This Retailer is Too Cheap to Ignore

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

With the small cap series, I would like to talk about small cap opportunities the value investing way. Warren Buffett mentioned that he could make higher returns with a smaller amount of capital, such as 50% yearly on $1 million dollars.  I think with a small amount of capital, he would focus on undervalued stocks with little analyst coverage and competition from other investors. However, the small cap stock might be illiquid. That is why investors should be patient, have a long-term view, and do not panic with large price swings. Like the previous small cap series article, this one is about a small cap retailer stock. This retailer was listed around two years ago, and since April, the price dropped from $30.69 to $9.56. It has delivered double digit returns on invested capital for the previous 2 years with consistent increasing EPS and cash flow. It is Body Central (NASDAQ: BODY).

Business

Body is a specialty retailer with 263 apparel and accessories stores for young women from different cultural backgrounds, mainly in South, Mid-Atlantic, and Midwest at value prices. More than two thirds of revenue comes from apparel, the other 24% come from accessories sales. The business doesn’t manufacture itself, but rather buys merchandise from around 220 US vendors. More than 50% of its merchandise is from the top 10 vendors in 2011, with the two largest accounting for 27.3%.  The main revenue source is from store operations, with 88.3% of total net sales in 2011.

Historical operating figures

In the last three years, the retailer experienced quite favorable operating figures, with consistent comparable store sales growth and sales per gross square footage, along with the increase in its number of stores opened.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>2011</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2009</strong></p> </td> </tr> <tr> <td> <p><strong>Comp sales growth</strong></p> </td> <td> <p>11.30%</p> </td> <td> <p>14.80%</p> </td> <td> <p>4.90%</p> </td> </tr> <tr> <td> <p><strong>No of stores<br /></strong></p> </td> <td> <p>241</p> </td> <td> <p>209</p> </td> <td> <p>185</p> </td> </tr> <tr> <td> <p><strong>Sales per gross square foot</strong></p> </td> <td> <p>$253</p> </td> <td> <p>$233</p> </td> <td> <p>$207</p> </td> </tr> </tbody> </table>

In addition, the EPS has grown more than 400% within just 3 years, from $0.23 in 2009 to $1.22 in 2011. In fiscal 2011, its return on invested capital was more than 27.5%. It is interesting to note that this retailer expanded without any leverage. As of September, it had $97 million in shareholders’ equity, $37 million in cash and short-term investment, and no debt.

Glitches

The recent quarter was not very good for the retailer. Its net revenue increased but its comparable sales experienced an 11.9% decrease. The income from operations fell significantly, including around $950,000 severance costs relating to its former CEO and CFO. The retailer kept expanding by opening 7 new stores in the quarter and closed 1 store to bring the total store count to 263, higher than 240 stores at the end of 2011. In the outlook for the fourth quarter, Body expected to have the full year net revenues to be in the range of $312-$314 million, with the EPS of $0.80 - $0.83. These financial glitches coincided with the management shakeup in the company. In August, its CEO, Allen Weinstein, resigned after three years managing the retailers’ operation. Since then, he has continued to sell his position. The board promoted CFO Thomas Stoltz to interim CEO while searching for a permanent replacement. The newly promoted interim CEO showed his confidence in the retailer by purchasing 10,000 shares at the price of $8.73 per share.

Comparable analysis

Compared to its peers including Rue21 (NASDAQ: RUE) and Aeropostale (NYSE: ARO), Body is obviously a better pick for growing retailers. It has the lowest PEG ratio of 0.4x, around half ARO’s PEG of 0.8x and Rue21’s PEG of 0.7x. In addition, it is the cheapest among the three with only 10.5x P/E, whereas the market is valuing Rue21 and ARO at 16.1x and 17.4x earnings respectively. Body is trading at $9.97 per share, with the total market capitalization of $162.22 million. Because it is holding a big chunk of cash and short-term investments, its enterprise value is just only nearly $119 million. The market is valuing Body quite cheaply at 3.85x EV/EBITDA, whereas RUE’s is 6.1x and ARO’s is 4.9x. The three retailers employ debt free operations. Being the smallest retailer with significant growth in the past, Body would keep expanding its operations. Rue21 is trading at $28.15 per share with nearly $670 million market cap, whereas ARO is trading at $13.08 per share with $1.06 billion market cap. Indeed, Oppenheimer thought alike, keeping the retailer in the Outperform category with a $19 intrinsic value tag, mentioning that Body is “too cheap to ignore.”

Foolish Bottom Line

Any businesses would have glitches during its expansion period. I think it is the case for Body. The small retailer has grown significantly in the past with outstanding comparable sales. It keeps growing by opening more stores each quarter. I might be wrong, but a cheap price and a low valuation give investors a decent margin of safety to bet on the stock. 


hoangquocanh is long BODY. The Motley Fool owns shares of Aeropostale. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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