jebmo’s posthaven

Thesis: West Marine (NASDAQ:WMAR) (or the Company) is a category killer with a clean balance sheet, stable core demand from maintenance and repair product revenue and significant asset coverage. Furthermore, the Company has been fairly successful thus far in diversifying revenue and should have the ability to positively impact margins via selective store consolidation. The Company weathered the recession with 3 years of single-digit sales decline but has experienced stable sales growth since, even while consolidating store numbers. The Company's market cap over cash plus inventory is 0.74x and the Company has had no material debt outstanding in the periods reviewed, and the Company holds ~$3.77 per share in cash (share price of ~$9.26) which could be returned to shareholders at some point. EV/EBITDA as of 12/6/2016 of 4.65x represents an attractive valuation given the aforementioned strengths, additional opportunities to increase margins/cash flow, comp valuations and collateral value.

Why is WMAR mispriced? The Company's price partially reflects general retailers which have been out of favor recently; however, in reality, the Company falls into the two retail categories that have been viewed favorably through this time, niche retailers and (to a lesser extent) luxury retailers (Cabela's (NYSE:CAB), Big 5 (NASDAQ:BGFV) and Hibbett Sports (NASDAQ:HIBB) trading at 19.2x, 9.9x and 7.25x, respectively, versus West Marine at 4.6x). Additionally, the Company is sitting on a material cash balance ($93M), and while management has not indicated plans to return this cash to shareholders, it is tough to think of an accretive target to use it on and a return to shareholders in the form of a buyback or dividend would represent value upside (currently holding ~$3.77 per share in cash at a share price of $9.26). Furthermore and to a lesser degree, the Company does not disclose store level information and on the outside seems slightly resistant to forfeit revenue growth for margin (number of stores has decline but newer stores are larger, total square footage has declined much less materially than total store count). Depending upon the results of a store level analysis, there could be additional value to unlock via further consolidation.

Brief Company Overview and Current Landscape:

West Marine is a specialty retailer of boating, recreational and other aquatic/marine supplies, parts, products, apparel and merchandise. The Company sells to the professional boating community, recreational boating community and, with increased focus in recent years, the recreational "waterlife" community (aquatic apparel, kayaks, etc.). As of 3Q 2016, the Company generated sales through 256 stores (89.8% revenue) and an e-commerce platform (10.2% revenue). The e-commerce platform is comprised of westmarine.com and portsupply.com, with the Port Supply brand being targeted more towards the professional boating/marina community. The websites also include extensive, proprietary how-to videos for installing parts. Though the Company has stores throughout the US (and a handful of international locations), a large majority of stores are clustered around ocean coasts and major bodies of water (i.e.. Great Lakes), please see the appendix for a store map.

The Company's business plan since ~2014 has included the following strategic initiatives: (i) increase revenue to "Waterlife" customers (non-boater, aquatic customer), (ii) increase e-commerce as a percent of sales (which includes order to store revenue?), and (iii) consolidate into fewer total but more "flagship" stores. A portion of this plan has been titled the "15/50" plan by management, with the target of generating 15% of total sales via e-commerce and 50% of total sales via waterlife stores. The Company has addressed the aforementioned initiatives as follows:

The Company has increased "Waterlife" stores from 24 FYE 2011 to 70 9/30/2016. The Waterlife stores are revitalized stores with an increased focus on recreational-boater or non-boater customers through selling apparel, marine leisure products, and other aquatic activity products. The Company reports sales of "Core Boating Products" versus "Merchandise Expansion Products" (of which nearly all are Waterlife only) with expansion products growing from 13.8% FYE 2011 revenue to 20.8% FYE 2015 revenue.

The e-commerce growth was initiated with the launch of a revamped website in early 2014. Additionally, the Company offers ship-to-store and ship-from-store options to leverage their existing footprint. The Company's e-commerce sales as a percent of total revenue grew from 7.6% FYE 2013 to 10.2% YTD 3Q 16.

Consolidation into fewer, but more comprehensive stores is evidenced in the decline in total stores. While total stores peaked at 404 in 2005 (revenue of $692M, therefore average ~$1.7M revenue per store), that number has fallen since, to 319 in YE 2011 and 256 9/30/2016. Additionally, average revenue per store has risen since that time, to $2.02M FYE 2011 and $2.75M LTM 3Q 2016.

