Cabela's Shoots for Higher Profitability

By Tom Gibbs - June 20, 2012 | Tickers: AMZN, BBY, CAB, HD, SPLS | 0 Comments

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Cabela’s (NYSE: CAB), much like other specialty retailers including Best Buy (NYSE: BBY), Staples (NASDAQ: SPLS), and Home Depot (NYSE: HD) has always maintained a very large and close-knit base of captive customers due to its narrowly focused operations in the outdoor and sporting goods product markets.  The retailer, which once relied almost solely on direct-to-consumer catalog ordering, made a huge splash into the brick-and-mortar sector, and has significantly expanded its store base following its 2004 IPO. 

Despite the outlets having an almost destination or tourist appeal due to their cavernous showrooms and impressive displays of taxidermied wildlife, large aquariums, and indoor mountains, the corporation has always generated average profitability. Sales, for example, have increased at a respectable 7.7% CAGR between 2005 and 2011, yet return on invested capital has averaged 12.1% over the same time period. 

The corporation’s return on invested capital of 14% in its most recent fiscal year represents a meaningful performance improvement over recent recessionary trough-like levels.  There are several key reasons why Cabela’s investors may continue to enjoy returns higher than the corporation’s historical average.

More Favorable Sales Structure

The corporation’s historical focus on direct-to-consumer catalog-based sales has gradually been placed in the shadow of its growing store base.  Cabela’s is still relatively new to the brick-and-mortar space, as the corporation only operated ten outlets at the time of its 2004 IPO.  The total store count has increased more than three-fold over the past seven years, and the retail reporting segment now constitutes more than 50% of the corporation’s annual sales, yet the venture into the brick-and-mortar space seems to have been handled with an almost guess-and-check type mentality.

In the three years following Cabela’s entry into the capital market, the total number of employees doubled (7,800 to 15,000) to man the corporation’s 27 retail outlets, its growing online presence, and its legacy catalog business.  At the same time, however, total sales per employee and sales per square foot dropped by more than 21% and 16%, respectively, and comparable store sales decreased by more than 6%.  The transition away from the mainstay in catalog sales was not extremely smooth.

After several years of slightly increasing sales and rather mediocre profitability, however, Cabela’s management seems to finally have a strategic plan to handle its brick-and-mortar, Internet, and catalog-based businesses in unison. 

• Improved Sales Channel Mix

The Cabela’s catalog has gradually evolved to become more of a continued advertisement for the corporation’s retail website than a source of mail-in or call-in sales orders.  As such, the corporation has been able to continuously decrease the total number of pages it mails and simultaneously increase its total website traffic.

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Pages in millions (left axis).  Website visits (right axis) intended to show percentage increase in visitors each year after the established base level of 1000 visitors in 2004.  Cabela’s website has become, over the past several years, the most visited outdoor retail website (Hitwise, nearly 2000 outdoor websites surveyed).

Nearly $30 million has been saved over the past three years as a result of the shift in catalog strategies.

Likewise, assuming that consumers continue to move beyond their high price elasticity as the economy further improves, the more targeted marketing strategy will naturally help to boost margins.  Through Cabela’s loyalty program (Cabela’s Club Visa card), a more systematic tracking of likes/dislikes through past purchase examination can be achieved.  Much like an Amazon.com (NASDAQ: AMZN) –esque marketing initiative, a higher willingness-to-pay can be exploited by mailing shorter, more targeted ads (in terms of products highlighted) to specific loyal customers.  The corporation’s loyalty program grew at a 10% CAGR between 2008 and 2011 and now contains nearly 1.5 million active members.   A continued growth in the loyalty program, the use of focused ads, and the increase in website traffic will only give way to a higher level of sales that increasingly costs less to generate. 

The proof of the strategy’s effectiveness is available in the corporation’s post-IPO performance.  Although average Internet/catalog sales between 2009-2011 were 2.5% less than average sales between 2004-2006 – due primarily to unfavorable macro dynamics in the retail sector – average operating margins were nearly 100 basis points higher in the latter three-year period.  As the shift from catalog to Internet-based sales progresses and further marketing efficiencies are unlocked, more dollars will fall to Cabela’s bottom line as the general retail landscape improves. 

• More Efficient Brick-and-Mortar Operations:

From their 2007 high, the number of employees has been subsequently cut by nearly 9%.  This streamlining initiative has naturally improved many of the retailer’s profitability metrics: sales per employee have increased more than 24%, sales per square foot has improved by 4%, and average comparable store sales have increased nearly 7%.  These are minor improvements, but improvements nonetheless.  Cabela’s should continue to experience further brick-and-mortar profitability gains in the future as the inherent structure of its physical stores change.

Small is the new…Big?

Having a system of stores that are viewed as a tourist attraction of sorts is something that many retailers cannot claim.  Cabela’s Kansas City location has experienced some years with over 4 million visitors per year, and the “cool” factor of the locations has boosted popularity, loyalty, and sales.  Retail outlets should be graded on a profitability basis, however, and stores that inherently require a disproportionately high level of capital expenditures, employees, and floor space vs. movable merchandise are undoubtedly less attractive. 

In its most recent annual filing, company management highlighted the rollout of certain smaller “core flex” stores that should drastically improve the corporation’s overall profitability in its retail segment.  These stores, which are three times smaller than the average store size, will actively target underserved areas with around 250,000 residents.  Six stores (17% of the existing store base) are to be constructed in 2012. The same smaller footprint growth strategy has been utilized by other big box specialty retailers including Best Buy and Staples.

Assuming that the concept catches on with consumers and the corporation continues to supplement its larger stores with these more niche-focused outlets in the future, profitability should receive a significant boost.  First, these stores will carry the fastest moving goods with the highest margins in Cabela’s portfolio.  The concept is similar to Best Buy’s Mobile stores, which leave behind slower moving flat screen televisions and larger appliances and focus heavily on fast moving and profitable smartphones, tablets, and laptop devices.  Best Buy has experienced such impressive results with these outlets that it plans to shutter all of its United Kingdom big box locations in favor of a more regional roll-out of Mobility stores.  Amazon.com has also followed suit, and plans on opening several stores in the Seattle region that focus on fast moving Kindle e-readers, Amazon exclusive books, and accessories. 

Less profitable hard goods (i.e. firearms) have only acted to dampen Cabela’s retail store margins over the past several years, so a more focused attention on the core inventory mix in the smaller store concept will act to further margin expansion.  The large showroom experience in Cabela’s existing stores is definitely a nice touch, but when considerable portions of the outlets are filled with less profitable merchandise simply for the sake of filling up space and creating a captivating in-store environment, the concept only appears less attractive on annual financial statements.  The corporation is definitely headed in the right direction by shifting the trade-off between profitability and an in-store “wow” factor more in its favor. 

Cabela’s has proven over its half-century existence that a focused offering of specialty merchandise to a targeted group of consumers is one of the best ways to captivate customers and build a deep economic moat around a given consumer brand.  The ability to successfully shift the entire dynamics of its business, for example – from traditional catalog-based sales to a more Internet/brick-and-mortar based strategy – further highlights the sustainable competitive advantage the retailer has constructed.  Although each of the small improvements Cabela’s has made over the past several years to boost margins is small in individuality, an entirely new level of profitability should be reached as the general retail environment continues to improve from its mid-recessionary trough.

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