I first found Buckle in my usual screening of the weekly Value Line reports. As I made my way through the specialty retailers (American Eagle, Men’s Wearhouse, Gymboree, J. Crew, etc…), Buckle Corporation showed up as a business with great economics working in its favor and a consistent track record for growth. Normally, I try not to get too excited when I find a company as good as Buckle because they are almost invariably overpriced. Not the case with this one.
As I ran through the various specialty retailers, I consistently saw the number of stores around 800-1200 for most of the established mall-based retailers unless they had many different operating divisions (Abercrombie owns Hollister, Gap owns Banana Republic, etc…). Buckle’s store count as of today is 423 stores, leaving a large potential for future growth into more malls across the U.S. Their current expansion plans are to open between 25-30 stores every year, financing it with their strong earning power. They have kept with this expansion plan for at least the last 10 years, all the while issuing no debt and not diluting their stock. This has raised their store count from 275 to 423 through pure internal growth over the decade. Growth in sales in the business has been somewhere between 12-18% annually over the last ten years.
Management’s ability in areas often unrelated to their true business model can be a good indicator of their overall business savvy. One way this can be shown is through their ability in real estate. Their stringent requirements for opening new stores include looking for areas with prime locations, populations above a certain figure in the surrounding areas, low costs of rent & construction, and availability of good management to run the store. I can confirm this from my area in Pittsburgh, having seen two stores and spoken with employees. Both locations were directly next to food courts on the upper level of the malls, which tend to have the most traffic. In essence, they were prime locations- every customer walking into those malls had to walk past Buckle. One of the store managers told me that he has known Buckle to wait to enter certain attractive malls until better locations opened up. After having read about these requirements in the annual reports, it is great to see it confirmed in reality by one of their employees.
Also, the management structure in Buckle was one I doubt I will see repeated in many places. They have a very small corporate level of management, with 20 district managers, a regional manager, a VP of every division (sales, leasing, merchandising, etc…) and their CEO. The company’s CEO started on the sales floor 30 years ago and has worked with the business ever since. Every single VP averages about 23 years with the company, having worked their way up the same way the CEO did. In addition, each of the 20 district managers averages 21 years with Buckle. If this doesn’t signify depth to management at a company, I cannot say I know what does. I am sure any one of these district managers could operate as the CEO in virtually the same capacity as the current one. Also, with such a small team at the corporate level, it allows for clearer thinking and less politics/structure involved in decision-making. Oh, and I almost forgot, the officers and directors of the company own 45% of the stock. Management’s compensation also provides incentives to continue to create shareholder value. Their interests in the business are directly aligned with their shareholders. In the last three years they paid out a sizeable special dividend in September that has been no doubt influenced by the heavy inside ownership. I tend not to chase dividends, but it can’t hurt.
If you haven’t visited a Buckle store, the age demographic they are targeting is roughly 15-30 years of age. Their best products, consisting of roughly 40% of sales, are their denim jeans. After going through their stores, I was mainly interested by the jeans. The same manufacturing company who supplies Abercrombie & Hollister with their high-quality jeans makes Buckle Jeans; Buckle charges anywhere from $70 to $150 for a single pair. This may seem pricey, but the consumers are willing to pay. Tops are the next largest segment, consisting of roughly 30% of sales. These are much more specifically tailored to a certain type of outfit. The jeans could be worn by anyone, but once you get into brands like Affliction and Billabong for shirts, you end up attracting a very specific type of shopper. This can often hurt sales, but with such a defined niche, it is easy to see they are the leader in the specific style they are selling. The rest of their sales are distributed through belts, shoes, and various accessories. Roughly 30% of their sales are private-label, meaning they buy clothing from certain manufacturers and then slap their Buckle logo on them. 70% of their sales are brand name, meaning they purchase them from other big brands such as Hurley, Affliction, Billabong, etc… and resell them to consumers. Private-label is a much higher-margin area, however it is a smaller percentage of sales for Buckle.
