Oct 19, 2013

$BODY – What’s Book Value Got To Do With It?

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Value investing is at its core the marriage of a contrarian streak and a calculator.” – Seth Klarman

Body Central Corporation (Ticker: BODY) is a retailer of women’s clothing focusing on the middle market, late-teens to early-twenties customer. Since their IPO in 2010, the stock has been something of a rollercoaster. Its latest turn has been sharply downward after reporting disappointing results in Q2 of this year. Indeed, since August the shares have declined roughly 45% and the stock now trades at ~90% of book value and ~30% of sales.  At first I was very intrigued by the fact that the company was trading at a discount to book value, was cash flow positive and carried no debt. But then I started to wonder, does book value even matter?

I’ve come to believe that as with many things, the relevance of price to book value for a retailer is a matter of degrees – the lower the better, of course. In BODY’s case a price hovering around 1x book value does not imply a margin of safety for several reasons. The most obvious is goodwill that we should almost always assume to be worthless when contemplating a liquidation scenario. Other considerations are the need to write-down inventories, and operating leases – which are effectively off balance sheet liabilities. In sum, for a retailer, an investor shouldn’t expect any margin of safety above 75% of tangible book value.

For prospective BODY investors, the relevant question (at the risk of stating the obvious) is, will this company be profitable?  The answer, I really don’t know. The new CEO is trying to reinvigorate the store format, and based on the Q2 earnings call, seems very enthusiastic about what’s been achieved.  That said, anyone remotely familiar with the retail market will note that the word transformational has taken on more a ominous connotation after the JCP / Ron Johnson debacle – retailer’s grand visions are now trading at a discount on Wall Street.

Another factor that should give investors pause is the company’s expansion plans. As of Q2 they remained committed to expanding the store count by 25 or approximately 10% of the total store count by the end of the year. My two cents is that management should be focusing on their core business and maybe buying back shares if they are REALLY confidant, rather than distracting themselves with an expanding footprint.

Conclusion

As a value investment, BODY rates highly from a contrarian perspective. Retail is an out of favor sector, and BODY can justifiably be characterized as being at the bottom of the retail barrel. The calculator side of the marriage is more mixed. Declining sales comps, an aggressive expansion policy, and unproven management don’t add up to a margin of safety. On the other hand, stripping out the expansion, the firm remains cash flow positive, and management seems to be working to address the issues. Net-net I think this investment offers better than average prospects but not a substantial margin of safety. Therefore I would advocate a small position at most, if any at all.

P.S.

For more information on the most recent quarter check out this article by 501 analysts on SeekingAlpa.com

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