The Week's Margins
by Louis Corrigan (TMF Seymor)
Atlanta, GA (April 13, 1999) -- Though we're gearing up for the earnings onslaught, we've got another limited selection of candidates on our Rising Margins screen this week. Two certainly worth noting are leading biotech Biogen (Nasdaq: BGEN) and Internet all-world Yahoo! (Nasdaq: YHOO). Each tends to be discussed often elsewhere in Fooldom, so I won't say more about them today.
Last week we looked at Best Buy (NYSE: BBY); this week we'll start with Circuit City (NYSE: CC), the number-two consumer electronics retailer, with 537 superstores nationwide. Circuit City's earnings press release is fairly detailed, which is necessary given that the company also owns a 77% stake in CarMax (NYSE: KMX) and has spent heavily to promote its proprietary Divx version of that VCR replacement technology known as DVD.
In other words, getting a feel for the core Circuit City business is more complicated than surveying Best Buy, because an investor must back out these two other money-losing operations. Then one must determine whether CarMax and Divx will ever amount to much or whether management has just been wasting shareowners' money. I think it's still a toss-up, though Divx, at least, has done fairly well so far, reportedly accounting for 20% to 25% of all DVD machines sold.
Looking at just the core Circuit City stores, Q4 sales increased 17% to $3.03 billion, with comp-store sales up 10%. Excluding a $32 million loss on Divx, EPS soared 48% to $1.26. Although gross profit margins declined to 24.4% from 25.1% in Q4 FY97 due to strong sales of lower-margin PCs and aggressive pricing, operating expenses declined to 17.5% of revenue from 19.5%. For the year, revenue jumped 17% to $9.34 billion on a 8% same-store sales increase. Backing out an $87 million loss on Divx, earnings sped ahead 46% to $2.34. Including both Divx and CarMax, FY98 EPS cruised ahead to $1.48, up 31%, while Q4 earnings per share increased 48% to $0.86, in line with estimates.
At $72 1/2, Circuit City trades for 31 times trailing adjusted core earnings, or 49 times reported estimates including the money losers. Based on the high-side estimate of $2.55 per share for the year ending next January, Circuit City's reported earnings could grow 72% this year, putting the stock at 28.4 times forward earnings. The overall balance sheet is fine but not exceptional, with inventories and accounts receivable contained, and about $161 million of debt net of cash.
Like Best Buy, Circuit City has been benefiting from the digital revolution and the strong economy, with consumers crowding into the stores to buy DVDs, wireless phones, digital camcorders, DirecTV, and other goodies. At 31 times core earnings, the stock is not too rich given current growth projections. What I dislike about Circuit City, though, is that an investor needs to figure out whether Divx will ultimately become a cash cow for Circuit City (since I find the system too complicated, I doubt it) and whether diversifying into the difficult and capital intensive car business will ever pay off (I doubt that, too).
Investors willing to wade through these issues may find Circuit City still offers value. But personally, I prefer Best Buy because it's easier to understand and thus easier for its management team to manage.
Next, Braun's Fashions (Nasdaq: BFCI), a value-oriented Minneapolis-based specialty retailer of clothing for working women. It operates 197 stores in 22 states, mainly in the upper Midwest. The company's future stores will operate under its Christopher & Banks clothing brand name.
Q4 sales tacked on 15% to $31.4 million on a 4% hike in same-store sales. Excluding one-time items, EPS shot up 54% to $0.43 per share. FY99 revenue increased 11% to $110.1 million on a 3% comp-store sales gain. Before one-time items, EPS hit $1.30, up 46%. Adjusted operating income rose 53% in Q4 and 22% for the year.
The company's gross margins improved for the year and the quarter while inventories remained flat despite having 9% more stores (it opened 24 during FY99 and will add 30 this year). During FY99, Braun's cut its long-term debt, as well as its interest expenses, by repurchasing $4.7 million of its 12% senior notes. The company ended the year with $6.4 million in cash net of long-term debt and leases, or $1.43 a share.
Backing that out of the $8 share price, we get $6.57, putting the stock at just 5 times trailing earnings. The company clearly thinks that's a bargain, since it paid $3 million to repurchase 368,000 shares (or $8.15 per share) during FY99. Moreover, Braun's recently reported that sales for the four week period ended March 28 increased 3% (following an 8% comp-store gain for February).
Braun's carries a market cap of just $36 million, meaning it's not likely to attract much attention from institutions or analysts. Still, it's certainly interesting at the current price. The company delivered a 5.6% net profit margin last year, but it trades at just 0.33 times sales, or 0.27 times sales after backing out the cash. That's cheap given the trailing return on equity of 27% and assuming the current positive momentum continues. And unlike other apparel retailers, Braun's isn't overwhelmingly dependent on Christmas sales.
While women's apparel is a tough market sector, the value end of things is usually a little less susceptible to fashion shifts. Braun's definitely looks worth investigating for those who don't mind the volatility that can accompany microcap investing.
Finally, Argosy Education Group (Nasdaq: ARGY), the nation's largest for-profit provider of doctoral level programs, with total enrollment of 4,800. Argosy operates four school groups, which together have 14 campuses in eight states and Ontario, Canada. In 1997, Argosy graduated 335 clinical psychology doctoral students, 8.4% of the national total.
Argosy offers a lesson in what becomes of IPOs that don't capture investors' imaginations. Underwritten by Salomon Smith Barney and ABN Amro, the stock went public March 8 at $14 a share and quickly plunged to as low as $6 5/8. Ouch! Could be that the stock is just too small to sustain interest from institutional investors. Or it could be that troubles at other for-profit education companies like Apollo Group (Nasdaq: APOL) and Computer Learning Centers (Nasdaq: CLCX) have left investors disappointed with the whole concept.
In any case, individual investors should approach IPO dogs with caution. Such companies recently had a chance to make their pitch to the professional investment community, and the pros yawned. Not a great sign! Then again, the stock is now trading at a 45% discount to its IPO price.
Q2 revenue rose 35% to $9.1 million, pushing EPS up 50% to $0.18. Year-to-date, revenue has booked a 32% gain to $18.4 million, with EPS rising by a more modest 17% to $0.54. Using the pro forma FY98 numbers from the prospectus, I calculate trailing 12-month revenue of $33.8 million and net income of $2.75 million, for an 8.1% net margin.
Including the IPO financing, the adjusted balance sheet as of November 30 shows $17.1 million in cash and $3.3 million in debt, so cash net of debt of $13.8 million, or $2 a share assuming 6.9 million shares (2 million of the publicly traded class A and 4.9 million of the supervoting class B controlled by Chair/CEO Michael C. Markovitz, Ph.D.). Adjusting EPS for the current share count, we get a slightly lowball estimate of $0.40. (On the flipside, earnings have been barely taxed, something to investigate further.)
So at $7.69, the stock trades at about 19.2 times earnings, or 14.2 times earnings if we subtract the cash. Is that a bargain given the revenue and earnings growth?
Qualifying for student loan programs requires some effort, which in turn creates a barrier to entry. In addition, with 63% of its students enrolled in Ph.D. programs and 18% pursuing a Master's, Argosy's students will likely be around for a while. The story is worth investigating, but my inclination would be to play hard to get on this one.