Special Opportunity Within Custom Consumables?

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

Build-A-Bear Workshop (NYSE: BBW) stock has bounced in recent days from an earnings preannouncement along with the CEO announcing plans to retire from that post.   Build-A-Bear is a specialty retailer of bears and other plush animals which are customizable with clothes, shoes and accessories.  Declining sales over the past two years led to underperformance in the shares of BBW.  The stock has steadily rebounded from its low of $3.36 on Oct 22, 2012 and surged on the recent preannouncement.

Build-A-Bear offers Customizable Experience

BBW’s direct competitors - Vermont Teddy Bear as well as other toy and hobby stores - are all privately held.  Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) as well as Amazon (AMZN) are all players in the toy category.  BBW is different and offers an experience, not just a place to buy a stuffed animal like WMT and TGT. Wal-Mart and Target have many other things to sell in order to make their $464 billion and $72 billion in sales.  There is a broad trend in people paying a premium to have an experience where they can customize their selection.  Starbucks (SBUX) is an example of the premium consumers will pay to customize what they buy.  Build-A- Bear benefits from this trend.  It offers a full interactive experience versus the anesthetized one of its competitors like Wal-Mart and Target.

Valuation – BBW Hit its Floor, Balance Sheet Healthy

BBW trades at 0.67x book value, which looks relatively inexpensive.  However, negative return metrics, return on assets of -6.6% and return on equity fo-11.9%, indicates the stock should trade at a discount to book value.  Book value is often looked at as a price floor for a stock, but that is not a good measure for BBW.

A look into the market value of the assets can establish a floor and also show the overall health of the balance sheet. The market value of certain assets of BBW requires some discount versus book value on the balance sheet.  For example, when you liquidate inventory, there is usually a steep discount applied.  If the PP&E was worth book value, the firm would likely generate a positive return on them.   After adjusting the assets to market value, the cash is used to pay debt and other certain liabilities.  The remaining cash is the breakup value to a shareholder.  This value should act as a truer price floor than book value.  For BBW, the following table results in an estimated market value of $3.89 per share following 3Q12 (stock bottomed at $3.36 noted above).  This quick analysis results in a level of support for the shares and an actual value of the marketable assets.

<img height="352" src="http://arbideas.com/wp-content/uploads/2013/02/BBW-chart.jpg" width="394" />

Restructuring at Build-A-Bear

Build-A-Bear stores have had declining sales over recent years although the magnitude fell to the low single digits from the 13.4% y/y decline in 2009 with and EPS loss of $0.66.  The loss in 2012 estimated at ~$0.40 per share is approaching those levels and in jump from the $0.11 loss in 2011 and profit of $0.01.

Management recognized the need for change and implemented a new store format, closing certain locations and a new marketing initiative.  The new store format utilizes technology in tandem with its current process.  The remodels drove a sales increase at those locations of 30% in 4Q12.  BBW plans to remodel 40-50 stores by the end of FY14.  This will likely utilize most of BBW’s free cash flow over that time period.   It estimates cash on hand of $45 million at the end of 4Q12, up from $22 million at the end of 3Q12.

The store rationalizations will occur over the next two years.  It will close 50-60 locations and target a size of 225-250 stores by the end of 2014.  Management noted in the past that 80% of the stores are profitable and it expects this number to reach 98% by the end of2014.  BBW does plan to continue to expand the number of locations in Europe from 87 largely through franchises.

The marketing initiative initiated in 4Q12 focuses on building additional brand awareness versus promotional activity.  The effectiveness of this is hard to measure and there is not update to report.

The preannouncement also gave some additional useful details.  Sales declined by 1.7%, which was not as bad as expected and ecommerce was up by 14%.  The departure of the CEO and founder is probably also a positive.  BBW can now find a CEO with greater expertise in restructuring and growing an established brand.

Conclusion

Build-A-Bear has bounced off its price floor and has started to rebound.   However, it may have gotten a bit ahead of itself.  The restructuring plan could still run into problems and expectations are for EPS losses into 2014.  The free cash flow, formerly a reason to own the shares, will largely go to the restructuring efforts.  Also, selecting the right CEO and their subsequent plan could still significantly impact the share price.


mthiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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