Recently, I looked at online audio bookseller Audible (NASDAQ:ADBL); now it's bricks-and-mortar bookseller Barnes & Noble's (NYSE:BKS) turn. What can I say? I like books.
Barnes & Noble sells books, music, and videos at 683 superstore locations, 141 B. Dalton mall locations, and online. Per last year's fiscal results, stand-alone superstores made up 85% of the company's revenue, while 4% was from B. Dalton, and 9% came from online operations. The superstores carry between 60,000 and 200,000 titles, with about 50,000 being common between stores and the rest being locally influenced. Unlike Audible, Barnes & Noble does carry the Harry Potter stories. And Starbucks (NASDAQ:SBUX) provides cafe services at the superstores. (Sorry, no drinks available over the Internet.)
Unfortunately, bookselling is a commodity business. Anyone can do it -- and everyone does. Competitors include Borders Group (NYSE:BGP), Books-A-Million (NASDAQ:BAMM), and Amazon.com (NASDAQ:AMZN), not to mention neighborhood grocery stores and drugstores. To set itself apart and create a brand for itself, Barnes & Noble has made the stores inviting, comfortable places to be, complete with the in-store cafes and plenty of chair nooks.
In trying to judge the best company, one can look at working-capital efficiency, which gives some insight to how well companies are able to make suppliers and customers work to their best effect. One way of gauging efficiency in this area is the cash conversion cycle (CCC), a measure of how long it takes to convert cash into inventory into sales and back into cash. This cycle tells us a bit about the company's customer savvy. A rapid inventory turnover -- a component of CCC -- indicates that the company has struck a chord with its customer base. For the trailing-12-month (TTM) period, Barnes & Noble's CCC was 58 days, compared with Borders at almost 109 before its recent earnings release. Amazon's CCC is negative, meaning it receives payment before it pays for its inventory. Effective online retailers are generally able to achieve rapid turnover and, in turn, manage working capital to their advantage.
Another measure is to look at which company allocates resources best, a proxy for which can be return on invested capital, or ROIC. Generally, for close competitors, the company that has a higher ROIC and is able to grow it will do better. For Barnes & Noble, the TTM level is 9%, some 2.7 percentage points above the FY 2002 level. In contrast, Borders has a TTM ROIC of 7.8% (per Morningstar data), some 0.3 percentage points below the FY 2002 level. Barnes & Noble wins here.
An obvious point of difference between Barnes & Noble and Amazon is that the latter is strictly an online retailer while the former has physical locations. People are shopping more online, so Barnes & Noble must work to attract customers. Furthermore, the costs built into its bricks-and-mortar business model reduce economic returns relative to competitors such as Amazon. Unfortunately, the online portion of Barnes & Noble's business was not profitable per last fiscal year results -- it delivered an EPS loss of 0.28 in FY 2004. Barnes & Noble must urgently address this issue, since online shopping is becoming more popular. On the other hand, one cannot go to Amazon to browse the aisles, pick a book off the shelf, and sit down to skim it while sipping a latte.
Let's look at some valuation metrics. Barnes & Noble's price-to-earnings ratio has ranged from 11.1 to 37 over the past nine years (that's as long as it's been public). The current TTM value of 25 is right about in the middle of that spread. If you take the forward-looking P/E of 18.2 and divide by Thomson First Call's median five-year growth rate of 15%, one gets a PEG ratio of 1.21. That's slightly overvalued by PEG standards -- a ratio of 1 is considered "fairly valued." The current price-to-sales and price-to-book ratios are well below both S&P 500 and industry values, but they are near the high end of the company's historic levels. That provides another hint that the company might be slightly overvalued right now.
This company is in a tough business, with competitors everywhere it looks. Of the two largest bricks-and-mortar companies, it is the most efficient, at least when using the metrics above. But to fight against Amazon, it must make its stores truly "destinations." I do sometimes have difficulty remembering which store, Borders or Barnes & Noble, I am shopping in, since they are quite similar. Barnes & Noble needs to somehow distinguish itself further.
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Fool contributor Jim Mueller and his wife have frequented too many bookstores for too long, as their house full of books will attest. Of the companies mentioned, he owns shares only in Audible. The Motley Fool is investors writing for investors.
