West Marine (WMAR) is inflecting upwards as investors are ceasing to value it on tangible book and starting to value it on 2014 EBITDA. We believe there is room for 80% upside as the company begins to trade on 2014 profitability.
West Marine is the unrivaled national leader in a timeless business, but similar to SAExploration, has been negatively affected by a conflux of one-time events:
Terrible weather over the past year, including Hurricane Sandy.
One-time tax hike to over 51%, during its second most profitable quarter in 2013.
Peak capital expenditures that will be reduced dramatically starting in 2014.
When these effects are removed West Marine can conservatively generate more than $50 million in EBITDA. Even better, indicators for 2014 are excellent as boat sales are particularly strong this year and the company will begin to reduce capex starting next year.
Based on 10x 2014 EBITDA, we believe West Marine is likely to trade upwards to north of $20 per share. The stock has already begun to move as we've written this article.
Company Background
West Marine might be described as the Wal-Mart of boating. The company sells boating supplies and accessories at 290 retail stores in the US, Puerto Rico, and Canada, and 5 stores in Turkey. For a better idea of the company's products, check out their website. West Marine also runs a wholesale business, Port Supply.
Current chairman and 30% shareholder Randolph Repass founded West Marine in 1975. After growing into a national footprint over many years, the company has focused on several initiatives to build shareholder value:
Real estate optimization program The company's store count peaked in the mid 2000s as Wall Street pushed the company, a hot growth story at the time, to grow too rapidly. West Marine is now focusing on optimizing its stores by closing less profitable ones and enlarging more profitable ones.
These initiatives are definitely key positives but hurt earnings as they are expensive, one of several factors hiding the earnings power of the business.
One-Time Negative Events
"The best thing that happens to us is when a great company gets into temporary trouble."
The key to the opportunity in West Marine is the series of unfortunate events that West Marine has had to cope with:
Revenue suffered from extremely poor weather during key parts of this year's boating season (revenues are highly seasonal). A savvy, skeptical investor might balk at this explanation for poor results, however, an objective check of boating related indicators supports this explanation. These indicators, including ramp fees, marina gas sales, and boat slip usage were all down a whopping 15% or more in the affected regions. Moreover, unaffected regions of the country performed well. In the Q2 call management noted that California revenue was up 3.6% in Q2. This effect was aggravated by Hurricane Sandy late last year, the second most destructive hurricane in US history. Sandy unfortunately hit squarely in the center of the company's largest market on the east coast.
West Marine had a one time tax charge in Q3, which boosted its tax rate to 51.3%. This is particularly significant as Q3 is the second biggest quarter of the year for West Marine. The 10-Q notes that the tax rate was 11.8% higher due to the charge, resulting in a $1.5 million income reduction.
The operational improvements West Marine is investing in, especially real estate optimization and e-commerce, are boosting capex significantly and hurting the bottom line. Management expects 2013 capex to be between $25-$29 million. The bulk of this is comprised of store optimization and ecommerce. There will still be investments in these initiatives in 2014, but spending is already slowing and will continue to slow next year. Based on fourth quarter capex, we assume that 2014 capex would be $20 million or less.
Despite the recent rise in share price, West Marine is already much more profitable than it currently appears: a fact that has not been fully priced in by the market.
2014 Demand Looking Excellent
Given the seasonal nature of West Marine's business we believe it is too late to look for an earnings improvement this year. However, recent boat sales have been excellent - a leading indicator for strong 2014 sales.
For evidence of this we look to YoY revenue growth for the three publicly traded boat manufacturers/dealers, MarineMax (HZO), Marine Products (MPX), and Brunswick (BC).
Company | Q1 | Q2 | Q3 |
MarineMax | 11% | 16% | 9% |
Marine Products | 17% | 10% | 9% |
Brunswick | 4% | 5% | 1% |
Brunswick's numbers are obviously not eye popping, but in an industry as mature as boating, anything faster than GDP is a clear positive. The average of all of these growth rates is over 9%. SA contributor Todd Campbell recently argued MarineMax could double again after doubling over the last twelve months. Marine Products and Brunswick have almost doubled as well. Finally, powerboat sales have also been strong, as noted by a recent article.
Valuation
The market is currently valuing West Marine at under 1.1x tangible book, a proxy for liquidation value. This is unnecessarily conservative considering the relatively liquid nature of its assets, timeless nature of its business, and proven profitability.
There is an excellent opportunity here to own West Marine as it makes the transition from tangible book to valuation on an EBITDA multiple, which should drive the shares to $20.
We believe West Marine can generate $51.75 million of EBITDA in 2014.
Due to significant positive developments in both revenue and operating margin compared to recent years, this is entirely reasonable in our view. The company has achieved significantly higher EBITDA in the last decade.
