Selling books is a tough business, and it's becoming more of an uphill battle because of recent industry trends. However, investors may still want to read up on bricks-and-mortar retailers Barnes & Noble (NYSE: BKS) and Borders (NYSE: BGP), or at least bookmark them for future viewing.
Barnes & Noble released fourth-quarter and year-end results this morning. During the conference call, management conceded that the industry is struggling, growing much more slowly than during the expansion years of the late 1990s. As a result, battles over existing market share have intensified between retailers, including Borders, Books-a-Million (Nasdaq: BAMM), and cyberspace seller Amazon (Nasdaq: AMZN).
More recently, the battle has moved to retaining existing customers, since new ones are more difficult to find. Borders and Barnes & Noble have rolled out loyalty programs that offer discounts and reward points to clients. In return, customers pay a monthly fee for the services. Barnes & Noble has experienced higher enrollments since adding more benefits to its program in October.
Problem is, the increased loyalty-program emphasis is hitting gross margins, causing Barnes & Noble to drop 2007 earnings guidance pretty significantly. Time will tell whether more volume can offset lower profitability. Fortunately, the company can handle the short-term pain.
That's because Barnes & Noble generates significantly more free cash flow than it reports in net income. This has caused value investors to hover around the name, and it may also entice private equity investors, who are snapping up retail firms such as Claire's Stores (NYSE: CLE) and Dollar General (NYSE: DG). Barnes & Noble is frequently mentioned as a target thanks to its strong cash generation, low debt, and stable sales.
An analyst asked management to comment on any private equity interest during the conference call. The company wouldn't oblige, instead touting its shareholder-value creation track record, including its share repurchase activities, recent dividend initiation, and spinoff of gaming retailer GameStop (NYSE: GME), which has skyrocketed since becoming independent.
Barnes & Noble has indeed performed well in recent years, but it is entering a stage of slower industry growth. It's unclear whether catering to loyal customers will enhance results going forward, but as long as the company can keep churning out cash, investors have a number of potential ways to make a buck. Borders is another potential value play, and it recently caught the attention of Philip Durell at Inside Value.
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Fool contributor Ryan Fuhrmann is long shares of Barnes & Noble but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.
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