Yesterday after the closing bell, outdoor sporting goods retailer Cabela's (NYSE:CAB) reported that profits for its third quarter had declined 8%, from $16.3 million last year to $15 million this year. Should I be concerned? I'm leaning toward no, because the company is working hard to make its business run more efficiently.
To let you know why, let's take a peek at how its three business segments performed and why the increased costs this quarter were made with the future in mind.
Cabela's Direct segment, consisting of its legacy catalog business and its Internet sales channel, continues to chug along with revenue growth of 4.7% and flat operating income growth. According to the conference call, catalog expenses dropped, which is a good thing because this is a mature business. Management would like to squeeze as much performance as possible out of its catalog business without making heavy investments. But it's still an important part of the Cabela's brand, because this is where the business started. Retail stores are the new growth initiative.
Sales at these stores grew 25.8% and operating income rose 39.3% during the quarter. The company opened three new stores this quarter and saw same-store sales click up 3.1%. That is a welcome sight, since that metric had been in decline for the previous few quarters. This is the future of Cabela's, and retail sales should pass direct sales over the next year or two.
The third leg of the stool is Cabela's financial services segment. It's a much smaller part of the business (less than 10% of company revenue), and its sales and operating income increased 28.8% and 32.7%, respectively. According to the conference call, growth in this division, which is responsible for the co-branded Cabela's Visa credit card, came from a 17% increase in the number of accounts, to 850,000, and a 5.6% rise in the average balance per account, to $1,640. More people charging more purchases means more revenue. And when costs are under control, operating income increases even faster.
Overall, gross margins increased slightly, but operating margins were down due to higher selling, general, and administrative (SG&A) costs. The company mentioned three things: increased store pre-opening costs, increased stock option expenses, and IT system upgrade expenses.
I look at it this way: The company is racing its car around the track right now. It's decided to change out the engine and chassis to give it higher performance (adding stores). But at the same time, it has to fine-tune the engine continuously in order to get the most performance out of it (spending on warehouse logistics systems, customer resource management systems, and store replenishment systems).
It needs all of those systems to work well to help it create value for shareholders as it grows. In 2007, for example, Cabela's will open eight more stores. With the right systems in place, the company should be able to get those stores up and running smoothly with much less effort. You can have a great brand, but if you don't have good operations to go with it, you can't create value for shareholders. (Think Ford (NYSE:F) and General Motors (NYSE:GM), two well-known brands that are having lots of problems right now because they can't compete effectively against Honda (NYSE:HMC) and Toyota (NYSE:TM), which have good brands and great operations.)
So do I like to see increased expenses cut into profits? No. No one does. But I do like to see a business invest in things that will help it get the most out of its assets. And that, in my opinion, is what Cabela's is doing. Better operations via more efficient processes means more of those huge gross margins (more than 40%) can drop to the bottom line in the future. Great operations are the hallmark of Wal-Mart (NYSE:WMT) and a large reason it generates so much value. Less efficient operations are also why Cabela's competitor GanderMountain (NASDAQ:GMTN) has trouble generating cash.
The fourth quarter is the big one for Cabela's, and management expects to have a great one. It will be our first chance to see how those new systems are really working.
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Retail editor and Inside Value team member David Meier owns shares of Cabela's, but does not own shares in any of the other companies mentioned. He is currently ranked 90 out of 12,074 investors in The Motley Fool's CAPS rating service. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.
