With the economy sputtering and investors skeptical of complex companies, now is a time for investing in simple businesses that sell everyday products. That's why I like The Sportsman's Guide Inc. (Nasdaq: SGDE). This tiny catalog retailer of value-priced outdoor gear doesn't have the growth or the margins to qualify for Foolish 8 consideration, but it does have a number of qualities that should make it of interest to any Foolish investor.
The Sportsman's Guide (hereafter, TSG) got its start back in the winter of 1970 in the basement of Minnesota outdoorsman Gary Olen. Olen's original enterprise was creatively named The Olen Company. In 1976, Olen sent out his first Sportsman's Guide Catalog, and by the next year the company incorporated itself under the catalog's name.
Originally focused on the deer hunter, TSG has broadened its offerings to target the value-oriented male in general, and the outdoorsman in particular. Gary Olen has remained in continuous service to his company over the years and currently serves as chairman. Olen is motivated by a 6.1% ownership stake, as are all the managers and directors who collectively own 26.3% of the company.
In 1992, the company began its value pricing strategy of offering hunting and shooting equipment at discount prices, later adding military surplus, manufacturers' close-outs and other lines of merchandise that appeal to a broader group of customers. The strategy paid off and sales increased from $38 million in 1992 to $128 million in 1997. Since then, sales have grown less steadily but still higher to last year's total of $170 million.
The company was consistently profitable from 1996 to 1999, but in 2000 the company turned a small loss due to higher shipping costs and one-time expenses associated with closing the company's one retail location (an outlet) in Moundsville, Minnesota. These negative events sent the stock to lows of under $1 in December 2000.
But in 2001, the stock began a steady ascent that hasn't yet tapered off. One of the major catalysts behind this move has been the transition of orders from the traditional catalog/phone combination to the greater efficiency of the Internet. The company first opened its online store in 1998, and since then online sales have grown to over $36 million in 2001. The percentage of sales by Internet reached 23% in the fourth quarter of 2001, compared to less than 1% for all of 1998. During the most-recent quarter (Q1 '02), Internet-related sales represented almost 27% of total sales.
Another key strategic development came in the fall of 2000 when TSG launched a "Buyer's Club" discount membership program. For a $29.99 annual fee, Buyer's Club members receive a 10% discount on all purchases (except ammunition). The program has been a huge success, attracting 254,000 members by the end of 2001. These loyal customers not only pay an annual fee, but also have been found to purchase two to three times more frequently than non-members. One can't help but notice that TSG, with its membership model and focus on high-value merchandise, has taken a page out of the Costco (Nasdaq: COST) playbook -- not a bad company to emulate.
The enhanced profitability of Internet-based sales and the Buyer's Club has delivered a dramatic boost to the company's asset turnover (revenues/average assets), which was an exceptional 4.5 during 2001. That means for every $1 in assets, TSG generated $4.50 in revenue -- a phenomenal rate of asset productivity. For context, consider that the retail mail-order catalog industry as a whole last year turned over its assets an average of 1.8 times. Even mighty Costco is less productive, with asset turnover of 3.7 times during its fiscal 2001.
Through high sales volume on a minimal base of assets, TSG was able to generate an 18.7% return on equity (ROE) last year, even though its net profit margin was only 1.7%. By way of comparison, Costco's 2001 ROE was only 13.2%, with an identical 1.7% profit margin.
Turning to recent results, TSG issued a well-received first-quarter earnings report on April 23. Sales grew 6.9% over the year-ago period, which was a faster rate of growth than the 5.9% pace in the previous quarter. Best of all, the company generated a solid 1.9% profit margin, compared to a fractionally negative margin in the year-ago quarter. The fact that the company earned a profit in the first quarter is significant, because this bodes well for TSG becoming a company that generates profitability year-around, not just during the seasonally strong fourth quarter.
Looking to the balance sheet, the company ended the first quarter with $4.1 million in cash and no debt. The balance sheet's health is also confirmed by a Foolish Flow Ratio, which has declined (on a year-over-year basis) for five consecutive quarters and now stands at 1.49, down from a high of 3.0 two years ago. (Remember, with the Flow Ratio, the lower, the better.)
In my assessment, TSG has the financial strength and business momentum to turn in stellar earnings for the remainder of the year. I conservatively estimate that 2002 sales can reach $180 million, which represents 6% growth over the prior year. If the company can continue its pace in Q1 and earn a 1.9% profit margin for the next two quarters, and then end the year with a 5.3% margin (equal to that of Q4 '01), earnings would equal $5.67 million. If diluted shares expand a bit to 5 million, then earnings per share for the year would be $1.13.
At a recent $6.06, shares of TSG trade for only 7.9 times trailing earnings. I think there's room for multiple expansion as investors recognize the quality of this company's business. Bear in mind this company generated a 25% return on invested capital in 2001. Even without growth, a company with these characteristics should trade, I think, for at least 12 times earnings. At a P/E multiple of 12 on my $1.13 estimate of 2002 earnings, the stock could reach $13.56 within a year.
Matt Richey is a senior investment analyst for The Motley Fool. As a youth in Tennessee, he bought hunting gear from The Sportsman's Guide -- long before he was a hunter of investments. At the time of publication, he had no position in any of the companies mentioned in this article. Matt's personal portfolio is available for view in his profile. The Motley Fool is investors writing for investors.
