Portfolio manager’s Letter June 2000
Abercrombie & Fitch (ANF), American Eagle Outfitters (AEOS), Buckle (BKE), and Pacific Sunwear (PSUN), are four Small retailers with a lot in common. There are all small Cap stocks that target basically the same customers. They operate primarily in Regional Malls and target younger consumers, Men and Women between the ages of 16 – 34.
They are all profitable, growing revenues rapidly and with the exception of Pacific Sun have large cash reserves. My guess is that their growth is coming out of the revenue of the large department stores, that young shoppers have grown used to shopping at mall specialty stores and now prefer them to large department stores.
Abercrombie & Fitch, and American Eagle Outfitters sell private label Merchandise and Buckle and Pacific Sunwear selling a mix of name brands and private label. PSUN = 64% name brands, and BKE sells 85% name brands.
Below are several tables with financial data of these four companies plus the Gap (GPS) as a basis for comparison to a bigger older company with a similar business.
Market Capitalization
All four companies are small capitalization and selling pretty cheap in terms of price to sales or PE ratios.
| Market Capital (Mil) | Sales (Millions) | Sales/Market Capital | PE Ratio | |
| AEOS | $796 | $832 | .96 | 9.1 |
| ANF | $860 | $1,042 | .83 | 5.9 |
| BKE | $269 | $375 | .72 | 8.2 |
| PSUN | $646 | $436 | 1.48 | 17.8 |
| GPS | $29,379 | $11,635 | 2.53 | 26.3 |
Cash
AEOS, ANF, and BKE, have a lot of cash, particularly when compared to their big brother, Gap. None of the companies except Gap have any debt. Buckle has a very conservative balance sheet (Current Ratio = 4.09).
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Cash (Millions) | Estimated Cash Flow 2000 | Current Ratio | Est. Cash Avail. 2000 |
| AEOS | $168 | $102 | 2.97 | $271 |
| ANF | $193 | $177 | 2.18 | $370 |
| BKE | $82 | $47 | 4.09 | $128 |
| PSUN | $32 | $50 | 2.83 | $82 |
| GPS | $450 | $1,563 | 1.25 | $2,013 |
Store Growth 2000
This table shows estimate of cash available from 1999 balance sheet and cash flow for 2000. It also shows an estimate of the amount needed to fund store expansion in 2000. The last column attempts to estimate the percent of available cash that will be needed to fund the store expansion. Again Buckle’s expansion is very conservative and Gap is pushing their expansion as fast as they can. Trying to keep their earnings expansion at a level that will justify a high PE for the stock.
| Stores open 1999 | New Stores 00 | Cash Required | % Cash Committed | |
| AEOS | 466 | 90 | $118 | 43.5% |
| ANF | 250 | 90 | $187 | 50.4% |
| BKE | 260 | 28 | $20 | 15.4% |
| PSUN | 450 | 125 | $56 | 68.5% |
| GPS | 3018 | 600+ | $1682 | 83.6% |
Store Size
This table shows the average square feet per store, the sale per square foot and the total gross square feet leased by the chain.
| Sale / SQ.FT. | Sales per Store (000) | Total SQ.FT. | Ave. SQ. FT. / Store | |
| AEOS | $451 | $1,785 | 2,039,380 | 4376 |
| ANF | $512 | $4,550 | 2,171,400 | 8686 |
| BKE | $334 | $1,581 | 1,124,251 | 4324 |
| PSUN | $398 | $1,084 | 1,254,373 | 2787 |
| GPS | $548 | $3,855 | 23,976,100 | 7945 |
Lease Commitments
While these four companies have no debt, this is not quite as good as it sounds. All their stores are leased. The leases are usually for ten years. They involve a total minimum lease commitment that is shown in the second column in this table. A lease obligation has many of the same characteristics as debt (it comes before shareholders in a bankruptcy). If lease obligations were viewed as debit, the balance sheets of these companies would not be anywhere near as pretty as they are without it. The very conservative approach of buckle looks a lot more rational in this table.
Buckle Started in the Midwest and has many of its stores in smaller cities I suspect this explains why their Rent is a smaller percent of sales. An interesting strategy, but hardly an original idea. Has anyone heard of Bentonville Arkansas?
| Rent/Sales | Lease payments (M) | Shareholder Equity (M) | Equity Percent | |
| AEOS | 9.2% | $403 | $264 | 39.6% |
| ANF | 7.7% | $520 | $311 | 37.4% |
| BKE | 5.6% | $175 | $163 | 48.2% |
| PSUN | 11.8% | $344 | $161 | 32.0% |
| GPS | 7.0% | $4,635 | $2,233 | 32.5% |
With these numbers, at least three of these companies appear attractive, they are cheap, they have the ability to grow 20% per year and they generate enough cash from operations to fund that growth. Anytime you can find a company that can grow 20% with out using debt you have the potential for a big winner.
There are problems of coarse, otherwise the stocks would not be so cheap. Some Sort term problems are obvious. With the Fed raising rates it is now likely that retails sales are not going to be as strong next year as they are now. A lot of that has been discounted by the current correction. ANF and AEOS are adding stores like crazy in the face of the FED’s tightening, this may prove to have been a bad decision.
If their cash flow goes below estimates they could have problems funding their expansion. Recent SSS sales at Buckle an ANF have been down. This could cause problems at ANF because it comes at a time when they are trying to expand their store base by 36% in one year.
PSUN has not corrected to the same extent that the other three stocks have and would appear over priced on that Basis.
GPS while the biggest and the most expensive of the companies would appear to be the least attractive on the basis of the numbers above. This should come as no surprise, in a market that overvalues big cap and undervalues small cap. How long this overvaluation will continue we have no way of knowing, but if you are buying stock to hold for the long term. It would seem reasonable to expect that the market will eventually revert to its mean, which says that over the long run small stocks will provide higher returns than big companies.
Stock buybacks can be an important indication of how management responds to interests of shareholders, but only if it represents the best use for available funds. The prices of these stocks are attractive, and buybacks would be an easy way to raise per share earning. Buckle announced a small share repurchase last year, but it would appear that have resources to pursue a more aggressive program. ANF announced a six million share buyback but with their aggressive expansion and a possible economic slow just over the horizon, it is possible they may have trouble finding the cash to complete it.
My favorite of the group is Buckle. They are definitely have the most conservative management of the group, and that makes me more comfortable in the face current uncertainties. But ANF and AEOS have better numbers for the last two years, and despite near term problems, either of these could eventually be the leader in this niche. One or maybe two of these stocks could turn out to be a ten bagger.
They have been able to target a market that responds to their merchandising and take business away from bigger stores. There have been some great success stories in retailing Home Depot, Wal-Mart, Costco, but for every winner there are probably ten losers. The next six months may go a long way in telling us if any of these stores will become a big long-term winner.
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