Buckle Long Pitch
High margin retailer benefitting from internal merchandising efforts, competitors exiting and a new denim cycle at 7.1x 2022 EPS. Upcoming special div -13% yield (next week) to trigger short squeeze.
Buckle (BKE) Long Pitch:
BKE is a 25% EBIT margin denim retailer with 441 locations mostly in rural America. Company has been knocking it out of the park, YTD Q3/21 sales & EPS are up 45% & 195% compared to YTD Q3/19. Despite this, the company is trading at 7.1x my 2022 EPS (ex. cash) which is a discount to the company’s historical average (~12.0x). The market thinks sales increases have been driven largely by federal stimulus and sales/earnings will fade into 2022+. This is incorrect and the core drivers have been: 1) internal merchandise initiatives and 2) competitors exiting the market. Both of which will remain and BKE will maintain positive Same Store Sales Growth (SSSG) into 2022-2023. BKE also benefits from medium trends such as a new denim cycle, de-urbanization and a rebound in oil. This opportunity exists because BKE has a nonpromotional management team and little sell side coverage (3 analysts) and while this will not necessarily change, I expect a special dividend of $6.33/13% yield in December, which the street and the investors short (30% of the float) cannot ignore. At 12.0x FY2022 EPS of $5.49 + adding back $7.10/share of excess cash, my upside target price is $73, a 50% premium to BKE’s current price.
Business Description:
Locations and inventory skew towards rural America and denim.
Operating margins are higher than public peers Abercrombie & Fitch (ANF) and American Eagle (AEO) because: 1) High private label mix (40% for BKE in FY2020) and 2) Most of locations are in B-malls with lower rent expense.
SSSG – Not Driven by the Stimulus:
BKE is trading at 8.1x my 2022 EPS (ex. cash), compared to the 5-year average NTM Cons EPS of 11.0x and 12.0x-16.0x the last time they reported positive SSSG (2012-2014).
Source:Koyfin
Despite trading at a trough multiple, BKE is hitting all time highs in operating metrics – SSSG, EBIT margin, Sales/sq. Ft and EPS.
Market is pricing in peak earnings, predicated under the assumption that SSSG has been driven largely by federal stimulus. BKE has increased revenue YTD Q3/21 vs. YTD Q3/19 well ahead of peers, stimulus alone cannot explain this.
Starting in 2014, BKE went through a deep inventory reset after years lackluster SSSG. The company used to sell $110 jeans, and that market moved away from them and now they sell $70 jeans and it took them 5 years to successfully cycle through that. On top of this, BKE expanded the sales of its footwear and youth categories in 2019. On the latter, BKE started a new initiative of youth stand alone stores, as well as expanding youth product in existing stores.
This is apparent when looking at when SSSG troughed, Q2/19, a full year prior to the pandemic - when BKE’s initiatives started to kick in.
BKE also benefitted from several of their competitors closing during the pandemic, which accelerated SSSG in 2020/2021:
Consensus (3 analysts) numbers are conservative - Q4/21 revenue is expected to be a 0.80% increase y/y, compared to Q3 2021 YTD increase of 58% y/y. Below shows the delta bewteen consensus numbers and mine.
BKE continues to put up strong monthly y/y sales, despite tough comparables.
All of the noted factors gives me confidence BKE can put up 3% SSSG in FY2022/FY2023.
Store Count – No Longer Shrinking - Market Realizing the Value of Brick & Mortar:
During 2015-2020, years of negative SSSG pressured margins and BKE began closing underperforming stores. The bear narrative was ecommerce competition was a secular headwind, particularly impacting BKE due to outsized presence to B-malls. BKE’s performance during COVID and thereafter ultimately proved this to be false. Prior to COIVD online sales represented 12% of sales, 21% of sales in 2020 (peak COVID), dropped back down to 12% of sales in 2021. There is a clear preference for BKE’s omni-channel offering, as consumers opted to shop in store when the virus subsided. In apparel, this is largely driven by trying clothes on in person and stores becoming integral as distribution hubs and convenient places for shoppers to pick up and return online purchases. Not to mention, the ecommerce only business model has yet to be proven as being economical (DTC brands have started to open up physical stores). WSJ has an interesting article on the topic. https://www.wsj.com/amp/articles/e-commerce-needs-real-store-locations-now-more-than-ever-11637836200.
