birks to its historic core strength as the leading Canadian prestige jeweler was initiated.
In August 2002, Birks invested $23.6 million to acquire approximately 72% of the voting control in Mayors, which was experiencing an unsuccessful expansion beyond its core markets and was incurring significant losses.
On November 14, 2005, Mayors and Birks combined their businesses to reduce the impact of regional issues, and so simplify the corporate structure. Each outstanding share of Mayors' common stock not then owned by Birks was converted into 0.08695 Class A voting shares of Birks. As a result of this merger, Birks became an NYSE listed stock.
In December of 2015, Montrovest (now knows as Montel) transferred a portfolio of its Class A and Class B voting shares to Mangrove. As a result, Montel owns 49.2% of the voting shares. Mangrove owns 26.7%.
As a result, the company has a free float percentage of 24.1%, which currently translates to $12.8 million (based on a $53.2 million market cap). When adding its management team, the free float drops to 17%.
Accounting for all available to sell equity and derivatives, there are only roughly 1.5 million shares left in this name. However, in this environment, it still trades with good liquidity as the stock is popular with day traders/retail.
With all of this in mind, let's discuss the company's value.
Birks Group Is A Deep Value Play
Birks Group is NOT a short squeeze name like GameStop (GME) and similar stocks that were used as pump & dump tools by various market participants. Shorts have never been active on this name going back over a decade. There is very little borrow available and the family (Montel) has repeatedly refused to lend out shares. While I am writing this, the company's short float is roughly 0.8%. As a comparison, Procter & Gamble (PG) has a 0.6% short float. It's a different stock, but it gives you an idea of how low this is as P&G is one of the safest stocks on the market (high-yield consumer staples stock).
That being said, one of the reasons why Birks is a value play is because of its struggles in the past. The company decided to radically redesign the company over the past 7-8 years in addressing the threat of mass jewelry retail migrating online. In response to this, they have gone up-market and more urban while building their online platform. This is why the company entered the pandemic with elevated debt levels.
In the first half ending September 26, 2020, the company generated net sales of $57.0 million. This is a decline of 33.2% compared to the prior-year period. The company's operating loss improved by $661 thousand to a loss of $1.4 million. EBITDA, however, rose by $1.1 million to $1.4 million as D&A costs were $2.8 million. Keep in mind that EBITDA was artificially boosted as the company received $1.2 million in Canadian wage subsidies (Canadian PPP). This supported the positive impact from rent abatements ($3.2 million) and lower compensation costs ($5.7 million).
With this in mind, the valuation is starting to look interesting when using normalized results. On a normalized basis, the company should be able to generate at least $215 million in annual sales. That implies an improvement of 27% compared to actual FY 2020 results (ending March 28, 2020). These numbers are based on 9% organic sales, a 12% price increase plus the fact that March 20 lost a month of sales. I do not consider this 9% organic growth rate to be aggressive as 2020 was only a half-year operating with newly launched flagship stores. I expect the gross profit margin to rise from 38.1% to 43.5% in this situation as the company has reduced discounting and has moved more Birks branded products. This results in a 45% (expected) increase in gross profit to roughly $93.7 million.
SG&A expenses are expected to rise by 16% to $76.4 million, which represents roughly 35.5% of total sales and is mainly the result of lower payroll and marketing expenses. D&A costs were straight-lined, and therefore unchanged. All things considered, a normalized EBITDA result of $16.8 million is expected.
Based on this context, let's take a look at the company's enterprise value as EBITDA is just one part of the equation.
Enterprise Value & Valuation
As of September 26, 2020, the company has $27.7 million in net assets before LT liabilities. This is based on a deficit in net working capital, which is OK as the company has plenty of liquidity in bank lines (this will be discussed in this article). The company has $2.8 million in LT account receivables, which has been adjusted for collateral and default rates (discounted by 40%). Net operating leases were calculated using a 6% discount rate on a 5-year average life. Then multiplied by the Federal/Quebec blended tax rate of 26.6%. Intangible value beyond current operations is in the books for $4.93 million. Normally, I would exclude this but I left it in as management is negotiating a China/Asia joint venture, so this number captures a bit of the company's international business potential.
On the liability side, the company has long-term funded debt (excluding leases) worth $36.2 million and $1.0 million in other long-term liabilities.
When subtracting liabilities from assets, we end up with $9.4 million in net liabilities. Note that the market cap we're adding includes any possible dilution, which includes 652,000 outstanding locked up stock options (>70% owned by Directors) and 131,209 in warrants exercisable at 3.34 per share. I also divided this number by 0.785 given that the stock trades in New York (currency impact CAD/USD).
These numbers give us an enterprise value of $92.8 million. Based on the just-calculated normalized EBITDA of $16.8 million, we end up with an EV/EBITDA multiple of 5.5x. One of the company's much larger competitors Signet Jewelers (SIG) is currently trading at more than 9.9x normalized EBITDA (ex leases). Tiffany's was acquired for 16.9x pre-COVID, which is probably close to 14x post-COVID. In other words, even if we exclude any potential growth beyond normalization, which could very well happen, the stock is trading at a significant discount compared to its competitors. Some discount makes sense for illiquidity and size reasons, but the current discount does not seem to make much sense.
