Description

Investment Thesis:

West Marine, Inc. (WMAR) has a dominant market position in the marine retail industry.  The industry has had a very rough couple of years, but the Company has good near and longer term prospects due to a significant reduction in industry store count and low competition due to the liquidation of the only major competitor.  WMAR was once a highly covered specialty retail growth story, but has disappointed for a number of years now and hence is completely unfollowed by Wall Street (no analysts cover the stock).  The stock is somewhat thinly traded and still remains very cheap despite an obvious major improvement in industry dynamics.  Due to improved industry dynamics, and a business that has gone a long way towards right sizing itself, I believe WMAR is on the way to significantly improved profitability in the quarters and years ahead.  I do not think the current stock price appropriately reflects the likelihood of an earnings recovery and I think there is significant upside and very limited downside from here.

Brief Business Description

I'll let you read the 10k for the full description, but very simply - the Company is a retailer of boating accessories.  Most stores tend to be 10,000 - 15,000 square feet (though they are tinkering with a new larger 25,000sf concept and also have a few small stores), and supply boaters with everything they neeed in order to get out on the water (except the boat itself).  The major product categories include apparel, maintenance supplies (paint, cleaners, chemicals, adhesives etc.), electronics, lifestyle products, safety products and boat hardware (deck hardware, lines, fenders, turning blocks etc.).   They've got 342 stores at last count and LTM revs of $596mm.  They also have a direct sales channel (catalog and internet) and "Port Supply" which serves as a wholesale distributor to marine professionals.  The latter two channels are a little over 10% of revs.

Liquidation of Boater's World

WMAR is by far the dominant player in the industry, with no serious competitor on a national or regional basis since the liquidation of Boater's World (BW).  BW was founded in 1987 as a subsidiary of Ritz Camera, who saw an opportunity to enter an attractive niche retail space occupied solely by WMAR.  The strategy of BW appears to have been to simply undercut WMARs pricing, while providing a narrower assortment of products and an inferior customer experience (worse locations, little investment in stores, less knowledegable employees).  In fact a number of BW locations were Ritz Camera locations that had been divided into separate spaces, so you had in certain cases cameras on shelves next to life jackets.  Anyhow, certainly ultimately a failed retail strategy but they were successful in capturing a decent amount of share from WMAR.  These guys were really annoying to WMAR because they would set up shop around the corner and undercut on price.  Ritz Camera filed for bankruptcy earlier this year and Boaters World was liquidated in March this year.  The liquidation was managed by Hilco/Gordon Bros. and virtually overnight, 129 stores were taken out of the system. 

What is interesting to me about this situation is that marine retail is such a specific, SKU intensive category.  There really aren't any other stores where you can buy specialized marine coatings, deck hardware, lines, safety equipment or boating specific apparel.  Sure, the big box retailers or sporting goods stores capture some business in categories like fishing, but if you want to fix your boat, you're probably going to a place like WMAR to do some shopping.

Furthermore, the store overlap between WMAR and BW is pretty remarkable.  I went through the exercise of mapping all of the WMAR locations vs. BW in the major markets.  Not surpisingly, the stores tend to be located right next to each other around marinas.  Florida, for instance, is the biggest market for both companies - WMAR has 80 stores in the state and BW had 34 stores.  Out of those 34 BW stores, 31 of those were located within 5 miles of a WMAR store and 20 stores were located within 2 miles.  In a number of cases the stores were located right across the street.  Similarly, in California, 7 out of 8 BW stores had a direct competing WMAR location within a few miles.  It doesn't take a genius to look at these maps and figure out that WMAR stores are going to capture a lot of the business from those closed BW stores. 

Clearly, in addition to capturing some additional volume, the elimination of a competitor whose sole strategy was to undercut your prices is going to help you out on margin as well.  There is already significant anecdotal evidence in the field that WMAR is raising its prices now that BW is gone.