Buckle’s store experience is very enjoyable (as a non-shopper, I even liked going in). Their store layout changed in 2002 and is very open; it reminds me a lot of how American Eagle is set up. Their employees are very nice and helpful; I was asked no less than 3 times if I needed any help within a 15 minute period.
Buckle also has some innovation (as far as I know) in retail. They have individual shopping appointments for customers where they can get advice on clothing from the employees and can bring in some of their clothes to match the new apparel they are purchasing. Customers I talked to love this and their employees also really enjoy finding things for people. In addition, the company has a very interesting inventory system, receiving only one of each size of their products and then assessing what is selling on a daily basis. Every store receives new merchandise daily and this drives customer traffic to continue returning to see what new things came in for the day. Any inventory that hasn’t sold quickly is shipped to another store where those types of products are selling faster. Their management believes that the cost of this daily inventory shipment is more than offset by not having to mark down prices because of increased customer traffic. Their sales rack is very small, and instead of putting the merchandise on sale, they simply ship it to another store in the area. Buckle also uses a “customer book” where they list frequent shoppers and their sizes in clothing. As new clothing comes in the store that employees feel are good for customers, they simply call the customers up individually to let them know about certain new jeans in their size or other merchandise. This type of help from employees drives customer loyalty and can crush competition.
Buckle’s closest competitor is PacSun. If you take a look at their business, you can see how much it has been destroyed by Buckle. Although they may charge lower prices, their jeans are not as high of quality, their store layout is terrible, and their customer service is nowhere near Buckle’s (I had an employee insult me at PacSun with some snide comment after being in the store just 2 minutes). PacSun was the incumbent with over 1,000 stores and Buckle found a way to undercut them. PacSun has been losing money for the last 4 years and is cutting number of stores by roughly 50-100 per year (It’s around 1,000 currently). It is very easy to point at a certain time when Buckle got large enough to drive away PacSun’s customers. Both companies sell the same brands (I even saw the same shirts being sold in both stores), however the economics behind both businesses couldn’t be more different.
Now, let’s move on from the business side to the financials. In retail, it is very easy to take a quick look at a couple key indicators of efficiency. I like to see at above 35% gross and 15% operating margins unless there is high inventory turnover, and have them be consistent year over year. Buckle’s margins are consistently at:
· 40-48% gross
· 20-25% operating
· 10-14% net
These margins have been consistently improving over the last decade as the business has grown and started to chip away at PacSun. Having 20-25% operating margins is extremely high, especially for retail. This also allows for some internal growth in shareholder value that can be measured by return on deployed capital. What I define as deployed capital is basically the money needed to operate the business, otherwise known as working capital (current assets minus current liabilities). If you divide the operating profits by the working capital, you can determine how much money the business earns from the money needed for operation. In a perfect world, you want a business that doesn’t need any money to operate; it would be great if it could just run itself. However, these extreme circumstances only occur within great businesses like Burlington Northern Santa Fe Railroad or Wal-Mart, where the working capital is consistently negative. For most companies, I like to see $0.50 operating earnings generated for each $1 of working capital, in other words 50% return on deployed capital. A business that can consistently turn a dollar held in the bank into 50 cents every year would generate enormous profits for shareholders over time. Buckle, with a return on deployed capital above 100%, generates more than $1 for each dollar of working capital. Allowing for enough time, the economics of this situation get very interesting very quickly.
As I stated before, Buckle is growing. Most retailers are twice to three times its size, such as American Eagle and Aeropostale, so I see this growth able to continue for at least another 5-10 years if they keep at their current pace. As I just described above, Buckle’s ability to earn more than $1 for each dollar of working capital allows them to generate much more money than they need to run the business. This extra cash can be reinvested in growing their company, and if you check their financials, they have never needed to raise debt to grow the business. Every single store they have opened has been a result of retained earnings and has been purely internal. They are growing annually over the decade at 10% in sales and 15% in earnings. It has accelerated in the last 5 years, at about 15% in sales and 25% in earnings. This may be due to their new centralized distribution center and their ability to shift merchandise around from store to store.