Revenue is likely to come in at $735 million or higher.
Sidoti's estimate is $701 million and we believe it is far too conservative. Sidoti had estimated $736 million until poor weather reduced revenue significantly. This likely reflects discounting for management using weather as an excuse. However, we are comfortable that this is not the case given data from other indicators of boat usage. Also, before the tough weather, West Marine management guided for 2013 revenue to be between $700 and $715 million.
Considering the extremely strong performance of boat sales since guidance in February, $735 million is conservative. If West Marine's sales grow just as fast as boat sales have, $770 million would be a better estimate assuming 2013 guidance would have been accurate except for weather.
We believe 5% is a reasonably conservative operating margin estimate.
This is slightly higher than Sidoti's 4.7% estimate. However, given operating leverage with our higher revenue estimate and progress due to the three initiatives discussed above it is reasonable to expect margins to come in meaningfully higher. This is not aggressive compared to West Marine's historical performance.
With a 5% operating margin and $735 million in sales, WMAR can conservatively do $36.75 million in EBIT next year. Assuming $15 million in Depreciation and Amortization, consistent with the last few years but conservative given increasing capex, we project EBITDA of $51.75 million.
Revenue | $735 million |
Operating Margin | 5% |
EBIT | $36.75 million |
D&A | $15 million |
EBITDA | $51.75 million |
For a consumer durables retailer of West Marine's size, defensibility, growth profile and industry dominance, a 10x EBITDA multiple is conservative. It's actually difficult to find a good comp for West Marine because there is no publicly traded company in the same business. However, a 10x multiple is conservative no matter what you compare it to.
Running a Bloomberg screen for consumer discretionary companies domiciled in the US and averaging 2013 EV/EBITDA shows that they trade at just under 12.5x. Changing the sector specification to either retail or consumer durables and apparel changes the average EV/EBITDA to around 14x. These are the most relevant to WMAR as the company is a retailer of consumer durables.
Keep in mind, these are median and average EBITDA multiples for entire sectors, and don't reflect the timeless nature of West Marine's business or its industry dominance. On the other hand, they are higher than WMAR because WMAR is not really a growth business whereas many of the companies included in that average are.
West Marine's EBITDA multiple at 10x is also conservative compared to boat manufacturers/dealers, which average well above 10x.
Ticker | Market Cap (millions) | 2013 EV/EBITDA |
HZO | $374 | 17.91x |
MPX | $354 | 34.65x |
BC | $4070 | 9.9x |
Finally, Bloomberg suggests auto parts retailers as the best comparable, and these also average over 10.
Ticker | Market Cap (millions) | 2013 EV/EBITDA |
(CRMT) | $370 | 9.2x |
(PBY) | $710 | 6.7x |
(ABG) | $1580 | 10.7x |
(LAD) | $1690 | 12.3x |
(MNRO) | $1590 | 14.6x |
We don't claim that all these companies are good comps. The above data is just to illustrate that despite a relative lack of good comps, 10x EBITDA is a conservative multiple to assign to West Marine.
At 10x 2014 EBITDA of $51.75 million and cash of almost $70 million, West Marine should trade at about $23.80 per share once it is trading on 2014 EBITDA. We believe this shift is beginning now and is likely to accelerate going into 2014.
Risks
The most significant risk facing West Marine is bad weather. It's possible but unlikely that weather will be just as bad next year as it was this year. Fortunately, the company does relatively little business in the first and last quarter of the year when it's too cold for boating in many parts of the country. This means that weather won't have an impact for the next few months at least, and investors don't have to worry about this risk for the next few months.
There is also the risk of competition from online retailers. While many companies, notably electronics retailers, have suffered from online competition, many others have been relatively unaffected. There is no real evidence to suggest that West Marine is currently suffering from online competition or that it will. It is likely that the specialty nature of West Marine and the domain knowledge that it can offer shoppers make it difficult for online shopping to compete.
Finally, as a retailer of boating supplies and accessories, West Marine relies on consumer discretionary spending, and is therefore a cyclical business.
Catalysts
This opportunity exists because the stock is very under followed (only one analyst and 85 SA followers at the time of writing despite $300 mm market cap) and relatively illiquid, making it inaccessible to many funds. Just like SAExploration, West Marine could be catalyzed significantly by increased investor awareness. This is already occurring as the stock has begun to move upwards, and recently picked up coverage from B. Riley & Co. The low volume as it moves upwards suggests a lack of stock for sale and that holders see meaningful upside remaining. We obviously agree with this and believe current prices are a bargain.
Due to the company's operational improvements and increased demand for boats, 2014 earnings and EBITDA should be significantly higher. These operational results should drive fair value for West Marine to north of $20 per share.
Disclosure: I am long WMAR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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