Description

Sportsman’s Guide has an unleveraged return on equity of over 35% and trades at 4.85x free cash flow (defined as operating cash flow minus capital expenditures).

The company is a retailer of sporting gear and other outdoor items. It sells its products primarily through its catalogs and web site. If you are not familiar with this company’s wares, please check out www.sportsmansguide.com and spend freely.

1) The company has a strong niche brand. Its customer following has been cultivated since Sportsman’s Guide was founded in 1970 as a catalog of products targeted at deer hunters. Over the years, founder Gary Olen has broadened the original catalog into a business producing $180 mil in revenue per year through a series of monthly catalogs with a distribution of 46 million per year.

Indicative of the loyalty of the customers is the success of the company’s recent Buyer’s Club initiative. Buyer’s Club members purchase a yearly membership for $29.99 to receive catalogs with limited run items available only to members. Members also receive 5%-10% discounts on most items. The number of members was 310,000 at 12/31/02. Membership grew 22% last year and has continued to grow in the 1st quarter.

2) A key competitive advantage for a catalog marketer is its database of customer names. 85% of the company’s revenues come from existing names in its database of sporting and outdoor enthusiasts. Sportsman’s Guide has 5.2 million names with demographic data and purchasing history in its customer files. Of these, 1 million names have purchased a product within the last 12 months. Over time, the company has used response data to subdivide this database into subsets of customers. These subsets receive different specialty catalogs in addition to the main Sportsman’s catalog. The specialty catalogs have different product focuses: government surplus, camping, shooting, hunting, etc. Subdivision improves response rates which reduces unnecessary mailing costs and improves economic returns.

Ever since the launch of the online Sportman’s catalog, the database has also been supplemented with email lists. There are approximately 900k names in the email database and nearly all of them receive a broadcast email every 1 or 2 weeks.

3) The company’s “bargain” focus is hard to replicate. The company has developed a customer following partially because of its history of value-priced bargain items in its catalogs. These items are 25%-60% off retail. The company is able to offer these prices to customers because the company's buying agents comb for discontinued/liquidation/overstock items through a network of 1200 supplier contacts. Because the supply of overstock items is irregular, it’s critical to have the ability to purchase opportunistically and store cheaply. All inventory is stocked in Sportsman’s warehouses in Minneapolis. Catalogs are customized to include these overstock items shortly before printing so the inventory carrying period is minimized. The company’s customer base of bargain hunters allows SGDE to move these items faster than other competing retailers. What cannot be sold via its regular catalogs and online store is liquidated through its bargainoutfitters.com site and a small retail location the company has in Minnesota. Everything from the low grade paper in the company’s catalogs to the incentive systems for maintaining high shipping accuracy is aimed at selling cheaply and producing a solid return on capital.

4) I believe there is a fundamental shift in SGDE’s business that is reducing costs in the company and improving return on capital. It’s this fancy new thing called the internet.

Up until 1998, all of the company’s business was done through print catalogs. Millions of these catalogs were distributed each year with each one incurring shipping and printing costs. There’s also higher production costs and longer product lead time required when doing business by catalog.

The company began its web site in 1998 and by February 1999 had its full product offering on the web. Sales generated through its web site have grown each year from 1998 to 2002: $1 mil, $14 mil, $24 mil, $36 mil, $53 mil. The company is encouraging this transition by prominently mentioning the web site in the catalogs it continues to distribute. In the 4Q of 2002, internet sales generated 30% of total company sales.

So what? Well, aside from the reduced capital needs, the company has a chance to take out a major portion of its operating expenses if it can successfully transition its business to the internet. Its current cost of distributing catalogs is approximately $30 mil a year. A large portion of any reduction of this $30 mil in expenses would drop to the bottom line. Considering that free cash flow is currently $8.3 mil, even a small amount of savings would produce a large effect. The company has reduced catalogs mailed from 80 million in 1999 to 46 million in 2002. SG&A (which include the catalog costs) has been falling: 34.8% of sales to 30.8% in 2001 to 29.3% in 2002. These are the initial signs of the internet's impact on Sportsman's business.

Catalyst

The company has recently initiated a share repurchase program to retire up to 10% of its outstanding stock. The company has a history of returning capital to stakeholders. $7.4 mil of debt was paid down in 2000. $5.2 mil of debt was paid down in 2001. (In 2002, cash simply built up because debt was retired). Now that the company is debt free, it is using a portion of its cash hoard (currently equal to about 20% of market cap) to retire a substantial number of outstanding shares.