Risks

Competition: West Marine's closest competitor historically, Boater's World, closed all stores in 2009 as a result of the bankruptcy and liquidation of its parent Company, Ritz Camera. Some commenters speculate (example here) Boaters World was the only successful business of Ritz Camera, and was collateral damage in the parent's bankruptcy proceedings; however, this cannot be verified. Today, primary competition for West Marine likely falls into three categories: online retailers, large sporting goods retailers and "mom-and-pop" stores. Among other factors, the Company's brand recognition and national footprint provide an edge, please see below for an overview of competitive positioning by competition category:

- Online Retailer: The Company could face competition from a number of online retailers (including Amazon (NASDAQ:AMZN), which presents competition for essentially all retailers), which offer boating, fishing, and other marine activity products; however, there are multiple factors which provide some comfort against online retailing competition: (i) the Company generates a portion of sales from large and/or heavy items which would require additional time and money to ship (ex. stand-up paddle board, kayak, anchor, SCUBA gear, small vessels), which one could be less likely to order online; (ii) the Company is focusing on the growth of West Marine's online platform which has grown from 7.6% ($50M) of total sales FYE 2013 to 10.2% ($72M) LTM 3Q 2016; (iii) the store's existing footprint in high-aquatic activity areas allows multiple advantages, including ease of access to customers, reduced shipping costs on ship-to-store orders, and expedited delivery on ship-from-store orders; (iv) time sensitive nature of certain products - as many core boating parts can be operationally critical it is important to have these products available quickly, for example if a boater is looking to go fishing and realizes the need for a replacement engine part to start his boat, the boater could quickly swing by the West Marine to salvage his journey. Additionally, the Company's leading brand name among serious and recreational boaters alike represent a competitive advantage.

- Large Sporting Goods Retailers: Large specialty retailers, such as Bass Pro Shops and Dick's (NYSE:DKS), carry a range of marine activity products (fishing gear, bathing suits, etc.) which would compete with West Marine; however, these retailers do not typically carry as comprehensive a range of niche boating products as West Marine. As these large retailers carry a wide range of sporting goods and apparel, they are less likely to focus as in depth on a range a niche boating parts. Additionally, West Marine's store footprint represents a competitive advantage. In the appendix at the end of this memo, there is a West Marine store map and a Bass Pro Shop store map, which show West Marine has a far greater number of stores (~256 West Marine Vs. ~91 Bass Pro Shop), which should enable West Marine to benefit from being the only player in certain locations. As shown in the Appendix as well, Cabela's footprint does not have as significant an overlap with West Marine and also has a materially lower store count.

- "Mom and Pop" Stores: The Company's scale allows it to keep a large inventory in stock while Mom and Pop stores may face working capital restrictions on inventory scale. Additionally, the Company's online platform, which West Marine has invested in considerably, allows various consumer friendly sales channels that a resource-constrained Mom and Pop store may not offer, such as ship-to-store and ship-from-store options. Furthermore, the Company's reputable brand could give consumers comfort in shopping with West Marine.

Macroeconomic Cycle and Secular Decline Risk: As a majority of revenue is generate through discretionary products, the Company is likely to be negatively impacted by a macroeconomic decline as shown below. However, as the below shows, the Company only exhibited three years of single-digit revenue decline from 2007 to 2009, while over this period the number of stores declined from 376 to 335, meaning average revenue per store declined from $1.8M to 1.76M or a CAGR of -1.4%, while a number of similar companies experienced materially worse declines from a total revenue standpoint (Note: Dick's and Foot Locker (NYSE:FL) experienced growth; however, part of this could be attributed to acquisitions). Furthermore, the Company experienced relatively stable EBITDA margins in all periods aside from 2008; however, it is important to note the Company had a ~$23M pretax charge associated with allowances against deferred tax assets that year. Furthermore, avid boaters tend to prioritize proper care-taking of their boats and commonly have above average discretionary income allowing for some insulation against general macro trends. As West Marine is a category killer, they should benefit as one of the only major outlets for critical parts. Furthermore, the Company could close down or not renew leases at unprofitable locations to improve overall profitability and cash flow during a down cycle. Presumably, a portion of these locations would be the weakest during steady state conditions and the effect of this could be positive from a profitability stand point once economic growth were to return. Please note the Company does not disclose financials on a store by store basis, reporting of this would enable further analysis on a number of topics, including profitability potential.

Number of new boat registrations have declined in recent years (Source: US Coast Guard, further discussed below); however, as the Company sells a large portion of maintenance and repair or aftermarket items (80.2% of revenue is from core boating products), demand from the large existing boat fleet (which saw record registrations in the early 2000's) should contribute to a stable core business. Additionally, the Company's diversification into the broader "waterlife" market should provide further mitigation to potential negative trends in new boat purchases. Furthermore, the Company's clean balance sheet and high working capital should allow for relative painlessness in navigating short-term secular disruptions.

