How would you like to own a retailer that is dominant in its niche, has stores concentrated in a geographic region with a healthy economy, and has a very strong brand name and great real estate , both of which factors would make it difficult for a competitor to threaten or supplant them?  Let’s say this retailer is growing its store base by close to 10% per year, is growing comp stores 3-5% per year, and has just weathered a tough year in the industry without missing a beat.  How would you value this company?  If you could buy it for 6.1x ’06 EBITDA and 5.6x conservative ’07 EBITDA, or 7.5x ’06 EBITDA – Cap X (including all new store Cap X) and 6.8x ’07, would that be attractive?  What if the company is not going to pay taxes until 2011 and will distribute most or all of its excess cash flow to shareholders until that time, but that even if you fully taxed earnings, the P/E ratio would be 10.7x ’06 and 9.8x ’07?  Even the most hardened value investor would likely find this attractive, unless he or she hates retailers and hates golfing.

Where would we find such a company?

Canada - where the government has just turned the stock market and investor community upside down by proposing regulations that will eventually eliminate all advantages that income trusts have enjoyed over the past 10 years.  This week, the average income trust is down 15-20%, as investors have calculated the impact of the changes and hit the market accordingly.  However, this has led certain companies to now trade at prices that would be attractive even if they were not income trusts.  I believe that Golf Town Income Fund is one of those companies.

Golf Town is the leading golf retailer in Canada, with stores in all the major markets across the country.  The company currently has approximately 28 stores, and has been opening 2-4 new stores annually, a rate it expects to continue for several years.  The stores average 18,000 square feet, and carry a huge assortment of clubs, apparel and accessories.  Management is excellent – CEO Stephen Bebis is viewed among the leading retailers in Canada, having previously run a home center chain that Home Depot acquired to enter Canada.

The business is fairly straightforward, so I will direct you to SEDAR (www.sedar.com) to view the company’s filings.  I will quickly run through the numbers (all in Canadian dollars).  The company has 12.5mm fully-diluted shares, and $15mm of debt, with total enterprise value of $142mm.  EBITDA is projected to be $24mm in ’06 and $26mm in ’07.  The company has a consistent record of beating earnings estimates and raising its distributions.  CapX is estimated to be $4.5mm annually, which covers 3 new stores at $1.4mm each, plus a small amount of IT and maintenance CapX.  The store base is young, so they do not have to spend much if anything on refurbishing stores, and their infrastructure is in good shape to handle the expected growth.  The company is currently paying out distributions at the rate of $1.15 per year, a conservative 70% of its distributable cash (a Canadian term) and roughly 100% of its free cash flow.  The table below lays out key financial information and some back of the envelope projections:

 

 

Stock Price		$   10.50
Shares outstanding		12.5
Market Value		131.3
Net Debt		15.0
Enterprise Value		146.3
				EV/EBITDA
EBITDA	2006	24.0		6.09
	2007	26.0		5.63
EBITDA - Cap X	2006	19.5		7.50
	2007	21.5		6.80
		2006	2007	2008	2009	2010	2011
EBITDA (10% growth after '07)		24.0	26.0	28.6	31.5	34.6	38.1
Amort.		4.5	4.5	4.6	4.7	4.8	4.9
Interest		1.6	1.6	1.6	1.6	1.6	1.6
Pre-Tax		17.9	19.9	22.4	25.2	28.2	31.6
Income Taxes (Theoretical until '11)		5.6	6.3	7.1	7.9	8.9	10.0
Net Income (Assuming fully-taxed)		12.3	13.6	15.4	17.2	19.3	21.6
EPS - Actual		$    1.43	$    1.59	$    1.79	$    2.01	$    2.26	$    1.73
EPS - Fully-taxed		$    0.98	$    1.09	$    1.23	$    1.38	$    1.55	$    1.73
Distributions per Share
(5% growth after '07)		$    1.15	$    1.20	$    1.26	$    1.32	$    1.39	???

 

 

There are several ways to look at valuation.  You can assume a terminal multiple on estimated 2011 earnings, and then take the NPV of that number as well as the estimated distributions between now and then.  Assuming 10% annual EBITDA growth, 5% annual growth in distributions, a 13x terminal PE multiple, you get to a value today or $15-19 per share using discount rates of 10-15%.  Alternatively, you can look at this as if it had an NOL that would cover the next 4 years of earnings.  In that case, you could put a multiple of 13-15x ’06 or ’07 fully-taxed earnings, and add the present value of the next 4 years of tax savings, around $2 per share according to my calculation.  That would put you in the same range.  Either way, I believe it is a steal in the $10.50 range.

A few other things to consider.  Close followers of the Canadian stock market have expressed the opinion that if this legislation passes, it will likely lead to much increased LBO activity, especially among smaller income trusts that would probably not have gone public except as an income trust.  Golf Town  would be a strong candidate.  There has also been periodic speculation that Golf Galaxy (GGXY) would be very interested in acquiring Golf Town.  Golf Galaxy is a Minneapolis-based company that was actually involved in the founding of Golf Town,(Golf Town was modeled after Golf Galaxy and has similar stores and merchandising strategies) and has a non-compete preventing it from entering Canada until 2008.  The upcoming expiration of the non-compete could be viewed as a negative if Golf Galaxy decides to open its own stores in Canada, but an acquisition might be a more likely route.  Another potential acquirer might be Forzani Group, which among other retail operations, owns the Nevada Bob chain in Canada (20 stores).  Forzani is trading at PE and EBITDA multiples of 18.3x and 7.1x, respectively on ’06, and 12.9x and 6.4x, respectively on ’07.
The company is reporting earnings for the September quarter (their second biggest quarter) in the next 12 days.  I have no particular insight, I do know that Golf Town raised its distribution in August, which probably is a good sign that business has continued to be strong.