In addition to the liquidation of BW, WMAR has also taken some medicine over the past few years.  WMAR was historically one of those retailers with an OK business model that expanded at an insane pace to satiate Wall Street's desire for an uber growth story in specialty retail.  I think they used to say that saturation was around 700 stores, though Im not sure what their perspective is on that these days.  Its probably not that relevant to the investment at this point.  Regardless, the Company now seems to be following a strategy that I find a little bit more sensible, which includes (i) closing underperforming stores, (ii) closing down multi store markets and replacing those stores with one larger store and (iii) agressively reducing expenses at the corporate level. 

Overall, WMAR peaked at about 400 stores in 2006 and has since reduced store count to 342.  Combine that with the closure of BW locations, and you have pretty significant reduction in store capacity in the space - well over 500 stores in 2006 down to 337 today. 

Anecdotally, as I think about the history of marine retail stores in my local market, we started with 1 WMAR store about 10 years ago, then picked up a BW store, then WMAR opened a second store in the local market (all stores within a mile from each other).  Since then, the 2^nd WMAR store closed and then the BW store liquidated earlier this year.  So, in my local market we've gone from 3 stores to 1 store over a pretty short time period.  That one store is doing pretty nicely these days, even in a tough economy.  I think the story is similar in a lot of places around the country.

State of the Boating Market

The boating market is clearly in one of the toughest periods in its history.  As it relates to WMAR, there are two primary drivers of busines. 

First is boat usage - total boat registrations may be flat, but if those boats are sitting in storage or at the dock, nobody will spend money accessorizing them.  Boat usage is generally pretty stable but is levered to fuel prices.  Last year was an extremely tough year from a usage perspective due to the economy and high fuel prices.

Second is new boat sales - this is important because when you buy a new boat it arrives at the dealer in a pretty bare state.  You immediately need to go out and spend thousands of dollars outfitting your boat.  The dealers have always ignored this business, so it's a nice driver for WMAR.  Obviously, new boat sales are in an extremely depressed state - it's the ultimate discretionary/luxury purchase. Compounding the problem is that sub $100k earners were armed with 100% LTV financings from likes of KeyBank and GE Capital.  Those days are gone, and new boat sales have fallen hard.  Powerboat sales were over 300,000 units in 2005, down to 203,000 in 2008, and I have heard speculation that they will be a little over 100,000 in 2009.  Clearly, this has been a big headwind for the Company over the past few years.

With respect to boat usage, trends have improved in 2009 - for whatever reason, there has been a solid increase in usage in '09.  Maybe its lower fuel prices, or perhaps people are just tired of having their boats sitting in storage. 

New boat sales are a big question mark for me, but I don't necessarily think they need a huge rebound from here in order to make this stock work.  Furthermore, there is a big overhang of boats sitting at the dealers that needs to get moved, and dealers are liquidating the inventory at really attractive prices.  This should help.  In addition, sales of used boats have increased significantly as people unload their expensive toys to others who can actually afford them - the data here is murky, but the industry experts Ive spoken to say the volume of used boat sales is up a lot in '09 - this is likely to help cushion the impact of low new boat sales.

Investment Highlights

• Dominant retailer in the space due to liquidation of BW
• Between WMAR and BW industry capacity has been reduced significantly, which will improve store level economics - SSS are already trending higher in Q3 2009, the first positive quarter since 2007
• Attractive valuation below tangible book value and strong capital structure (no net debt at 6/30/09) provide a strong margin of safety
• Strong upside potential in scenario where WMAR returns to reasonable EBITDA margin level - this is my "expected" scenario for 2010 given lower competition, reduced industry capacity, and leaner cost structure
• Significant upside potential in scenario where new boat sales improve after 3 years of declines and WMAR's economics improve such that it makes sense to open more stores again
• No analyst coverage - as operations and financial performance improve, this is a pretty good story - niche specialty retail, growth potential, weak competitors. In an upside scenario I could see this stock trading at an above average multiple. On recent earnings calls there have been very few questions asked, and none of them by analysts, always by investors. On the Q2 call, they had a customer call in to ask if he could buy stock at retail stores. This stock can only get more coverage/interest from where we are now.
• Pretty strong insider incentives - Chairman/Founder owns 34.5% of the Company; CEO owns 4.2% of the Company (about half of which is 2013 options struck close to the current stock price). Pretty likely that most of CEOs money will be made by getting the stock price up vs. salary.

