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A Mediocre Read (BKS)
With a new Harry Potter book due out in a couple months, big-name bookseller Barnes & Noble (NYSE: BKS) seems positioned to make a killing, but the truth is that block-buster books don't do much for retailers. Barnes & Noble is a giant in the bookselling industry, but it is now and having difficulty in competing with big-box and online businesses.
Barnes & Noble (NYSE: BKS) is one of the largest retailers of books, magazines, music and movies direct to the consumer. BKS operates 681 Barnes & Noble stores, 118 B. Dalton stores (Malls) and a website to sell book through the internet. BKS also owns 74% interest in Calendar Club and operator of seasonal kiosks. The superstores operate in all 50 states plus the District of Columbia. The superstores are quite elaborate and the pre-opening campaign is typically launched with a print and radio advertising blitz. The opening of new stores is quite capital intensive.
A Tough Business
The extent of BKS's retail network and the high capital requirements has kept extensive competition in the mass selling book markets low. BKS has about 17% of the consumer book market.
High fixed costs, high working capital and the absence of pricing power over either customers or suppliers make it difficult for BKS to earn an adequate return above its cost of capital. The positive to this difficult operating environment is the book business is quite stable and is not very sensitive to economic fluctuations. The margins are very low, but stable and typically work in a counter intuitive manner. Mega-selling books carry low margins while the quarters without a block-buster (lower sales) have better margins.
Signs of Trouble
The fourth quarter for BKS was a bit of a disappointment. Sales growth was expected to be in the 4% to 5% range. Sales came in at 3%, 2% if you exclude the extra week. Comparable store sales were especially disappointing as they declined 0.1%. Although gross margins held firm, the net margins were whittled away by escalating costs. SG&A expenses increased over 10%, depreciation and amortization also increased 10% and pre-opening expenses nearly doubled to $2.41 million. The result was that operating profits were slim at $218.66 million or 1.9% of revenues. Operating margins did expand 60 basis points to 11.64%. Net profits rose a mere 3.25% to $127 million. (To learn more, see What Is A Cash Flow Statement? .)
In addition to its operating problems, BKS was rocked with severe options backdating problems. In April 2007, an internal investigation found the company stock-grant practice lacking. Fortunately, despite the backdating problem the company announced that it will not be restating numbers as there was little material impact.
This poor performance comes at a time when big-box retailers like Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) are making a push to expand their book offerings. Additional pressure is coming form online book seller Amazon.com (Nasdaq: AMZN). Wal-Mart and Target stock best sellers which make up about 50% of the book-selling business. The has had the effect of stagnating BKS's profit over the last four years.
Strong Financials
Despite having a return on capital employed of just over 9%, BKS has dramatically improved its balance sheet since its spin-off of Gamestop (NYSE: GME) in 2004. Its debt to capital is a conservative 19.5% and BKS has about $400 million in cash on its balance sheet. BKS has been a fair generator of free cash flow. Last year free cash flow was nearly $140 million; however, with current operating issues, that is expected to decline.
Upcoming Fiscal Year
In an effort to stimulate sales, BKS has announced a customer loyalty program. This will have a short-term impact on gross margins, but the expectation is to increase sales over the long-term. In order to trim costs, BKS has closed one of its distribution centers. Comparable stores sales in the first quarter (and full fiscal year) are expected to flat to slightly positive as the affects of the new loyalty program will not be fully felt. The charges from the closure of some facilities will lead to approximate losses of eight cents to 12 cents per share in the first quarter. The full-year forecast for warnings is expected to be $1.49 to $1.67, down for the prior year.
Risks
BKS is facing two primary risks:
1 - Increased competition from Borders (NYSE: BGP), Amazon, Target and Wal-Mart
2 - Failure to maintain market share. BKS is attempting to cut its costs, but it remains vital to maintain market share through expansion.
BKS needs to focus on its core book business.
