Category: TLF

New CEO Janet Carr got a proper chance to address investors on the 4Q18 earnings call on March 7th.  A key theme throughout the call is that FCF, instead of top line growth, will be a priority driving decisions going forward.  Consistent with this focus, the retail stores will be operated to maximize cash flow, likely leading to 4-6 store closures in 2019 in addition to the 3 closures announced in February.  No store openings are planned so Capex will likely be at a lower level than we have seen in recent years ($1mm ’18, ~$1.7mm in both ’17 and ’16).  Tighter Inventory management continues to be a priority. Even after falling $3.5mm throughout 2018, we are still looking at ~$34mm of Inventory.  It was loosely mentioned on the call that 3.0x Inventory Turnover is an aspiration, given 2018 sales that would imply a further $7mm improvement in Inventory.

Outside of the FCF focus, TLF is also re-focusing on Commercial Wholesale customers.  This is really a no-brainer, and will be a good growth component in a time when the retail segment is being right sized.  Tandy’s main benefit is how large they are in their niche of leather crafting.  Given this, they have the ability to compete most effectively in what is a more commoditized segment of the business.

The focus on FCF should be music to investors’ ears.  FCF yield was >10% in 2018, a year full of one-off expenses.  Now we look to 2019 and despite it being a reset year, I expect the focus on FCF to drive a year over year improvement.  The company continues to buy back shares: 243,387 in 2018 for $1.6mm.  Subsequent to year end, the company fully repaid the $9mm outstanding on the revolver while also having repurchased 53,626 additional shares for $300k.  853,780 shares remain on the current buyback authorization that expires in August.  At today’s (3/18/19) closing price, to complete the authorization would cost $5.5mm for a company that has ~$15mm on the balance sheet and no debt.

I had initiated a small position in February and will be adding to it in the coming weeks.  I really am encouraged by management’s focus on cash flow over top-line growth and as I stated above the focus on the Wholesale business is a no-brainer.  TLF remains a Cash Flow machine, and sooner than later the rest of the market will take notice.

 

I own shares of Tandy Leather Factory (TLF).  This article is opinion only and not a recommendation to buy or sell.  

 

 

 

Tandy Leather Factory is a niche brick and mortar retai…..wait guys! Stop! Why are you running away so fast!

Tandy is the dominant market leader selling leather and leather crafting items to retail and wholesale customers in North America (115 stores) and Internationally (1 location in both UK and Spain). In some ways 2018 was rocky: 1) CEO and President (both with long tenures at TLF) abruptly resigned in October. 2) This caused 2020 financial targets to be withdrawn ($87-90mm annual sales and >10% operating profit margin) to be withdrawn. 3) In the past week TLF pre-released 4Q 2018 sales numbers which included notes on 2 U.S. store closures, the closure of the 1 Australian location, and that 2018 operating profit would negatively affected by these and other one-time events. But 2018 wasn’t all bad: 1) The company will end up recording its first positive annual sales growth (+0.9%) since 2015. 2) With the announcement last week, TLF also disclosed their cash balance as of 12/31/18 was $24.1mm, +$5.8mm YoY.

Currently the market is punishing TLF for the negatives of 2018 while ignoring the company’s strong competitive position and arguably very wide moat. Before we dive more into how cheap TLF currently is, take a look at the following link. This report was very informative and helped me get a better idea of TLF’s world and how they have come to dominate it. I feel no shame in linking to another great piece of work as I feel it would be a waste of time to reinvent the wheel. The report was completed in 2015 so some of the ways the company classifies its segments and store count have changed but the main points remain the same:

• The company sees potential for 150 stores in North America (115 today)
• Absent new stores, focus on relocating to larger stores in nicer areas
• Have identified 20 countries outside of NA that could support a TLF store
• Growth in the U.S. has been constrained by the difficulty in finding and retaining key talent (store managers mostly) as its a tough argument to get someone to uproot their life for a $36,000 salary (raised 40% in Dec. 2016) and 25% of store EBIT as compensation
• About 40% of sales are leather and 60% leather crafting accessories; the leather sales are commodity-like and lower margin

After reading more on TLF’s competitive position I think it should be easy to see that this in not a cigar butt by any means. The market is offering us a high-quality business, with a sustainable moat, for not too much more than liquidation value. As of 9/30/18, Net Current Asset Value was $44.3mm vs. a market cap of $52.6mm (2/1/19). And despite the noise in 2018, TLF will still likely report ~$5.5mm of FCF for the year.

Despite the removal of the 2020 financial targets I think it is safe to assume a 10% operating margin is a level the company will continue to strive towards. At current EBIT levels, TLF is valued at less than 6.5x EV/EBIT. If you assume they can get to 10% EBIT margin, this drops a full turn, assuming no top line growth.

Concerning the excess cash that’s building on the balance sheet, TLF has an outstanding share repurchase authorization of ~1mm shares, about 11% of outstanding. The company has $8mm of debt outstanding on a $15mm line of credit that is expressly for the use of share buybacks. (It will be converted to a 4-year term loan once the authorization is completed). The buyback has already been extended by one-year as the illiquidity of TLF stock makes it tough to complete buybacks.

The abrupt departure of the former CEO and President is a definite negative, but it doesn’t do too much to shake my confidence in the company or how shareholders will be treated going forward. A main reason for this confidence can be attributed to Chairman, and 30% owner, investor Jeff Gramm. Gramm joined the board in 2014 and has been an advocate for creating shareholder value; he even wrote a book on the history of shareholder activism all the way back to Ben Graham titled, Dear Chairman. Gramm’s involvement leads to me believe that the path forward will include narrowing the gap between intrinsic value and market value while also growing intrinsic value over time.

In summary we have the following:

• High quality business with a large moat trading for around 6.5x EBIT
• Current market price near Net Current Asset Value
• A share repurchase authorization to repurchase 11% of outstanding shares
• A major shareholder and chairman who is strong advocate for shareholders and narrowing the gap between intrinsic value and market value

Whether it’s the executive departures or just the fact this is an illiquid micro cap in a very niche end market, I think the market is completely undervaluing TLF today. It may not happen in 2019, but I am confident that the 4 bullet points above will combine to create value for shareholders going forward.

I own shares of Tandy Leather Factory (TLF).  This article is not a recommendation to buy or sell.