Industry Focus Mailbag -- A Look at Buckle Inc and Kirkland Signature

On this episode of Industry Focus: Consumer Goods, host Vincent Shen welcomes senior Fool.com contributor Asit Sharma to the show to answer listener questions. Find out about the attractive dividend payouts and challenging outlook for Buckle (BKE 3.71%) before the team dives into the history of Kirkland Signature, including the potential for collaboration between Costco (COST 1.01%) and Amazon.com (AMZN 1.30%).

A full transcript follows the video.

This video was recorded on July 18, 2017.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and it's Tuesday, July 18th. For this episode, we'll be answering listener questions. We've had a backlog of these build up over the past few months, and I promised myself that after theme week, we would start working our way through the mailbag. Joining me via Skype again this week to help me answer these listener questions is senior Fool.com contributor Asit Sharma. Hey, Asit! Good to have you back.

Asit Sharma: Thanks, Vince! Always always, fun and great to be back.

Shen: Sure. Our first question of two for today comes from Levi Waddell, who's a loyal listener and big fan of the Motley Fool. Levi chats with us pretty often. We encourage all Fools to reach out with questions or feedback either by email to [email protected], or on Twitter @MFIndustryFocus.

Levi wrote, "What do you think of BKE? The Buckle is one of my favorite stores to shop at. The stock is down huge over the last year, and it's caused the dividend to shoot up to REIT territory. I know mall-based fashion is in danger, but BKE has a huge presence in denim, which never really goes out of style. With mall-based stores going out of business, I believe this one will take market share. Any thoughts on this one?" 

If you're unfamiliar with this company, Buckle is a U.S. apparel chain based in Kearney, Nebraska with about 465 stores. The top five states for store locations include Texas, Florida, Ohio, Michigan and Illinois. Buckle generated about $975 million of revenue in fiscal 2016. As Levi mentioned, the company is known for denim, which was its biggest product category last year, making up 42% of revenue, followed closely by tops at 31%. So there you have a quick lay of the land for Buckle. To address some of the main concerns and issues that Levi brings up, it's important to note as well that BKE's stock is down over 35% in the past 12 months, and well over 60% looking out two or three years. Asit, can you give us a rundown of how the company has performed recently? What are investors seeing in the financials and operations that they've punished the stock for these past few years?

Sharma: Vince, investors haven't so much punished the stock as they're shying away from it a bit. You and I often talk about retail. Everyone is under pressure who exists in a brick-and-mortar environment. If you look back about five years at Buckle's revenue, they've lost about 13% over that time. That's a gradual decline. Investors also keyed in on the fact that to retain mall traffic, Buckle, like other of its competitors, has had to engage in promotions, that is price discounting, to keep those customers coming in. Net profits have also declined, they're down about 400 basis points over the last five years to just under 10%. So, this is a primary concern to investors. The chart does look ugly over that five-year time period. There are some positives, though, in Buckle. It's still profitable, it has pretty generous operating cash flow for its roughly billion dollars in sales. So it's not one of these stocks that is considered decimated by Amazon.com and the erosion of mall traffic that is losing money. The question is, when do these trends flatten out and begin to improve?

Shen: Sure. For me, personally, Levi, I have to say, you'll have a hard time convincing some investors of being confident in any retailers that ultimately rely heavily on mall traffic. Keep in mind that for Buckle, of their approximately 465 stores, nearly 400 of them are based in shopping malls. Regular listeners of the show have heard us talk about some of the struggles of store closures and consolidation for mall-based apparel chains, and even the anchor department stores, too. But Asit is totally right. There's a point where things do flatten out and potentially improve. But with the numbers, I think it's really important to keep in mind for this company -- look at recent comparable sales for Buckle, down 13.5% in fiscal 2016. And obviously, there's a toll that's been taken on the company's operating leverage. We've seen things trend down or in the wrong direction for profitability. Operating margins down 6.6 percentage points in just two years' time. Even online sales in fiscal 2016 were down 5.4% to just under $100 million, so that's about 10% of the company's total revenue. This weakness has continued into the first quarter of fiscal 2017. Comps again down 12.7%, online sales down another 7.2% for that period.

