Cabot Small-Cap Confidential Issue: October 5, 2023

The Big Idea

Back in the early ‘90s Maxine Clark worked in merchandise development, planning and research for May Department Stores. She then went on to become a president of Payless ShoeSource.

One day she was shopping with a 10-year-old girl who suggested they make their own stuffed animals.

A light bulb went off. What if she designed a store that allowed people to make their own stuffies?

In her own words, Clark said this about pitching the idea to the public:

Adults told me my idea wouldn’t work. “Who wants to make their own stuffed animals?” they argued. But every kid said, “Where is it? When can I do it?” We knew we had a winner in our first year, when we achieved more than double our projected sales. In 2005 we opened our 200th store...”

Two and a half decades after opening her first store in the Saint Louis Galleria mall in Missouri, Maxine Clark’s company has sold more than 225 million furry friends and has 50 million guests visiting over 500 locations every year.

Why does it work?

Because as every parent knows, the correct number of stuffies a kid can have is always [n + 1].

This is the story of Build-A-Bear Workshop (BBW).

The Company

Build-A-Bear Workshop (BBW) is a specialty retailer and entertainment company with online and physical locations that, depending on location, allow guests to buy off-the-shelf furry friends, make their own stuffed animals, or host group events (think birthday parties) with stuffed animal-centric activities.

The company has a market cap of $423 million.

For those wishing to make their own stuffed animal, they can participate in the stuffing, fluffing, dressing, accessorizing and naming of their own teddy bears and other stuffed animals.

E-commerce sites are focused on gift-giving, buying collectibles and licensed products, designing a custom stuffy with the Bear-Builder tool, engaging digitally with the Bear Builder 3D Workshop, and shopping on the age-gated, adult-focused Bear Cave and HeartBox gift sites.

Broadly speaking, the company offers a shopping and entertainment experience that spans the simple “click-to-buy” to “DIY” continuum, all focused on furry friends and comfort clothing (pajamas, etc.).

One of the reasons the concept works is that people are always looking for a special, relatively low-commitment social activity with a lasting memory. And in the grand scheme of things, a stuffed animal is just not that expensive, especially relative to the happiness they bring.

Add in the ability to customize, hold a birthday party at a workshop location or even gift pajamas and it’s not hard to see why Build-A-Bear’s concept keeps customers coming back.

It’s worth mentioning that, while stuffed animals are often aimed at kids, Build-A-Bear generates a lot of interest from other age groups, and it’s working very hard to do more in this department. Management says 40% of sales are for teens and adults (supporting data is gathered through a “name me” registration database and post-purchase surveys).

That all said, there’s a reason Build-A-Bear is still a small-cap stock 25 years after it was founded. This isn’t ever going to be a $50 billion company.

But it’s doing a lot of things right these days that it didn’t do just a few years ago. And the stock has a history of providing decent returns heading into the holiday season, which has historically been the strongest selling period.

To be perfectly clear, I don’t expect we’ll own BBW for years upon years, though we’ll take it as it comes.

Products & Distribution

A significant part of the Build-A-Bear business revolves around sales and experiences at a variety of physical destinations, of which the company has more than 500 spread across North America and select international locations.

These locations come in different shapes and sizes, including traditional retail stores, stores designed to fit in a Walmart (WMT) or airport, seasonal and temporary locations, full-on tourist/event-styled destinations, vending machines, and even shops at theme parks and on cruise ships.

One of the newest and biggest revenue generators is the Build-A-Bear Adventure Workshops. These are larger format destination locations with Fun Zone arcades, multi-story play zones and rooms for private parties and group events. Groups can select from different packages with options for stuffed animals, activities, clothing items, food, etc. Pricing starts at about $38 per person.

A lot of the company’s locations serve a dual purpose, acting as mini distribution centers to fulfill e-commerce orders coming through digital channels. This is another area of growth for the company, which is increasingly leveraging social media to raise awareness of the brand.

Growth Initiatives

New Store Openings: Build-A-Bear is growing its footprint, having opened over 20 locations in 2022 and on pace for 20-30 more in 2023. The format of new locations varies, but some of the bigger recent launches include a site at Six Flags Magic Mountain, the Pro Football Hall of Fame and a number of Build-A-Bear Adventure locations (with arcade and party rooms). Management says 100% of corporate-operated stores are profitable.

Digital Transformation: The company is being more intentional with its digital investments, not just to grow e-commerce sales but to better target different customer segments with experiences aimed at them. The strategy includes a new Buildabear.com website (launched Q3 2022) featuring Salesforce digital and analytics capabilities. The site helps direct consumer segments toward experience and product categories (Workshops, online bear building, gift shop, pajamas, etc.) that best meet their preferences. Management says digital revenue accounted for 15% ($65 million) of business in 2022.

Seasonality: Build-A-Bear’s biggest selling season is October through December, with January through March being the second biggest (roughly 60% of sales over these six months). It’s not always the case but the stock tends to be strong in the October through December time frame.

