Equity research: West Marine, Inc.

Part 3

West Marine analysis: Why financial performance has disappointed

Competition

In retail, West Marine, or WM, competes with many brick-and-mortar retailers as well as online merchants. Its biggest competition from retail stores is from Bass Pro Shops and Wal-Mart (NYSE: WMT). On a lesser degree, it competes with Cabela’s and Gander Mountain. Online, it faces Amazon (NASDAQ: AMZN) and Google (NASDAQ: GOOG) shopping as well as some small regional players like Defender.com. Price competition is fierce but they do maintain price integrity by matching others’ offers. Its wholesale business competes with Brunswick (Land and Sea), Donovan’s, and Fisheries, among others. As the company grows its merchandise breadth, it competes more with sporting goods stores and apparel retailers.

West Marine Financial OverviewEnlarge Graph

Acquisition history

WM is not looking to grow through acquisition. The company had acquired other chains in the past and found the deals unsuccessful. It acquired 63 Boat U.S. stores in 2003, which initially increased its sales by 25%. WM ended up closing most of those stores over time. In 2009, one of its largest competitors, Boaters World, liquidated 125 stores through bankruptcy. Through all this, WM continued to generate cash and maintain its industry-leading position.

Recent financial performance

Recent results have been disappointing. West Marine, or WM, has had to lower guidance significantly the past two quarters. This past spring was incredibly rainy and the boating season got off to a very late start. Although one hates to blame weather, this certainly is a legitimate gripe this year. Additionally, the New Jersey region was affected by Hurricane Sandy, and many boats did not make it into the water this season. Industry data available in the regions of the US impacted by weather showed ramp fees, marina gas sales, and boat slip usage down 15% to 30%. Conversely, in California, where the weather was more typical, WM realized an increase in sales in the second quarter of almost 4%. Weather aside, the boating industry news has been quite positive. Boat sales have increased nicely this year based on results from Brunswick (BC), Marine Products (MPX), and Marinemax (HZO). New boat sales are a leading indicator for boat accessories. Although usage was down significantly this season, there are more boats out there to serve next season, assuming the Sun comes out again. Gross margins declined 30 basis points year-over-year due to a shift in mix to more wholesale sales relative to retail. The retail business is more impacted by shorter-term issues like weather, and wholesale sales run lower margins due to purchase volume discounts.

The company has managed inventory quite carefully given the replenishment nature of the business and cash flow has stayed strong. In fact, WM is sitting on $45 million in cash and no debt. Cash should finish this fiscal year about where it started despite, almost $30 million in capital expenditures to support the new large stores and technology investments. Capex is about $10 million greater than the prior year due to these additional investments. I would expect the capex budget to be down next year and, over time, drop significantly once the store optimization program is completed.

The Market Realist Take

West Marine’s net income for the third quarter was $6.3 million (or $0.26 per diluted share) compared to net income of $10.3 million (or $0.43 per diluted share) for the third quarter of last year. Excluding the impact of the $1.5 million valuation allowance recorded during the third quarter of this year, which followed a California tax law change, net income for the third quarter would have been $7.9 million (or $0.32 per diluted share).

In terms of guidance, the company said it’s reaffirming its expectation for pre-tax income to be between $15.5 million and $17.5 million. Excluding the impact of a California tax law change that required the company to record a valuation allowance of $1.5 million, its diluted earnings per share are expected to be between $0.37 and $0.42. Its GAAP diluted earnings per share are expected to be between $0.31 and $0.36. Comparable store sales for full-year 2013 are anticipated to be down 2.0% to 4.0% (using the new definition for “comparable store sales” outlined above), with total revenues expected to fall between $650 million and $660 million. West Marine anticipates capital expenditures for fiscal 2013 to fall between $25 million and $29 million.

As part of its share repurchase program initiated earlier this year, the company repurchased 48,859 shares of its common stock in open-market transactions for $0.5 million during the third quarter, at an average price of $11.21 per share. As of September 28, 2013, it had $9.5 million remaining under its current share repurchase authorization. West Marine said in its earnings call that the relatively low number of shares purchased was due to the stock price increasing above the prearranged purchase pricing grid for most of the quarter.

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