The back-to-school season is all about cool commercials. Staples (NYSE:SPLS) wants you to believe "it's the most wonderful time of the year." OfficeMax (NYSE:OMX) has "The Rubberband Man." It's also about buying things. And since my daughter starts second grade this year, the niche sparked my interest, as both a father and an investor.
So, in this column, I'll cover retailers, product companies, and service companies -- my "circles of competence." The five major back-to-school categories are clothing, footwear, haircuts, electronics, and the school of hard knocks. Be forewarned: Not all of the following investment ideas are buying opportunities. Still, I'll explain how I evaluate each company and arrive at my recommendation.
Ding-ding-ding. Class is in session.
Clothing
Gap (NYSE:GPS) has been everywhere in the news lately. From poor inventory planning at Banana Republic to lower-than-expected July comps and sales to turnarounds that have not yet come through, it just doesn't seem like this company can do anything right. My contrarian nature tells me it must be the right time to invest. (Note: My recommendation comes independent of information from the Motley Fool Stock Advisor and Tim Beyers' excellent article.)
Unlike Fool Seth Jayson's past shopping experiences, my wife and I have a good time looking around (she doesn't ask for my feedback, and I don't park myself in "nodders' row"). We have done a great deal of shopping lately, and my field research tells me one thing: People in South Carolina still love Gap and Old Navy. The stores were always packed, and the line stayed 10 deep as we browsed. Maybe customers are not buying as much, but they certainly pack the stores in force.
Gap has a market cap of $17.6 billion and about $3.3 billion in cash and short-term investments on the balance sheet. It also carries $2.3 billion in long-term debt, giving it an enterprise value (EV) of $16.6 billion. Recently, it has been generating about $1.6 billion in free cash flow (FCF) per year, giving it an EV/FCF of about 10. I think that's cheap considering this is a quality business where, odds are, the turnaround has not been priced in yet.
Footwear
I wanted to write about Nike (NYSE:NKE), but I just couldn't. I agree with Fool Rick Munarriz: It's not cheap. Still, growing kids need durable footwear, and Timberland (NYSE:TBL) has packed the stores with a dizzying array of choices. The shoemaker makes classic, quality products that are always in step with students' needs.
Timberland recently announced a healthy second quarter, producing solid growth in revenues and earnings. At $53.49 per share, Timberland sports a market cap of $1.87 billion. It carries no debt and has $163 million in cash in the coffers. It creates about $130 million in FCF, giving it an EV of $1.7 billion and an EV/FCF of 13. While this is certainly not a great value, I don't think Timberland is overvalued.
However, Timberland's high accounts receivable relative to sales (about 50%) does concern me. The company must be offering some good terms to retailers and distributors in the supply chain. So take a look at Timberland's cash-conversion cycle and Foolish Flow Ratio. It takes 111 days to convert resources purchased to make its products into cash flow for the company, and its Foolish Flow Ratio is 2.55. Neither are compelling numbers. No wonder management focused on wanting to improve operating efficiency in its latest press release. Fortunately, insiders own almost 45% of the company's shares and have a vested interest in fulfilling this promise.
Haircut
A good haircut can make the kid, as well as a positive first impression with a teacher. (I certainly know that greeting my teachers with a smart haircut gave me at least one or two grace periods when I caused trouble in class.)
And Regis (NYSE:RGS) is just the company to help kids make the right start on that first day of school. Regis owns and franchises 9,617 salons internationally under the names Regis Salon, Supercuts, Vidal Sassoon (which sparks some funny memories of teen hairdos), Mastercuts, and Cost Cutters (for guys like me who get their heads shaved every few months).
Regis has a long record of success. A quick glance at the company's chart shows some very impressive returns. And, with several good recent months under its belt, Regis has the biggest, shiniest barber pole in town. Its EV/FCF of 17 reflects that future success seems to be built into the stock. Despite being a great company, I encourage you to schedule a purchasing appointment for a later date.
Electronics
I wanted to include pizza as a category but figured that was more appropriate for when everyone is back in school. So, let's think about the cool electronics our young geniuses will need to start out.
A computer is a must. Heck, our nanosecond society can hardly function without them. Students also need a programmable calculator to whip through calculus problems that just can't be done by hand (no, I'm not speaking from experience!). Kids "need" an MP3 player to listen to tunes on the bus. And college-bound freshmen need cell phones to call home -- if only to beg for money.
Where is the best place to get all this stuff? Perennial favorite Best Buy (NYSE:BBY). (Note: I can't count the times I've wanted to buy this stock but failed to follow through. Sometimes, I think I'm too smart for my own good!) Best Buy has the perfect back-to-school setup: Sell the latest and greatest cool electronics to early adopters and pitch extended warranties along with the purchases. It's a wonderful business model.
However, despite the recent pullback from its 52-week high, it is still expensive. Its EV/FCF ratio is a smokin' 24. That is some serious value added! You pay for a cheery consensus, and there's a whole lot of it for Best Buy, especially since the company just signed leases for 38 more stores. Jot down this stock idea after your Regis notes and be smarter than me when the next opportunity to buy comes around.
The school of hard knocks
This one goes out to all you college students who graduated last spring, spent one last great summer with family and friends, and will now contemplate your next exciting step. Your first lesson in the school of hard knocks? Get to work! (Start funneling money into Social Security so I can get what's coming to me when I retire.)
For you, young investor, the choice is Limited Brands (NYSE:LTD). The company houses The Limited, Express, Bath & Body Works, White Barn Candle, and the store with undoubtedly the best "nodders' row," Victoria's Secret. Limited Brands specializes in products for your home, personal, and fashion needs, as well as your... well, the editor might frown if I go there.
In a recent Matt Logan interview, famed value investor Bill Nygren explains why he thinks the company is undervalued, and I can't do any better. It passed my wife's litmus test as she makes plenty of purchases from Miss Victoria. My sister has loved The Limited since high school. And, get this, its EV/FCF ratio is 11.
The other intangible is that management is not afraid to sell off poorly performing assets and allocate the capital to better places. Once there was a plethora of businesses under the Limited Brands umbrella. The most recent transaction occurred when Limited Brands sold its 22% stake in Gaylan's to Dick's Sporting Goods.
And the winner is...
Gap. Not only is the company cheap, but it's still in the midst of a turnaround. That means there is an opportunity to buy a quality company at a very fair price. Is that a recipe for a winner, according to the Fool's new value maestro, Philip Durell, who heads up Inside Value? I can't say. But it's at least an opportunity for above-average returns over the long run in my book. And you'll be in good company, as esteemed Nygren owns a part of this one, too.
Well, I wish your kids the best of luck in their new school year. May they study hard, listen to the teachers, and ask good questions. (And don't forget to get a haircut. It could be the best investment you'll make this year!)
Fool contributor David Meier believes the greatest investment we can all make is in our kids' education. Nothing is more important than learning to think, and that's what makes us Fools. He owns shares of Nike, but none of the other companies mentioned. The Fool has a disclosure policy.