Investment Risks

• New boat sales enter a protracted slump for a multi-year period - note that I think the business can make money given the competitive dynamics, even at current levels of new boat sales
• Boat usage declines, perhaps due to high fuel prices - note that a significant portion of customers and revenues (about 40%) is related to sailing (not levered to fuel prices) vs. powerboating
• New competition emerges - I cant imagine anyone would want to build a chain of marine retail stores right now, but I guess it could happen
• No insider buying. No insider selling either, but it would be nice to see insiders step up to the plate.

Valuation/Capitalization

Q3 2009 Results

WMAR posted Q3 results on 10/29/09 (earlier today); at first glance the reported results looked good but nothing spectacular.  But due to a calendar shift vs. the prior year quarter, I think the Q3 results understated the improvement in financial performance.  Q3 of the prior year included the 4^th of July weekend, while it did not in the current year.  That is the biggest weekend of the year for the Company, so the calendar shift had a dramatic impact on year over year comparisons.  Despite this negative impact, WMAR managed to increase EBITDA to $13.3mm vs. $10.6mm in prior year and increase gross margins by 60 basis points (despite deleveraging assoicated with lower volume).  If the quarters were compared on an apples to apples basis, I estimate that EBITDA would have been closer to $18mm for the quarter and gross margins would have been closer to 29% vs the reported number of 28.2%.  Comparable store sales, adjusted to remove the impact of the 4^th of July shift, were +3.7%, the first positive comparison since 2007 (note that the number w/o the adjustment for 4^th of July was -4.3%).  I think these results are an early indicator of the positive impact of the BW liquidation as well as WMAR efforts to boost profitability through cost reductions.  Q1 and Q2 this year had negative SSS of 6.8% and 5.2% respectively.  Further, note that WMAR is comping against a -9.9% comp in Q4 and comps in Q1/Q2 2010 should be relatively easy as well.

Conclusion

This is a stock that has underperformed for a few years and is now completely ignored.  However, competitive dynamics in their industry have improved substantially and the Company has taken its own efforts to rationalize its business and improve profits.  They now have a dominant position in their niche (albeit a difficult niche to be in right now), and there is no reason they shouldn't be able to generate a reasonable level of profitability.  The Company is in a net cash position and has absolutely no liquidty concerns and the stock trades at a discount to tangible book value.  Management has pretty strong incentives to get the business back to profitability and get the stock price back into the high teens.  Recent results confirm the thesis that the business is turning the corner.  I think this is a pretty good bet, and I'm looking for a stock price in the mid teens a year from now, with additional upside to that if the economy improves and the boating market rebounds.

Disclaimer:  retail is not my favorite place, by any stretch, to be invested right now and I am short a number of retailers.  I happen to think this one is pretty well positioned, but in my own fund I am short retail generally speaking.

KML Files

As a convenience, I posted the following KML files (for use with Google Earth), that show the closed BW locations as well as the WMAR locations that are nearest to those closed BW locations. I find that its easiest once you open Google Earth to change the colors on one of the files to a different color as the other file - I think all the dots come up black as a default, but you can reformat that in order to see the WMAR/BW locations more clearly.  Note that I only mapped about 80% of BW locations, in the major markets (enough to get a pretty clear sense of the dynamics). 

Closed BW locations

http://www.mediafire.com/?1mymyyo3yzh

West Marine Locations (within same regions as closed BW locations above):

http://www.mediafire.com/?zjjzzgmzdww

Catalyst

Significantly improved financial performance in the next 12 months, evidence of which we are already seeing.  Stock starts getting some attention.  Cash on the balance sheet continue to build.