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Source: Info from CapIQ and Company Filings, Chart Self Made

Recent Capex and Effect on FCF: In recent years, capex has increased from 2.6% of revenue in 2011 and 2012, to 4.3%, 3.6%, 3.2% and 3.1% in 2013, 2014, 2015 and LTM 3Q 16, respectively. This increase in capex as a percent of revenue has been due, in large part, to the build out and remodeling of waterlife stores as well investments in the build out of the online platform. This increase in capex has represented a material use of cash, however at the same time the Company has demonstrated the ability to grow cash balances and inventory. Furthermore, if the Company ran into any near-term liquidity problems as a result of these investments, the Company also has access to an undrawn $145M credit facility. As shown below, the significant increase in capex led to negative Free Cash Flow (as measured by EBITDA less capex Less Interest Less Taxes) in FYE 2013, while increased capex and compressed margins led to additional negative FCF in 2014. FYE 2014 margins experienced a decline from historical margins due to costs associated with the web platform build out, increased benefit costs, increased training costs and increased health claim costs. Though this cash burn is a negative investment consideration, a material portion of this capex is expected to be one time from the build out of the online platform and certain Waterlife stores. Furthermore, in a period of demand softness, the Company should be able to reduce capex related to the further build out of Waterlife stores, and the Company should have to ability to reduce capex via the closure/non-renewal of poorly performing locations. Additionally, the below FCF analysis excludes any working capital analysis, and as West Marine has significant inventory levels, the Company could likely generate cash through reducing inventory levels. The Company's assets (namely cash and inventory) provide material coverage, Cash plus Inventory Plus AR less A/P and Accrued expenses results in $230M and the business has no debt outstanding.

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Source: Info from Company Filings, Chart Self Made

Strengths

Clean balance sheet and asset coverage: As of 3Q 2016, the Company had $93.9M Cash and $231.7M Inventory, with no outstanding debt and accounts payable of $55.3M. The Company's Inventory to Enterprise Value of 2x and working capital of $247M are the highest in the reviewed periods. The Company's cash balance, and lack of obvious acquisition targets, could represent an opportunity for a substantial return to shareholders. Accounts payable have increased in recent periods; however, per management, this is due to improving terms with the vendor community (which could suggest negotiating power over suppliers). Please note waterlife stores are greater than 10k Sq. Ft. and Traditional stores are less than 10k Sq. Ft.

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Note: Store Breakout not available 2012 and prior

Source: Info from Company Filings, Chart Self Made

Store Count Consolidation: The Company has been consolidating number stores since peaking at 404 in 2005, with average revenue per store of $1.71M, to 256 at 9/30/2016, with average revenue per store of $2.75M. In the period from FYE 2011 to LTM 9/30/2016, the number of stores declined from 319 to 256 while average revenue per store increased $0.73M, although EBITDA margins fell from 5.72% to 4.32%, due in part to cost associated with building out waterlife stores and growing the online platform (please note average revenue per store includes online sales, which grew from 6% of total revenue to ~10% of total revenue during this period). The Company does not report store by store performance therefore one cannot determine the potential value in closing lower profitability stores; however, given the store density in certain areas, further consolidation combined with increased e-commerce sales as well as a reduction in expenses associated with building out waterlife and e-commerce platforms could lead to margin upside. (Please see chart below next strength for per store trends)

Category Killer of Niche/High-End market, with material MRO and critical part demand and an established footprint: West Marine is the largest boat supplies and marine lifestyle retailer in the US, with a dense footprint in the most active marine communities in the US. As the Company does not sell vessels (aside from smaller dinghies, etc.), a majority of its boating revenue is derived from aftermarket and repair/maintenance demand, from life jackets and boat fenders to engine parts and electronics. The Company generated 80.2% of LTM revenue from "Core Boating Products". As such, the Company's demand is insulated from trends in new boat purchases. As the chart below (source: US Coast Guard) shows, the number of registered vessels has fallen in recent years from ~2004 peak; however, the large volume of in-use boats provides stable demand for West Marine boating products. Furthermore, in recent years the Company has leveraged its position as a go-to boating supply store to diversify into other marine activities (which makes sense given both brand reputation and geographic footprint) and has increased the total % revenue from "Merchandise Expansion Products" from $89.4M FYE 2011 to $151.1M 3Q 2016, as Core Boating Product sales have remained relatively constant. The Company has an established footprint and brand name in high-activity boating communities (see store map in appendix), which it services out of two distribution centers: a 472,000 square foot facility in Rock Hill, SC, and a 240,000 square foot facility in Hollister, California.

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Source: US Coast Guard

Valuation and Valuation Trends: As shown below, the Company's EV/EBITDA, as of 11/28/16, has declined by 1.1x from FYE 2011 and 6.1x from FYE 2014. As EV/EBITDA has fallen over 50% from 2014, both revenue and EBITDA per store have increased, revenue increased from $2.42M average per store FYE 2014 to $2.75M 3Q 2016, while EBITDA has grown from $0.08M to $0.12M in the same period. Furthermore, during this same period, the number of stores has decline by 23 and both cash and inventory have risen materially, with cash more than doubling from $45.7M to $93.9M.