Another major bright spot that Levi mentioned in his question has to do with the company's dividend. The company made $0.25 quarterly payments last year. That alone would be a 6% yield as of the most recent closing price of $16.70. But the company has also been paying regular special dividends. In 2016, it was $0.75 per share. In 2015, it was $1 per share. In 2014, it was $2.77 per share. If you include those payouts, we're looking at yields well into the double digits. Very attractive, undoubtedly. Asit, do these look sustainable to you?

Sharma: Actually, they do, at least that $0.25 quarterly dividend. This is, in some ways, an old school company. By that, I mean it's been around since the late 40s, and they have a very conservative approach their stock valuation. The company realizes that since revenue is declining, it has to give shareholders a reason to stick around. If you crunch the numbers, you'll find that Buckle is actually allocating about 50% of its net operating income to this regular quarterly dividend of $0.25. As you mentioned, that share price has declined about 60% over the last five years, it's pushed up the yield to that 6%.

Then, management actually waits to see what net profits are at the end of the year. In December, they declared a special dividend which goes up to about over 90% of total net income. They're signaling to shareholders, if you stick around with us, we're going to give you an appreciable total return, especially if our stock turns around. So, Levi -- I have to say, what a great name for our listener to ask about a denim company -- there is something in here for you that is very intriguing in the the company is making a profit, it has positive cash flow, and it's very carefully managing that dividend. Now, Levi's question was, is this dividend sustainable? I think the quarterly dividend is definitely sustainable. It's a fraction of net income and it's a fraction of operating cash flow. The company has no long-term debt and it has a pretty strong balance sheet. The question is this special dividend. I think that's what might be in danger if the trends in revenue and net profit can't reverse soon, you'll see that special dividend compress because they're following their net income each year. So that's what you need to watch out for. But at 6% base yield, boy, this is starting to look a little interesting, everything considered.

Shen: Yeah, absolutely. Again, I'll reiterate the fact, on my end, I do believe the outlook for this company and the space that it operates in is not going to get any less competitive, it's not going to get any less challenging. That mall-based presence could prove to be an ongoing liability, in a way. But the profitability, the close attention that management pays to the dividend to keep investors in the stock, and the fact that the balance sheet and some of the other financials for the company are still quite strong, for me, I'm kind of on the fence. It's something that, Levi, we'll be watching here, too. We haven't followed this company very closely previously on Industry Focus, so we'll try to provide an update maybe in the next few months, next year. Thanks for the question, we'll definitely have to follow up with you soon.

Asit, our second question comes from Shubhra Garg, who wrote, "I was listening to a recent podcast where you had mentioned limits to Costco's growth and competition with Amazon. I wanted to get your perspective on the collaboration between these two companies. I'm a frequent buyer at both, noticed recently that Amazon was carrying the Costco local brand, Kirkland. Any comments on this collaboration and future potential?" Shubhra, you're definitely onto something here. I would probably stop short at calling this a true collaboration between the two companies. We'll get down to the details behind that but first a bit of context. If you're a Costco shopper, you'll know that the company has its own private label brand called Kirkland Signature. It's been around for about 20 years, and it now makes up about 20% of all products at Costco stores. Kirkland products encompass everything from packaged goods to apparel, food and beverage, even alcohol. They're known for offering high quality at a pretty good value. 

Kirkland also makes up 25% of company revenue. Keep in mind that Costco is one of the world's largest retailers. They had $125 billion of sales in the last 12 months, meaning that Kirkland itself is a $30 billion-plus brand, and some of its items generate annually $1 billion in revenue. That should give you an idea of how popular and massive this private label brand has become. This reflects, overall, a trend across the retail industry with grocery stores and retail pharmacies investing a lot into their private labels as well. Asit, you know the tie up here between Kirkland and Amazon probably has more so to do with some of the online efforts and distribution with Costco. Can you give us some high-level thoughts here, in terms of this potential for collaboration that Shubhra wants to know about?

Sharma: Absolutely. Shubhra, your question brought two song titles to my mind. Everybody Wants to Rule the World by Tears for Fears, and Give Peace a Chance by John Lennon. There's very fierce competition between two giants, why can't everybody just get along? What we see between these two companies, if there's cooperation, it's really tentative, as Vince mentioned.

