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Tuesday, September 8, 1998
Borders Group, Inc.
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Phone: 734-913-1100
Website: http://www.bordersstores.com
Price (9/4/98): $22 1/4
HOW DID IT FIND TROUBLE?
This leading retailer of books and CDs has been bound, gagged, and shredded. It took fourteen months for the stock to double to an all-time high of $41 3/4 in July. It's now taken less than two months for the stock to be remaindered nearly into oblivion. You don't need to be a chartist to see that this solid bestseller has taken a hit.
But judging by the August 12 earnings report, Milli Vanilli this ain't. Tearing a page out of its standard songbook, Borders Group reported second quarter sales of $546 million, a 17.1% increase over last year's results. Superstore sales led the way, up 25.8% thanks to 42 new store openings and a 5.4% gain in comparable-store sales.
Results at the mall-based Waldenbooks were a little weaker than expected, down 3.9% overall and 2.5% on a comp-store basis. But Borders' overall gross margins booked a gain to 25.6% from 24.7%, pushing earnings to $0.03 a share. That met estimates and beat last year's $0.01 per share.
So why did the stock drop 39% over the ensuing three weeks? Given the often frenzied action in shares of online bookseller Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> and the reaction to Barnes & Noble's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKS)") else Response.Write("(NYSE: BKS)") end if %> news that it would soon take its online unit public, it seems that investors who had bestowed an e-tailer premium on Borders decided to take it away.
With Borders once again delaying the launch of its website, this time until some time in September, partisans began to think that Barnes was nobly succeeding at leveraging its brand to the Web. Meanwhile, Borders was simply marginalizing itself to the slower growth bricks and mortar business even as Amazon seemed determined to flood the industry with red ink.
BUSINESS DESCRIPTION
Through its 213 Borders superstores (most of which also sell CDs), the company is the second largest book superstore operator in the world. Its 899 Walden Bookstores also make it the largest operator of mall-based bookstores. The company has a growing international presence with superstores in Singapore and London and 23 Books Etc. stores in the United Kingdom.
Once owned by K-Mart, the company has recently focused on expanding its Borders superstores. The Borders unit has seen 47% compound annual sales growth for the last three fiscal years. Each store carries about 128,000 book titles, 50,000 music selections, and 6,500 videotape titles. Nearly every superstore also includes an espresso bar, which helps make the stores a social destination.
Though the Borders.com website opened in early May, about eight months late, the company has delayed the gala official launch until this month as it works to beef up the site. While FY98 online revenues were projected to run around $25 million, sales so far have only amounted to about $2 million.
Insiders own 7.4% of the stock according to the latest proxy, with Chair/CEO Robert F. Diromualdo holding 2.5% of the total.
FINANCIAL FACTS
Income Statement
12-month sales: $2,427.3 million
12-month income: $85.5 million
12-month EPS: $1.04
Profit Margin: 3.5%
Market Cap: $1856.7 million
Balance Sheet
Cash: $44.8 million
Current Assets: $988.5 million
Current Liabilities: $844.9 million
Long-term Debt: $58.0 million
Ratios
Price-to-earnings: 21.4
Price-to-sales: 0.76
HOW COULD YOU HAVE SEEN IT COMING?
At its high, Borders traded at 34 times FY98 projected earnings of $1.22 a share. Given that we're talking about a 25% per year grower that delivered 3.5% net margins last year, that should have seemed pricey.
The stock's high correlated with Amazon.com's first ride into the $140 plus stratosphere, a ride that also carried Barnes & Noble to its recent high. If you thought Amazon was being carried along by hype -- and, you know, stocks aren't supposed to go straight up -- then you also might have figured that Borders' prospects were also being exaggerated. All three stocks have since fallen off the charts, though Borders' more than the others.
WHERE TO FROM HERE?
The Boring Portfolio's Greg Markus and Mark Weaver have repeatedly made the case for Borders both as a steady growth stock and as a more appealing pick than either of its leading book-selling rivals. Unlike Amazon, Borders is not just making money -- it has actually managed to meet estimates every quarter it's been a public company.
Meanwhile, Barnes & Noble's second quarter sales (up 9.3% overall, with superstore sales up 11.1% on 5% comp-store growth) paled compared to Borders' results. Moreover, Borders hasn't blown a wad of money marketing its website. In fact, the company seems reluctant to spend serious bucks to become an online destination, preferring instead to position Borders.com as a complement to the existing stores.
On its own terms, Borders now looks like an interesting value trading at just 17 times management's guidance for the year ending January 31. Assuming 25% long-term growth, the stock now sports a PEG of around 0.81, not bad for a profitable national retailer, though not dirt cheap either.
The company plans to open a total of 36 new superstores plus three new international stores (two in the U.K., one in Australia) in the second half of the year. The superstores should produce comp-store sales gains in the low 5% range for FY98 overall. Also, senior management recently decided to take this year's compensation in stock options with a $29.81 strike price.
Yet, Borders has also taken on a lot of short-term debt ($246.7 million today versus $55.2 million a year ago) to finance its store expansion. In addition, online retailing isn't going away. It could trim gross margins at brick and mortar retailers for years to come. Borders' ambivalent stance on this competitive threat may ultimately hurt the company by forcing it to spend millions playing catch-up or simply leaving it without a serious presence in the fastest-growing book and music selling space.
For now, though, CEO Diromualdo and his team seem to think they know what they're doing. And despite the stock's recent demise, investors haven't had any serious reason to doubt them so far.
Related articles:
-- Boring Portfolio, 08/20/98: Book Wars!!
-- Boring Portfolio, 08/14/98: More on Borders
-- Boring Portfolio, 08/12/98: Thoughts on Borders
-- Boring Portfolio, 08/11/98: Borders Preview
-- BORDERS Q2 Conference Call, 8/12/98
-- Louis Corrigan
([email protected])
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