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Indigo: Book Retailer Facing Pandemic Headwinds But With Strong Balance Sheet And 114% Jump In E-Commerce

Jan. 25, 2021 9:57 PM ETIndigo Books & Music Inc. (IDGBF)
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Summary

  • Indigo Books & Music has seen foot traffic fall significantly during the pandemic. However, their balance sheet strength and e-commerce growth are a couple of positives.
  • As of Fiscal 2021Q2, they had no debt and held C$137.5M in cash, versus C$46.6M a year ago.  But mostly the increase is from working capital, including deferred rent payments.
  • Total liabilities are up by 32M since a year ago, which includes around ~16M of rent payments that were suspended during concession negotiations.
  • Online sales increased by 113.6% year-over-year in 2021FQ2, making up close to 31% of total sales.  Total sales grew by 0.9%, in contrast to a -10% decline in 2019FQ3.
  • Meanwhile, the share price is down about -84% relative to highs three years ago, and there has been only minimal dilution over the years.

Indigo Books & Music Inc. (OTCPK:IDGBF) is Canada's largest book, gift, and specialty toy retailer, with a market cap of about C$88M. They have a reasonably strong balance sheet, strong e-commerce growth, and have so far navigated the pandemic, but new covid variants are on the horizon and additional lockdowns have taken place both in FQ3 and at the start of this year. 2021FQ3 results, which include the "all-important" holiday season (typically about 40% of annual sales), should be announced sometime in the next couple of weeks, and it will be interesting to get an update and see how the market reacts.

Apart from the pandemic, Indigo competes directly with a juggernaut like Amazon, so there are good reasons to be cautious about investing. But I have shopped at Indigo over the years, have found them to be competitive online, and after seeing the 2021FQ2 results, decided to take the plunge and go long. There has been a roughly 50% rally since then, and this blog post goes over some of the pros/cons of being invested, as I see it -- it is clearly not a complete assessment.

Some Pros/Cons for an Investment Case

A few positive aspects jumped out at me:

  • As of 2021FQ2, which ended September 26, 2020, they had a strong balance sheet with no outstanding debt and a cash position of C$137.5M (book value was around C$32M, and of course, they do have lease liabilities).
  • This compares to a market cap of ~C$88M, as of January 22.  The share price is down 84% from all-time highs, without significant dilution, although it's down only 10-15% from just prior to the pandemic. 
  • Cash flows have been positive (+17M fiscal year-to-date), although mostly from working capital and including deferred rent payments of what looks like around C$16M.
  • They've also entered into a C$25M revolving line of credit, for additional liquidity availability, which was undrawn as of 2021FQ2.
  • Online sales increased by 113.6% year-over-year, making up close to 31% of total sales. This allowed them to eke-out sales growth of 0.9% in 2021FQ2.
  • Despite the slow vaccine roll-out, the Canadian government is still claiming that all Canadians who want a vaccine can get one by September.

On the other hand:

  • Total liabilities increased by 32M from a year ago.  Their book value has declined to around 32M (2021FQ2) versus 84M (2020FQ4). Note that there is a seasonal build-up in liabilities, leading into the holiday season.
  • There have been additional Covid-19 lockdowns, and perhaps more are to come, which should significantly dent sales in the next couple of quarters, at least.
  • Prior to the pandemic, in FY2020, there was negative sales growth (-10% in 2020FQ3) and a drop in profitability, which seems to have been a key reason for the share price decline over the last 3 years.
  • Apart from the principal shareholder Gerald Schwartz, insider ownership is not really that strong. The CEO did buy C$0.99M of stock in August, with an average share price of C$1.85.

With a slow vaccine roll-out in Canada, and more contagious covid variants that have appeared, intermittent lockdowns could be an issue throughout 2021 -- Ontario's recent state of emergency is the latest example. It's always hard to say how much of this the market is already factoring in.

There were some bullish articles on SA over 2014-2018, until the share price took a turn for the worse in mid-2018 and tanked since then.  A main reason for this is presumably a decline in total and online revenues -- sales declined by 8.0% for the 39-week period ended in December 2019 versus the prior year.  The decline for FY2019 was 3.0%.

Indigo's explanation was a strategic reduction in promotional activity, to improve profitability.  This sounds plausible, and I can't help but wonder if the -84% share price decline over the last three years is overdone, especially with essentially flat sales in the most recent reported quarter, in the middle of a pandemic, no less.

On the balance, I would view Indigo as a company worth keeping a tab on, with pandemic-related volatility potentially creating some trading opportunities. I think there could be longer-term speculative upside, as well, based on the idea that there could have been an overreaction to short-term underperformance prior to the pandemic.

In terms of downside, I expect that a relatively strong balance sheet should get Indigo through the pandemic, but with more lockdowns ongoing across Canada, short-term share price risk looks weighted to the downside. The pandemic could also weaken them for the longer-term by an increase in liabilities.

Some Comments about the Business

Apart from books, magazines, and eReaders (~61% of sales), Indigo sells home and lifestyle products, e-books, toys, and electronics (~36.5% of sales), and has some other revenue (e.g. cafés and loyalty program revenues: ~2%+ of sales). 

They describe themselves as a "cultural department store", a term that I concede is somewhat cringe-worthy given the retail apocalypse and investor sentiment around that.

I've had a positive experience shopping at Indigo. The selection and online prices for books and other printed products are competitive with Amazon, and I've found shipping times to often be slightly better than Amazon. One place where Indigo's website is lacking is in fewer customer reviews and "recommendations" that could use a lot of improvement.  As a result, I have often searched and browsed on Amazon, before buying on the Indigo website.

Indigo's brick and mortar stores are nice to browse through, but prices are often noticeably higher (e.g. 10% or more) than their own website.  This has been the case for a while, so it might be supportable in terms of price discrimination with respect to consumers that want an in-person shopping experience (maybe the pandemic will end up changing that). Despite a gradual shift to include more of other categories, floor space is still largely dedicated to books. 

I'd expect that the +114% jump in e-commerce growth is more a testament to having some brand value, customer loyalty in the face of the pandemic, and ability to execute on the e-commerce front, rather than signalling a start of continued epic e-commerce growth. We will see. 

Conclusion

After an abrupt rally in December, I'm not adding more shares at the moment, and have instead cut back somewhat on my position. With the (recently) strong balance sheet and robust e-commerce growth, I think that survival is not really a concern, but the pandemic might nevertheless take its toll through increased liabilities and reduced book equity value.

Ultimately, the last two quarters aren't really enough to figure out what normalized performance looks like amidst intermittent lockdowns.  My default plan for now will be to trade around the edges of a core speculative position.  

A big question will be the extent that they can find a path to long-term growth and sustained profitability -- if the declines mostly in FY2020 just prior to the pandemic turn out to be an anomaly (big if), then I'd expect that there would be further upside to come.  I will be looking forward to the results over the next year or so, for clues in that regard, and their performance during these uncertain times.

Analyst's Disclosure: I am/we are long IDGBF.

As usual, this is not financial advice! My views could change at any time, particularly if material new information becomes available. You're responsible for your own due diligence.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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