This Small Growing Retailer Seems to be a Good Buy Now

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As a value investor, I always look for small cap companies, which have historical and potential growth. Those companies might operate in different industries such as consumer goods, chemicals, retailers, etc. I become excited when those small cap growth companies are selling at a discount to its intrinsic value. That was what I felt about Zumiez (NASDAQ: ZUMZ) in September last year. I wrote about the company when the stock was trading around $17.50 per share. At that time, the estimated intrinsic value was around $28.50 per share. Just two months after I wrote that article, Zumiez reached nearly $29 per share, delivering a spectacular 166% return. The rise didn’t stop until it reached $41 in June. 

<img src="/media/images/user_14219/screen-shot-2012-11-01-at-82735-am_large.png" />

Of course, trees can’t grow to the sky. Since June, Zumiez’s stock has begun its downturn. The stock took another hit when the specialty retailer of action sports released its October results and its third quarter guidance. October sales were $41.90 million; an increase of 20.2% compared to $34.90 million in the same period last year. The same-store sales experienced a 0.6% growth, missing analysts’ estimates of 4.6%. In addition, the company revised its third quarter’s EPS guidance from the range of $0.42-$0.45 to $0.38-$0.39. The lower guidance was due to the challenging outlook in Europe business. Right after the release, its shares was down 11% to $22.52 after hours. At $22.52, Zumiez’s total market capitalization is $706 million. Zumiez is valued at 17.9x earnings and 2.5x P/B.

Investors could have limited their losses in Zumiez recently by looking further into the retailer's inventories over time. As of July, its inventories are nearly $100 million in the balance sheet, much higher than the previous quarter of $70 million and the same period last year of $84 million. In addition, investors should have stayed away from the high valuation of 24-29x P/E, which the company received during the first half of 2012. Nevertheless, Zumiez is still a debt-free retailer with a strong balance sheet.

Compared to its top competitors including Pacific Sunwear of California (NASDAQ: PSUN) and Hot Topic (NASDAQ: HOTT), Zumiez seems to be the most performing retailer. Pacific Sunwear is generating losses so its P/E is not valid. In addition, it is the most leveraged retailer among the three. Hot Topic is the only company, which pays dividend, with a 3.7% yield. Zumiez delivers the highest net margin (three times higher than Hot topic’s) and return on invested capital of 15.2%. Furthermore, it is much cheaper with 17.9x earnings valuation compared to 24.1x P/E of Hot Topic’s. 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>ZUMZ</strong></p> </td> <td> <p><strong>HOTT</strong></p> </td> <td> <p><strong>PSUN</strong></p> </td> </tr> <tr> <td> <p><strong>Net margin (%)</strong></p> </td> <td> <p>6.6</p> </td> <td> <p>2.1</p> </td> <td> <p>-10.5</p> </td> </tr> <tr> <td> <p><strong>ROIC (%)</strong></p> </td> <td> <p>15.2</p> </td> <td> <p>7.9</p> </td> <td> <p>-50.7</p> </td> </tr> <tr> <td> <p><strong>D/E</strong></p> </td> <td> <p>0</p> </td> <td> <p>0</p> </td> <td> <p>0.9</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>17.9</p> </td> <td> <p>24.1</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p><strong>Dividend yield (%)</strong></p> </td> <td> <p>N/A</p> </td> <td> <p>3.7</p> </td> <td> <p>N/A</p> </td> </tr> </tbody> </table>

Foolish Bottom Line

Zumiez is still a debt-free retailer of choice with a good margin, high return on invested capital, and nice growth. The $28.50 intrinsic share value was calculated based on the assumption that the retailer would grow its free cash flow at 8% in 5 years, and 1% after that to infinity. I think at the current price, Zumiez could be a good buy for long-term patient investors. In the short-term, the weak business environment could affect its share price. Personally, I would rather wait for its price to drop further in the short-term so that I can buy at a much lower price.

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool owns shares of Pacific Sunwear. Motley Fool newsletter services recommend Pacific Sunwear. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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