Description

This is a short writeup. Duckwall-Alco is a regional retailer with a focus on under-served markets that have no direct competition from other full-line discount retailers. The company operates in two business segments consisting of –
a) ALCO Stores –Accounting for 92% of sales, this segment consists of stores with an average selling space of 20,800 sq. feet and deals with general merchandise. Duckwall operates 185 Alco Stores - 151 of these stores being located in communities that do not have another full-line discounter.
b) Duckwall Stores – Accounts for 8% of the Company’s total sales. This segment consists of 80 Stores primarily located in communities of less than 2500 residents. They average approximately 5400 sq. feet of selling space.

There is a good writeup of DUCK on VIC dated 6/14/2002 detailing the company’s business model. Especially interesting is the Company’s focus on small-demographics which provides it with a competitive advantage against other retailers.

The company’s focus over the last three fiscal years has been to implement new merchandising and marketing initiatives in an effort to increase customer traffic and same-store sales. One of the initiatives was a remodel program. During fiscal 2004, the Company remodeled 23 stores. During each of fiscal 2003 and fiscal 2002, the Company remodeled 32 stores. The Company has also opened a total of 17 new ALCO stores during the last three fiscal years that incorporate the enhanced merchandising concepts of the remodeled stores, bringing the total number of stores with this new format to 104 at the end of fiscal 2004. In June 2004, the Company converted its first ALCO store to an “ALCO Market Place” store. This new format devotes approximately one fourth of its floor space to a limited, but greatly expanded assortment of foods, including produce, dry goods and products displayed in freezers and coolers.

Despite all these efforts, SSS have failed to match the industry average - Oct-04 1.30%, Sep-04 1.10%, Aug-04 -2.70%, Jul-04 -0.20%, Jun-04 -0.20%, May-04 0.50%, Apr-04 -3.30%, Mar-04 2.40%, Feb-04 -0.40%, Jan-04 -0.10%, Dec-03 0.60%, Nov-03 3.20%, Oct-03 0.10%, Sep-03 3.70%.

So why am I interested? In August 2004, Strongbow Capital filed a 13-D with the company and outlined a series of actions they believe will enhance shareholder value –

a) Employ an independent firm to investigate the make proposals to the Company for improving below par performance. Management has hired Alix Partners to provide insight to provide strategic business advice on how they could increase sales, reduce operating expenses and improve competitiveness. The company currently operates at $102 per sq. foot – which compares to $160 per sq. foot for DLTR, or $151 per sq. foot for DG. As an example, a 1% increase in the Company’s sales would equal $4.33 million using FY 2004 figures. Assuming a gross margin of 33%, this would add $1.43 million to pre-tax earnings. With a 36% tax rate, this equates to an increase in Net income of $914,000 (or 21c per share). At a P/E multiple of 10, incremental EPS of 21c equates to $2.00 of incremental market value per share.

b) The company’s inventory/assets ratio of 0.78 is very high compared to similar retailers who maintain this ratio at about 0.4 - 0.52. If the company improved its merchandising mix or liquidated inventory to make it more in line with the industry average, it could potentially free up (using 0.45) $68 million of cash which could be use to reduce debt or buy back stock. Or put another way, even if we use $30 million cash from liquidation as a conservative number, it reduces the company’s EV to $65 million and EV/EBITDA to 3.7.

c) SG&A reduction. DUCK’s SG&A is about 29% of sales as compared to an industry average of 20% - 25%. As mentioned in a), a small increase in sales (or decrease in expenses) can lead to a large increase in share price and ROE.

e) The company trades at a low valuation compared to industry peers. Excluding the one-time expense of $328,000 for fees paid to Alix Partners –
EV/EBITDA = 5.4 (not including operating leases)
P/B = 0.67
P/E = 12.
ROE = 5-7%.

Peers trade at substantially higher multiples (P/B = 2x EV/EBITDA = 7x, P/E = 17x).

Other positives –
Management acknowledged StrongBow’s letter in a recent conference call and is willing to work with shareholders to increase shareholder value – as evidenced by them hiring an independent firm to provide consultation in this regard.
Stock option grants are low here compared to other companies. Options granted in 2001 and 2003 and the current options outstanding are 6.3% of outstanding share count.
MFP owns 2.7%, Heartland owns 10% of outstanding shares and Franklin owns 7.5% - so we are in good company here.

Risk Factors

Management might not take any action and continue to operate this company to destroy shareholder value.
Their “Market Place” concept might bomb.
Competition from Dollar Stores trying to enter their markets – self-explanatory.

Catalyst

Takeout by a larger retailer
Implementation of initiatives suggested by Alix Partners and activist shareholders to enhance shareholder value
Increased share buybacks