Liquidity & Financial Risk
As part of overall business risk, it is important to assess the company's financial situation. Especially when it comes to liquidity. As of September 30, 2020, the company has $38 million available under its $98 million Wells Fargo Canada Secured Revolver. These loans carry an interest rate of CDOR (Canadian Dollar Offered Rate) plus 1.5-3.0% with the main covenant being that Birks must have $8.5 million available under its facility or another facility at all times. Wells Fargo's collateral is high-quality inventory and everything else. Note that the company re-upped Birks in October of 2020, which I believe is a vote of confidence in the company.
The company also got a loan from Investissement Quebec valued at $10 million, with a yield of 3.14%.
In addition to that, the company is likely to receive more PPP loans if needed.
All things considered, the company has plenty of liquidity for at least 18 months (based on terrible business conditions), which given the current situation, should give the company enough time to deal with the ongoing pandemic and eliminate any bankruptcy risk.
Economic Reopening As A Catalyst
Birks Group is a micro-cap jewelry retailer that got off the grid because of losses in the past and the impact from COVID-19. The company's historic losses came from a business transformation, which now puts the company in a position to benefit from reopening economies.
Investors get to buy a company with a very low free float, and a very low short float. Therefore, this is not a short squeeze opportunity but a deep value opportunity. Right now, the stock is still very much undervalued despite being up more than 300% year-to-date.
I believe that the stock is extremely undervalued because of a few reasons. The company is very small and illiquid. This makes it impossible for large institutions to buy the stock and causes the stock to fly under the radar. Stocks this small can technically speaking rise 1,000% before anyone notices.
Additionally, the company's potential only becomes visible when digging deeper as we did in this article. The situation is far, far better than anyone would think given the challenges in 2020 and prior to the pandemic.
The company was at the end of a 3-4 year capital campaign 6 months before COVID hit. This left them with more debt than they traditionally carry at a time that stringent lockdowns in Canada shut most of their stores for periods that nearly proved fatal.
However, the company managed to avoid bankruptcy because of a $10 million investment from Investissement Quebec, and very supportive actions from Wells Fargo.
Even under current, difficult circumstances, the company has enough liquidity to last more than 1.5 years. Add to that the reopening of Canadian cities, which will improve the situation significantly and more or less eliminate bankruptcy risk.
The majority owning family has not sold a single share and is working to turn things around. I would not be surprised to see new deals overseas that would not only improve the situation as it is but add to the company's long-term growth potential.
As the economy reopens, we will likely see a focus shift on the earnings power of the Birks Group, which withstood one of the most severe retail downturns in modern history. The company, which saw flat Holiday sales despite having most of its stores closed, will benefit from a long transition and a surge in brick-and-mortar sales.
Long-term, investors will benefit from the company's ability to quickly deleverage. However, I am very optimistic that investors do not have to wait long before expecting significant gains. All it takes in the current situation is a buyer of roughly 1 million shares, which will cause a significant book imbalance and, as a result, a steep stock price increase. Keep in mind that - in this case - 1 million shares equals roughly US$3.5 million, which shows how tight the company's free float actually is.
As a result, I expect the stock to double in the short-term. My target for the summer of 2021 is US$7. That would make the stock fairly valued. However, if the reopening is a success, and the company starts to expand into new markets, I think that even US$9 per share wouldn't make this company overvalued.
Risks To Keep In Mind
As this is a micro-cap opportunity, there are a number of risks to keep in mind. The most obvious risk, completely unrelated to the company's market size, is the speed at which jewelry sales will pick up. Given the rapid increase in global stock prices, the rebound in economic sentiment, and the reopening of Canadian cities, I have little doubt that luxury sales will pick up soon. However, renewed lockdowns are a risk to bear in mind. Another risk is that the company is flying under the radar. There is next to no coverage, which makes it tricky for less-experienced traders and investors. I expect this to change. Especially once the company expands into Asia. For now, however, this is a risk to consider.
It is also important to keep in mind that the stock is illiquid. I already mentioned it, but be prepared to encounter a lot of volatility and illiquidity. This will turn into a bigger problem when trying to execute 'large' orders. The volatility can be dealt with by adjusting one's order size accordingly. Do not confuse this with the long-term dividend investments I usually cover.
Keeping in mind the very attractive valuation, the company's long-term potential, its (what I believe to be) limited short-term risks, and the expected book imbalance, I am fairly certain that I may have found one of the best risk/reward opportunities I have ever discussed on Seeking Alpha.
This article was written by
Leo Nelissen is an analyst focusing on major economic developments related to supply chains, infrastructure, and commodities. He is a contributing author for iREIT on Alpha.
As a member of the iREIT on Alpha team, Leo aims to provide insightful analysis and actionable investment ideas, with a particular emphasis on dividend growth opportunities. Learn More.
Analyst’s Disclosure: I am/we are long BGI. 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.
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