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Source: Info from CapIQ and Company Filings, Chart Self Made

Supplier and Customer Diversification: West Marine purchases merchandise from over 800 vendors, with the largest vendor accounting for ~9% of total vendor purchases and the top 20 accounting for 41%. As noted above, Accounts Payable increased in recent periods (however, per management, expected to remain stable around current levels) as a result of revised terms with vendors, showing the Company's ability to manage vendor relationships on favorable terms. Given the Company's position as the largest boating supply retailer and a growing retailer in marine lifestyle products, it is possible the Company is able to exercise pricing power over suppliers who rely on West Marine as a key distribution channel. Furthermore, the Company has a material number of stores across a broad geographic footprint leading to customer base diversification. The Company's recent push into waterlife has increased the diversification of its customer base as well.

Value Accretion Opportunities and Related Thoughts:

Activism or Acquisition: Due to the clean balance sheet (including significant cash), EV discount to asset values, category killer status, and maintenance/repair/replacement (including critical parts) revenue from the boating industry, West Marine could be a good target for either shareholder activism or a potential take-private offer. The ability to close low profitability stores or consolidate stores in close proximity to one another could represent the opportunity to improve margins while temporarily reducing inventory purchases, positively affecting cash generation. Though there has been a consolidation in number of stores over the past decade, and notably in recent years, the recent expansion of larger "Water-life" stores has led to a slower decline in total square footage and while revenue per store and per square foot has improved, EBITDA per store and square foot has been relatively flat to down on a margin basis. Perhaps management is unwilling to sacrifice sales to improve profitability, and this could be part of the why they do not report any financials at the store level (which would be a key piece of diligence). However, given the current valuation, the downside protection from stable core boat product demand and asset values, as well as potential for margin and cash flow enhancement, West Marine could present an opportunity for material upside for an active shareholder or a private buyer.

Analysis of Capex: The Company has increased capex spend in recent periods primarily to build out waterlife stores and improve the online platform. Capex increased from 2.67% of FYE 2011 revenue to 3.21% of FYE 2015 revenue. As the Company does not report financials on a store level basis, one cannot determine the exact use of this capex and the returns generating from these investments.

Compensation, Board and Ownership: CEO Matt Hyde has made greater than $1M (total compensation) each year since joining in 2012, with 2012-2015 total comp of $1.6M, $1.0M, $1.1M and $1.5M, while 2015 represents the highest year of cash compensation at $1.1M. The next three highest paid employees on a total compensation basis for 2015 were EVP of Stores and Wholesale, CFO and EVP of Merchandising, Replenishment and Logistics, who made $0.66M, $0.64M and $0.57M, respectively. FYE 2015 total compensation for each board member was $100k or above, with cash compensation for each board member of $50k or more.

The largest individual shareholder is Randolph Repass (founder and affiliated director) who owns 24.5% of outstanding shares. The rest of management and the board combined own less than 2% of outstanding stock. The largest institutional shareholders are Franklin Resources (15%), Dimensional Funds (8.4%), Royce (7.1%) and BlackRock (5.7%). An opportunity could arise if Mr. Repass seeks partial or full liquidation as he ages or the institutional shareholders seek liquidity (ownership figures per CapIQ). Furthermore, some investors may be justified in thinking that given the high compensation of management, perhaps more of their worth could be tied up in West Marine.

Trading Comps:

The below represents the comparable universe for publicly traded companies of similar size or in similar industries.

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Source: CapIQ and Company Filings

Conclusion: WMAR provides upside for both value and growth via stable cash flows, potential margin enhancement opportunities and valuation increasing towards comp norms while significant asset value and no debt provide downside protection. Shareholders could further benefit from a return of cash via a buyback or dividend. While the present consolidation plan seems relatively positive, additional upside could be unlocked if a store level analysis proves certain stores to consistently lag on a margin and return on capital basis. The Company's core boating products revenue and clean balance sheet should provide stability in a period of macro headwinds. The existing valuation of ~4.75x EV/EBITDA represents a discount based on historical levels, comps and expected cash generation.

Upside Catalysts:

- Return of significant cash balance to shareholders

- Ability to expand margins via consolidation of poorly performing square footage

Downside Catalysts:

- Increased competitive pressures from big sporting goods retailers and online competitors

- Significant top-line headwinds due to competition or macro softness

Appendix:

North America WMAR Store Map

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Source: Google Maps

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Source: Basspro.com

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Source: cabelas.com

Sources:

Capital IQ

WMAR Filings and Presentations

Disclosure: I am/we are long WMAR.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.