Mostly, it's third-party sellers which are selling Kirkland products on the Amazon site so far, as far as I can see. I certainly haven't read anything about any deeper cooperation. However, it's something that Amazon might have wanted to pursue over time, but I think the window on that is closing with this purchase of Whole Foods Market by Amazon. Whole Foods Market has its own private label brand that's called 365. The thing that listeners should remember here, and I have a hard time remembering this myself, private label brands like Kirkland and 365, they're not manufactured by these retailers. They're simply great deals that the retailers have struck with their suppliers, to put their own label on products, hopefully at a better margin. So if you visualize Amazon's ability to take 365 private label products by Whole Foods and sell at least the nonperishable food items which are household goods, sell them straight out of their warehouses with very few human touches -- because, remember how good Amazon is at robotics, fulfillment, logistics -- they can actually improve the margin that Whole Foods is already getting off of its own private label. And now that Amazon will own Whole Foods, it all hits their bottom line. Very small incentive left to try to do some deal making with Costco to push a lot of Kirkland products through their site. What are your thoughts on that, Vince?

Shen: The big thing that sticks out to me in terms of seeing these Kirkland products on the Amazon store is, keep in mind that Kirkland Signature, the private label is not exclusive in terms of where you can find those products, at Costco store shelves or on its own website. So I do have some numbers here for the first half of 2016, they're from data analytics company 1010data. They indicate that Amazon actually, not Costco, was the biggest online seller of Kirkland Signature products, with 70% share. Again, that was for the first half of 2016. Meanwhile, Costco.com came in second with a 23% share. But as you mentioned, Asit, that 70% for Amazon comes from their marketplace sellers. It's not direct Amazon sales. So again, it's not really an official partnership but really a byproduct of the fact that we have Kirkland, a very large, popular brand, we have Amazon, one of the biggest marketplaces on the internet, and this is basically where they intersect. So the prospects for more collaboration between these two companies appears less likely, especially with the push that Amazon is likely to make with the Whole Foods buyout. 

The last note that I mention regarding Kirkland is that Amazon is not the only competitor carrying the private label. Even a direct rival in Wal-Mart ends up selling Kirkland Signature products through its Jet.com business. There were some reports last month that Wal-Mart wants to wind down its sales of Kirkland products to bolster its own private label. They have their Sam's Club warehouse club, and its own private label is called Member's Mark. So my search this morning before coming into the studio still shows over 200 products available on the Jet.com marketplace under the Kirkland Signature brand. But there are some additional numbers here from May from Slice Intelligence, a market research company. They show that Jet.com has indeed reduced its share of online Kirkland Signature sales. Before, it was Amazon, Costco, and Jet.com selling the most Kirkland Goods. Now it's Amazon, Costco, and Google Express. Any other thoughts from you, Asit, in terms of the dynamics here between how some of these competitors can end up, due to the popularity of these brands, coming together and carrying each other's product lines?

Sharma: It's good for all companies if they can distribute on each other's platforms. When you get into a product, your typical Kirkland product, it's basically packaged in a way so that you're buying in bulk, often excessive quantities. That's part of Costco's business model to get you into its store and offer you that product, where you're bringing home a lot of it. That doesn't work as well online, but Kirkland has proven over the years to be a somewhat popular brand. I think Costco would do better, though, as it moves forward, to emulate Wal-Mart, as Vince brought up. They should seek to buy something like a Jet.com, although Jet.com was maybe the last viable online retailer, and Wal-Mart took advantage of that. But Costco should try to copy Wal-Mart's playbook and find some ways where it can acquire more online presence. I'm not so sure that just using their own platform, they'll really be able to keep up with this aggressive pace that Amazon.com and Wal-Mart are going out with their marketplace purchases, Amazon buying Whole Foods, Wal-Mart buying Jet.com. Costco needs to up its game rather than look for a collaboration between these two, because that will be hard to come by.

Shen: All right. Thanks a lot, Asit. That wraps up our mailbag discussion for this show. Again, remember that you can email us at [email protected], or tweet us @MFIndustryFocus with any questions. Thanks again for your help with the questions, and thanks, Fools, for tuning in. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!