Valuations
The earnings growth rate for BKS is expected to be around 7.5%; P/E is around 19 times and price/cash flow of 8.2-times. Given the difficult first half of the year that BKS expects, the stock is liable to come under some selling pressure. If BKS is able to stabilize its earnings and continue to generate free cash flow, the shares may attract interest from private equity firms. The chairman owns about a 20% stake in the company. The balance sheet is conservatively leveraged, and the business is fairly stable which is attractive to the private equity model. There is no current indication that the company has any interest in going private or in doing any type of acquisition to help leverage its growth, however BKS shows attributes of a company that is suited to those types of transactions.
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Barnes & Noble (NYSE: BKS) is one of the largest retailers of books, magazines, music and movies direct to the consumer. BKS operates 681 Barnes & Noble stores, 118 B. Dalton stores (Malls) and a website to sell book through the internet. BKS also owns 74% interest in Calendar Club and operator of seasonal kiosks. The superstores operate in all 50 states plus the District of Columbia. The superstores are quite elaborate and the pre-opening campaign is typically launched with a print and radio advertising blitz. The opening of new stores is quite capital intensive.
A Tough Business
The extent of BKS's retail network and the high capital requirements has kept extensive competition in the mass selling book markets low. BKS has about 17% of the consumer book market.
High fixed costs, high working capital and the absence of pricing power over either customers or suppliers make it difficult for BKS to earn an adequate return above its cost of capital. The positive to this difficult operating environment is the book business is quite stable and is not very sensitive to economic fluctuations. The margins are very low, but stable and typically work in a counter intuitive manner. Mega-selling books carry low margins while the quarters without a block-buster (lower sales) have better margins.
Signs of Trouble
The fourth quarter for BKS was a bit of a disappointment. Sales growth was expected to be in the 4% to 5% range. Sales came in at 3%, 2% if you exclude the extra week. Comparable store sales were especially disappointing as they declined 0.1%. Although gross margins held firm, the net margins were whittled away by escalating costs. SG&A expenses increased over 10%, depreciation and amortization also increased 10% and pre-opening expenses nearly doubled to $2.41 million. The result was that operating profits were slim at $218.66 million or 1.9% of revenues. Operating margins did expand 60 basis points to 11.64%. Net profits rose a mere 3.25% to $127 million. (To learn more, see What Is A Cash Flow Statement? .)
In addition to its operating problems, BKS was rocked with severe options backdating problems. In April 2007, an internal investigation found the company stock-grant practice lacking. Fortunately, despite the backdating problem the company announced that it will not be restating numbers as there was little material impact.
Strong Financials
Despite having a return on capital employed of just over 9%, BKS has dramatically improved its balance sheet since its spin-off of Gamestop (NYSE: GME) in 2004. Its debt to capital is a conservative 19.5% and BKS has about $400 million in cash on its balance sheet. BKS has been a fair generator of free cash flow. Last year free cash flow was nearly $140 million; however, with current operating issues, that is expected to decline.
Upcoming Fiscal Year
In an effort to stimulate sales, BKS has announced a customer loyalty program. This will have a short-term impact on gross margins, but the expectation is to increase sales over the long-term. In order to trim costs, BKS has closed one of its distribution centers. Comparable stores sales in the first quarter (and full fiscal year) are expected to flat to slightly positive as the affects of the new loyalty program will not be fully felt. The charges from the closure of some facilities will lead to approximate losses of eight cents to 12 cents per share in the first quarter. The full-year forecast for warnings is expected to be $1.49 to $1.67, down for the prior year.
Risks
BKS is facing two primary risks:
1 - Increased competition from Borders (NYSE: BGP), Amazon, Target and Wal-Mart
2 - Failure to maintain market share. BKS is attempting to cut its costs, but it remains vital to maintain market share through expansion.
BKS needs to focus on its core book business.
Valuations
The earnings growth rate for BKS is expected to be around 7.5%; P/E is around 19 times and price/cash flow of 8.2-times. Given the difficult first half of the year that BKS expects, the stock is liable to come under some selling pressure. If BKS is able to stabilize its earnings and continue to generate free cash flow, the shares may attract interest from private equity firms. The chairman owns about a 20% stake in the company. The balance sheet is conservatively leveraged, and the business is fairly stable which is attractive to the private equity model. There is no current indication that the company has any interest in going private or in doing any type of acquisition to help leverage its growth, however BKS shows attributes of a company that is suited to those types of transactions.
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