Winmark's Latest Earnings Don't Reflect Long-Term Opportunity

Winmark  (NASDAQ: WINA  ) continues to outperform and slide under the radar of most investors and analysts. The small-cap retail franchise and business leasing company holds a long list of traits that any long-term investor seeks. It is a high-margin, cash-printing business. Though a strong performer over the past few years and currently near its 52-week high, the stock can push higher on an expanding retail footprint and a back-loaded lease portfolio. With the recent earnings report fresh off the press, let's take a closer look at Winmark.

Recap
For the uninitiated, Winmark is the company behind consignment retail names such as Plato's Closet, Play It Again Sports, Music Go Round, Once Upon a Child, and the recently added Style Encore. The company does not operate any of the stores, but franchises them to small-business owners. As a complementary element to the franchises, Winmark also operates a growing medium- and large-company equipment-leasing business, as well as a small-business leasing credit business.

All of these businesses hold high gross margins and are cash-generating.

In the just-ended quarter, Winmark brought in $5.25 million in net income -- or $1 per diluted share. This comes in nearly 22% higher than the year-ago quarter, in which the company earned $0.82 per diluted share. However, investors should note that the gains were not closely tied to sales improvements. Royalty income from the franchises gained just under 7%, while leasing income actually declined year over year. Overall, income from operations grew about 1%. In the year-ago quarter, the company took substantial non-cash charges related to long-term investments.

It wasn't a fast-growing quarter on an operational level, but it was a value-building period for the company.

Fresh concept
The past quarter saw the launch of Style Encore -- the newest franchise opportunity from Winmark. Style Encore is a fashion-oriented women's consignment store. The franchise is looking to sell to a broad range of women ages 20 to 50.

Winmark is seeing some appealing demand for the franchise, as at the end of the quarter, there were 21 new approved franchisees. Total, Winmark has just under 1,000 retail locations franchised.

Quarter-to-quarter fluctuations do not accurately reflect the growth of the business, given that its franchise and leasing revenues can be lumpy and/or back-loaded. When you zoom out, though, it's easier to recognize the opportunity.

As franchise renewals have come up in the first six months of this year, nearly every single franchisee has re-signed, indicating at least some success in the businesses. In addition to its 995 current locations, the company has awarded 88 yet-to-be-opened ones. These new franchises will show up later on the income statement in the form of growing royalties -- the bulk of the company's revenue.

A good bet
On top of operating performance, Winmark is just an attractive company to own. It's an owner-operated business (CEO John Morgan owns more than 30% of outstanding shares), has extremely high margins (higher than 90% gross margin, roughly 50% operating margin), and the market pays little attention to it (presenting a greater chance for pricing inefficiencies).

The company has made mistakes in its long-term investments before, and the leasing business could suffer if business owners find more attractive sources of capital or equipment. For the most part, though, Winmark's business is one that does well in times of strife and during economic prosperity.

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