Management does not give forward guidance, but they claim they are comfortable with their current store footprint. As a result, I think net store closers are finished. SSSG and Sales/Sq. Ft indicate unit level performance is healthy. In my model I keep net store count flat, but one can argue for net store count growth going forward, which would be a catalyst for the stock. This would be driven by BKE’s success with stand alone Boys 8-20 and Girls 7-14.
Outer Years BKE Benefits From 1)New Denim Cycle, 2)De-Urbanization Trend and 3) Oil Rebound:
BKE has a strong multi-year outlook which will drive positive SSSG for the next 3-4 years. These trends are harder to quantify/model:
New Denim Cycle: The last “fit shift” (skinny jeans in late 2000s) lasted 5-10 years. Now the industry is referring to a new denim cycle (wider leg / higher waist) alongside a new silhouette (tight- and loose-fitting tops). This could drive a multi-year replacement cycle. “We are in the early stages of a new denim cycle that could drive revenue and profit growth for the next 5 years (at least).” – LEVI Q2 2021 Earnings Call.
De-Urbanization Trend: As a result of COVID I see lasting lifestyle tailwinds from Work From Home/Hybrid Work From Home policies that structurally enables people to live further away from city centers than ever before. This in turn causes more people to live in rural areas. In addition, there has been state migration to Texas (12% of store count).
Oil Rebound: BKE’s Texas stores were negatively impacted by the peak in US rig count in late 2018/early 2019. If recent high oil prices were to persist, this may cause US oil production to ramp and the underlying economy in Texas to do well, which would increase demand for apparel in BKE’s Texas stores.
Margin Expansion Driven by Supply Chain Issues and Increased Bargaining Power With Landlords:
In the beginning of COVID retailers canceled orders, as supply reduced, demand came back in strong, faster than the supply chain could allow. This resulted in rightsized inventory, and thus no heavy discounting. This has been an industry wide and has likely contributed to high gross margins at BKE. Supply chain issues are likely to persist well into FY2022, therefore I expect GMs to remain consistent. BKE has done a good job of sourcing inventory and management feels comfortable being able to continue to source inventory to meet demand.
With the large amount of store closures, retailers have been able to effectively negotiate lower rents than pre pandemic. BKE has mentioned this dynamic on conference calls but has not quantified the magnitude. Levi’s has claimed that they have been negotiating rents that are 15% lower than pre-pandemic levels.
Macro:
Despite my belief that idiosyncratic reasons have driven the increased sales at BKE, the biggest risk for the retail sector is that this is peak earnings. I think the interim cash generation, which will be returned to shareholders and the structural cost savings (reduced store footprint and lowering of rents) adequately protects downside. That being said, there is a number of reasons why I think industry apparel sales will be sustained.
Due to the large drop in sales experienced in the beginning of the pandemic, trailing twelve-month US apparel sales is marginally above trend and trailing twenty-four months is still below trend. This indicates pent up demand for apparel, especially as people adjust to new fashion styles and clothing sizes.
In addition, checkable deposits are still at elevated levels, implying there is still a lot of excess money in the system that can be used for apparel purchases.
Why This Stock is Mispriced:
BKE is a Midwest company with a nonpromotional management team. They do not do conferences, CEO only talks with investors on conference calls and management does not provide guidance. BKE also has sparce sell side coverage, they do not do banking business with the street and has a low market cap – US$2.6bn.
Catalyst in Capital Allocation:
CEO/ Chairman own 33% of the stock. As a result, the company pays shareholders a special dividend every year in early December. The payout is typically the cash on the B/S in excess of $225mm. I expect a special dividend of $326mm or $6.33/ share (13% yield). This has the potential to drive a short squeeze (~30% of the float is shorted).
Valuation:
Last time BKE reported positive SSSG it was trading at 12.0x-16.0x fwd eps. I think 12.0x is a fair multiple for a company with a 25% EBIT margin/30% ROIC, management team that returns cash to shareholders and can grow SSSG for the next 3-4 years. I expect a 50% TSR by H1/2022.