Barnes & Noble Inc - 13 March 1998
2
Fourth Quarter Profits Strong
Despite Internet Losses
Barnes & Noble achieved its fifth consecutive
improvement in quarterly earnings in the fourth quarter
despite losses from its internet operations. The company
reported operating fourth quarter diluted EPS of $0.98, up
8% from the prior year. Results were $0.01 above our
estimate and $0.02 above the First Call consensus. Fiscal
1997 EPS of $0.93 was up 24% on a 14% sales gain. We
forecast a loss per share of $0.05 in the first quarter up
from a loss of $0.06 a share in the prior year. We are
raising our fiscal 1998 EPS estimate $0.01 to $1.13, an
increase of 22% over the prior year. Our preliminary 1999
EPS estimate is $1.40, up 24%.
Internet Losses Should Continue
Management expects the internet business to produce
losses in the first two years of operation but turn profitable
by 1999 unless growth plans are ramped up significantly.
Online sales were $14.6 million in 1997 and losses were $9
million or $0.13 per share. At the end of February,
BarnesandNoble.com had a customer base of 368,000 and
expects that to grow to one million by the end of 1998.
Over 40% of sales are from repeat buyers. Sales are
expected to reach $100 million in 1998 with losses of $13
to $14 million or $0.18 to $0.19 per share in 1998. These
losses reflect increased advertising expenditures utilized to
grow sales online. Start-up expenses are dis-proportionate
to early sales and should decline over time.
n Superstores Drive Strong Sales Gains
Superstores continue to drive above plan sales gains for the
total company and accounted for 79% of total sales in the
fourth quarter. Total sales rose 10% in the fourth quarter.
Superstore sales increased 14% as a result of a 12% rise in
number of stores and above plan 9.6% comps. Mall sales
decreased 10% in the fourth quarter from a 9% decline in
stores and an above plan comp gain of 1.6%. We expect
sales to remain strong in the first quarter with a total
company gain of 12% forecast. We expect superstore sales
to increase 14% from a 9% gain in stores and 7% comps.
Mall sales are projected to decline 11% from a 9% drop in
stores and a 1% decline in comps. Internet sales are
expected to ramp up throughout the year with about $10 to
$15 in sales forecast for the first quarter. Inventories rose
16% in line with sales growth.
n Strong Gross Margin Improvement Continues
Gross margin increased for the fourth consecutive period in
the fourth quarter with a gain of 110 basis points and 13%
in dollars. This improvement reflects the shift in the
merchandise mix to superstores and higher margin titles,
freight cost efficiencies and more direct buying. We expect
first quarter gross margin to rise 32 basis points.
n Increased Expenses Reflect Internet Growth
Expenses as a percent of sales increased for the third
consecutive quarter, after seven quarters of improvement,
reflecting an increased investment in the internet. SG&A
ratio increased 35 basis points and 12% in dollars in the
fourth quarter. The core retail business experienced
slightly expense leverage in the quarter. We expect the
SG&A ratio to rise 30 basis points in the first quarter.
n EBITDA Continues to Rise
EBITDA margin increased for the eighth consecutive
period in the fourth quarter with a gain of 91 basis points.
We believe that EBITDA margin could be down slightly in
the first quarter reflecting an increased internet investment.
n Positive Free Cash Flow for First Time
Barnes & Noble generated free cash flow of $47 million in
1997. This was the first time the company had positive
free cash flow since the beginning of the superstore roll-out.
We expect free cash flow generation to continue to
grow as superstores mature.
Valuation Remains Attractive
Year to date, Barnes & Noble's shares have appreciated
13% versus a 10% gain in the S&P 500 and a 23% rise in
the S&P Retail Composite. The shares are currently
trading at 33 times our 1998 EPS estimate. However, we
believe that the internet business is significantly
undervalued. If given an equivalent value as its largest
competitor online, Amazon.com, Barnes & Noble's retail
business would only be trading at 19 times 1998 earnings.
We believe continued growth of online sales should be
increasingly reflected in the stock price. In addition, we
believe "sustainable growth" retailers, like Barnes &
Noble, should benefit as investors look for domestically
focused companies that can report double digit earnings
gains as corporate profits slow. We are reiterating our
intermediate and long term Buy ratings.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
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