Quan’s Avid Hog Watchlist: Tandy Leather Factory (TLF)

by Quan Hoang

In order to find investment ideas for The Avid Hog, I asked Geoff to send me 3 stock tickers every week. I’ll do initial research on these companies based on the 10-Ks, CEO interviews, and my quick check on customers and products. From the initial research, I’ll decide whether to do further research. So, I’ll start writing regular posts on companies that I find interesting.

One company I’ve looked at is Tandy Leather Factory (TLF). Tandy sells leather and leather craft supplies. This includes a large variety of hides, tools, glue, books, and accessories.


Tandy is the Biggest Fish in a Small Pond

They have 29 wholesale stores and 79 retail stores. Wholesale stores are bigger. Wholesale stores average 5,000 square feet. Retail stores average 2,400 square feet.

The products sold in wholesale stores and retail stores are similar. Wholesale stores sell to bigger customers like tack and saddle shops, western stores, craft stores, and other retailers. Retail stores do 60% of business with individuals.

Tandy says wholesale stores compete with small, independently owned retailers. In most cases, these retailers are also Tandy’s customers. There are a few hundred small independent stores in the US and Canada. Tandy itself has 79 retail stores. So, I think the market is small.

Tandy’s strategy is to offer a broad range of leather and leather supplies so that customers can complete their projects from a single source. I think this is the right strategy. I think customers are hobbyists. The market is small. A local market can’t support many stores. By offering all the items that customers need, Tandy may have a local moat.


Scuttlebutt Shows that Tandy Has a Moat

Reading some blog posts about customers confirms this view. In this blog post, I found two useful facts. One, Tandy gives customers a lot of choices:

Recently, I made a trip to Tandy Leather Factory in Union City, CA (there’s another in San Mateo, CA). I usually get my leather from Fabric Outlet in San Francisco, but their selection is very limited, so I went to Tandy in hopes of finding the very specific color I wanted. I was not disappointed!
Tandy’s Leather Factory is nestled in a compound of unassuming office buildings. Not only is it filled with a large variety of hides (the usual pig, cow, deer, but even exotic ones, like Stingray skin), it also has all the tools, glue, books, findings, and accessories that you can imagine a leather craftsman might even think of using. The staff is extremely friendly and knows leather – I always appreciate it when employees are knowledgeable about what they are selling!

Two, customers are price conscious:

Tandy’s leather is priced by square foot, which is normal. Unfortunately, Tandy no longer allows cuts, which means you have to commit to the whole piece as-is, so it’s hard to find what you need without buying a whole hide. (The scrap bins really are just scraps.) I’m a bit deterred by this – I think I’ll still defer to Fabric Outlet for leather, since they sell several colors and types but have skins in smaller cuts, and it’s always 50%-off! I’d much rather go up to San Francisco and spend $25-$80 for smaller pieces to make a garment, rather than shell out $200 at Tandy for one giant piece.

But I doubt that price is a more important factor than convenience. If the customer in the blog post can buy a smaller piece at Tandy at a slightly higher price, he’ll go to Tandy. That’s because he knows he can find everything he needs. Being able to buy smaller cuts is part of the variety of choices rather than cheapness.

Another blog post gives me some hints about what customers do with the stuff they buy from Tandy. The writer of the post made her DIY over-the-knee boot spats by recycling her leather skirt. Some comments are useful:

Wow... So exciting... Thanks for sharing this leather shop... I make handbags and am always looking for new leather places....
Thanks for sharing this! I've been looking for a place that sells leather. All my local fabric shops just sell crappy vinyl and it's too hard for me to buy online because I like to feel it before I purchase it. Hopefully, I'll be able to make it up there this week.
Wow, what for an amazing shop, you are really lucky to have such a great offer nearby you!
I used to LOVE going to Tandy with my Dad as a kid. We did all kinds of leather work projects. I still have the belt he made me and a few other treasures.

These comments show that customers are hobbyists and that they are always looking for stores that address their needs.