Holiday-Themed Marketing Events, Movie & New Products: The company is turning up the marketing and promotion dial. Part of this is the promotion and release of a holiday-themed animated movie, Glisten and the Merry Mission (November 3 release). The company is also launching new products through collectible license offerings and Build-A-Bear exclusives ahead of the holidays.

Return Cash to Shareholders: Management adopted a $50 million stock repurchase program in August 2022 ($35.3 million remaining at the end of July) and the company has also been returning cash to shareholders through special dividends. The last special dividends ($1.50 announced on March 8, 2023), equated to a yield of over 7%. There’s no guarantee of future special dividends but the potential is a nice carrot.

The Business Model

Build-A-Bear generates the bulk of revenue (95%) from direct-to-consumer retail sales (online and in-stores) in the U.S., Canada, Ireland and the U.K. About 4% comes from licensing and wholesale deals, and the last 1% comes from international franchising. While around 15% of sales currently come online, this is still very much a physical shopping experience type business. Average dollars spent per transaction last year was $50.59.

The Bottom Line

A little context. In the fiscal years from 2015 through 2020 revenue growth ranged from -6.0% to +0.6%. Revenue in 2020 was $338.5 million. The most the company earned in any year during the 2015 – 2020 range was $1.60, and that was in 2015. EPS in 2020 was $0.02.

In other words, this was a completely mediocre story from a financial perspective. No growth, a little profit.

Like a lot of companies, Build-A-Bear Workshop had a wild ride through the pandemic. Sales plummeted -25% in 2021 as stores were forced to close temporarily. Then growth roared back in fiscal 2022. Revenue soared 61% to $411.5 million and EPS was $2.93.

Management has been working to establish modest growth at a much higher level of profitability than prior to the pandemic. It appears to be succeeding.

In fiscal 2023, which ended in January 2023, revenue grew 13.7% to $468 million. EPS was $3.15.

In the first half of the current fiscal year (fiscal 2024, which ends in January 2024) Build-A-Bear has grown revenue by 5% to $229 million and EPS by 24% to $1.57.

Second-quarter fiscal 2024 revenue grew 8.5% to $109.2 million and EPS grew 50% to $0.57.

Looking forward, management has guided for full-year fiscal 2024 revenue to grow 5% to 7%. Analysts, of which there are not many, expect revenue to grow 6.4% ($498 million) and EPS to grow 15.2% to $3.63.

Risk

Consumer Spending: As we all know, consumers are dealing with a number of spending headwinds, and discretionary spending is at risk if inflation persists and the economy heads south. That said, average spend per transaction at Build-A-Bear is around $50. This is not a big-ticket item retailer. And spending on experiences and gifts, especially for kids, tends to be pretty resilient around the holidays.

Covid & Other Health Concerns: People, and a lot of parents, are a lot more paranoid about germs since the pandemic. If there are more intense waves of Covid, the flu, RSV, etc. this holiday season and winter they may not want to go to kid-centric places full of germy hands and kid boogers.

Inflation: Yeah, it’s still a problem affecting a lot of retailer pricing and consumer spending decisions.

Brand Dilution: Build-A-Bear is trying to expand its market beyond just stuffed animals for kids and target more tweens, young adults and adults. That means adding product categories and diverting marketing resources. It appears to be going well, but it might

Competition

In very broad terms, anything that offers family time activities (movies, mini-golf, etc.) is a competitor, as are any retailers of stuffed animals and pajamas. But much more specifically, Vermont Teddy Bear Company (private) is the closest direct competitor (just one location, but also online), and Funko (FNKO) and 1-800-Flowers (FLWS) are in the same gift-giving space. Sellers of plush toys include Mattel (MAT), Hasbro (HAS), Lego, Steiff and more. One of the attractions of Build-A-Bear is it has a presence across physical stores and experiences as well as online, in a few product categories, so there are some scale and brand awareness advantages. International Money Express (IMXI), Wise (UK-based), OFX Group (Australia).

The Stock

Trading Volume: 90-day average trading volume is 218,000 shares. While I don’t think we’ll move the stock in a significant way, with a price under 30 we could have a minor influence on any given day.

Historical Price: IPO priced at 20 in October 2004 and shares rose to around 30 soon after. That was a top. Stock was below 10 for most of the 2008 – 2014 period, ran briefly above 20 in 2015, then was back below 10 in 2017. Pandemic low was below 2. BBW was back above 12.5 by the end of May 2021 and hasn’t fallen below that level since. Most of 2022 saw shares trade in the 15 – 22 range. The stock has traded in the 20 to 26.5 range for most of 2023, other than a brief dip to 18.2 in May. In July BBW moved back above 22 and the stock has been grinding higher since. The move above overhead resistance at 26 in early September is noteworthy.

Valuation: BBW currently trades with an EV/Trailing Revenue multiple of around 1.0. Over the last two years, this multiple has ranged from a high of 1.2 to a low of 0.6, and the yearly highs have both been in the first half of December.

Buy Range: Over the next couple of weeks, expect to buy BBW within the 26 to 32 range.

The Next Event: The Q3 fiscal 2023 earnings report is expected around November 29.

Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for

November 2, 2023.