One of the other important indicators of great operational efficiency is the return on assets. This is the money generated from the total amount of assets a business owns and can be a great indicator of efficiency. Buckle generates about 25 to 30 cents for each dollar of assets, at 25-30% ROA. This measure of efficiency has been increasing over the decade, starting at 12%, up until 36% today. This figure may decrease in the future, but I do not see it changing by much; it is mostly a historical measure of the intelligence by which management has invested in their assets. Buckle has placed all of their stores in prime locations and their return on assets is the best measure to show how good their track record has been. Their clearly defined real estate strategy has them making intelligent decisions and I can reasonably assume it will continue far into the future.
I normally would have more to say about the balance sheet, but in this case their isn’t much to discuss. With no debt and all the growth in the business internally generated, there isn’t a whole lot to check out with their financial situation.
So, in summary, Buckle is a great business from every angle I can look at them. My only concerns for the future are fickle consumers who no longer like their style of clothing. This is a very real situation that occurs, but Buckle has been consistently selling to customers for at least 30 years. I do not have the resources to go Nebraska and meet with the company and speak with the marketing/sales team, but Buckle does claim to have a superior sales team who consistently stays ahead of market trends. They stand by this by claiming their 30-year track record of success in gauging their customers’ wants and needs. Granted, it is a compelling story, but until I speak with the sales team, I cannot truly believe 100% in the company. With that warning in mind, let’s go onto valuation.
I believe this company is undervalued. Every once in awhile I run into great businesses, but they are almost always overpriced. I value companies on a cash flow basis, dividing free cash flow by the purchase price. The reason for this is that if you believe in management’s ability to reinvest the earnings, every dollar of cash flow can be considered as at least a dollar paid earned by you as a shareholder. Buckle made roughly $150 million in cash flow last year. At a current purchase price of $1.25 billion ($25.50 per share), you end up with an initial return of 12%. Buckle is growing at about 10-15% per year with superior economics working in its favor. I can see Buckle, with its outstanding track record, continuing this on far into the future and doubling, if not tripling, from its current price. This is not a huge discount to net realizable assets or earning power, but allowing for time, this company will internally compound its growth and generate great returns for shareholders. You’re looking at about 7X cash flow today, which normally would be considered somewhat decent as a value investment, but it allows you to be a part of a great business at a fair price~ something Buffett often likes to talk about. The reason Buckle is selling at such a low price is the current dynamics within the retail industry. It seems to be almost conventional wisdom that whenever we hit a recession, the retail industry suffers. This is simply not the case here; Buckle hasn’t been hurt at all from 2008 or 2009. The current problems have lasted the last 3 months and stem from low customer traffic in malls and stores. A large majority of retailers I have looked at have had much lower comparable sales this past quarter than in the same quarter last year. Wall Street, being the short-minded traders that they are, allowed for me to buy into a situation with high uncertainty (will customers return any time soon?) and low risk (no debt, great expansion possibilities, great management, inside ownership). I feel as though I can wait out the storm on this one; I am not going to attempt at a guess when customers will return to malls, only to know that when they do, Buckle will go back to printing money for its shareholders.
The reason Buckle is selling at such a low price is the current dynamics within the retail industry. It seems to be almost conventional wisdom that whenever we hit a recession, the retail industry suffers. This is simply not the case here; Buckle hasn’t been hurt at all from 2008 or 2009. The current problems have lasted the last 3 months and stem from low customer traffic in malls and stores. A large majority of retailers I have looked at have had much lower comparable sales this past quarter than in the same quarter last year. Wall Street, being the short-minded traders that they are, allowed for me to buy into a situation with high uncertainty (will customers return any time soon?) and low risk (no debt, great expansion possibilities, great management, inside ownership). I feel as though I can wait out the storm on this one; I am not going to attempt at a guess when customers will return to malls, only to know that when they do, Buckle will go back to printing money for its shareholders.
Disclosure: Long in Buckle, no position in Wal-Mart or PacSun, or any other companies mentioned