So, my initial scuttlebutt convinced me that Tandy has a local moat in a small niche. They sell to hobbyists so they may have some pricing power. Gross margin in the last 10 years has been impressive. It improved steadily from 54.4% in 2003 to 63.1% in 2012. A 63% gross margin means price is about 270% of Tandy’s cost. And Tandy improved margin during a period when the price of every commodity went up. That tells much about Tandy’s pricing power.


Will People Do DIY Projects with Leather in 10 Years?

My biggest concern with Tandy Leather is durability. Will as many people still be doing DIY projects with leather in 10 years? In other words, is the niche getting bigger or smaller? I asked Geoff and he said:

I think durability is probably high because the number of customers for the entire industry is so low. Most people will never do anything with leather. If you can turn a small number into hobbyists, you can be successful. I think it is an issue where the marketing by the company, etc. is more of a factor than societal trends. Leather crafting is not something most people are even aware of. So it is not like analyzing International Speedway (ISCA), DreamWorks (DWA), etc. where there is a cultural question about how many people will actually want to show up at a racetrack, movie theater etc. in 5-10 years. Those are much bigger parts of the general culture. This is much smaller.

Tandy Leather somehow reminds me of Games Workshop (GAW:LN). Games Workshop grows the popularity of Warhammer by opening new stores and educating hobbyists. On Tandy Leather’s website, we can find a lot of free lessons, projects & tips, and Buyer’s Guide in the Leathercraft Library. Tandy offers free classes in its stores. A lot of blogs I read mentioned Tandy’s in-store classes. It seems that Tandy gets a lot of word-of-mouth referrals from DIY hobbyists. I think David Meerman Scott, the author of The New Rules of Marketing & PR, would praise Tandy for its communication with customers.


Tandy Leather Has Entrepreneurial Store Managers

It’s also worth mentioning that Tandy has entrepreneurial store managers. Some blogs mentioned Tandy’s store managers calling top customers when they have closeout inventory. One mentioned offers to sell at a low cost, but only if the customer was willing to take the items in bulk (buy hundreds of dollars of leather at once). In that example, the manager said he was calling the store's top 100 customers. That may indicate the close relationship with customers. Good store managers can really help to build a local hobbyist community.

It’s not a surprise that store managers get 25% of the operating profit of the store they run. And Tandy’s biggest challenge is not finding locations but “to continuously find new, hardworking young employees and give them the year or two it takes to understand our business before they can really be a benefit,” said Ronald Morgan, the CEO, in an interview in 2007 with The Wall Street Transcript.


The Price Is Good but Not Attractive Enough

So, qualitative factors look good. The price is quite good. In 2012, Tandy made $9.1 million EBIT. Current market cap is $80.6 million. Tandy has $7.6 million cash and $2.7 million debt. So, EV is $75.7 million, and EV/EBIT is 8.3. This is quite low but I don’t think it’s attractive enough.

Tandy says they plan to reach 100 to 120 retail stores. They currently have 79 stores. Before 2008, they opened about 10 stores each year. So, they can potentially grow the number of retail stores by 50% in the next 4 years.

In 2012, wholesale stores made $26.9 million revenue, and retail stores made $42.6 million revenue. Assuming that both wholesale and retail stores can grow organically at 3% along with inflation, and that the retail business can grow 50% in the next 4 years, potential revenue would be $102 million. That’s about 8.8% annual growth, compared to 10% sales growth in most years except for the 2007-2009 period.

Wholesale stores and retail stores have similar EBIT margins. Applying a 13% EBIT margin, potential EBIT would be $13.3 million. At an aggressive 10 EV/EBIT, potential EV is $133 million. So, the stock price would appreciate 14.4% annually in the next 4 years. At 8 EV/EBIT, potential EV is $106.4 million, and the stock price would appreciate 8.4% annually.

So, Tandy can be quite a good buy and hold investment if the growth assumption is right. At a better price, the potential return would rely less on growth. I’ll do further research if the price goes lower. And I’ll keep Tandy in my watch list.

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