Belk Inc. Offers Good Value...If You Can Find Shares - BKLIA/BLKIB

Belk Inc. is a department store chain with over 300 locations throughout the American South. Belk has been in operation since 1888, when it was founded by William Henry Belk. Since nearly ceasing to exist in the 1990s, Belk has been restored to health and has embarked on an aggressive expansion, remodeling and rebranding legacy locations and expanding into new markets.

Today, Belk's finances and growth potential are at least as good as its competitors, yet the company trades at a substantial discount to its peers. Despite being one of the largest unlisted companies, Belk stock is highly illiquid. Belk family members and associated entities control over 90% of shares outstanding.

Founded in Monroe, North Carolina, Belk quickly spread throughout the Carolinas and into neighboring states. Belk introduced new retailing practices uncommon at the time, such as clearly marking prices to prevent haggling, accepting only cash rather than extending credit, and allowing returns or exchanges. By the time of founder William Henry Belk's death in 1958, the company owned nearly 400 stores in eighteen states and Puerto Rico.

As time went on, Belk fell victim to the same issues that beset most multi-generational family businesses. As the original owners passed away, their stock holdings became diluted among many children and grandchildren, most of whom did not work in the company and were only interested in their regular dividends. These heirs formed partnerships and companies to manage their share holdings, and some sold shares to Belk's competitors. Belk's corporate structure grew more and more convoluted. Even some of Belk's stores were owned by multiple parties, giving rise to many hyphenated properties like Belk-Leggett and Belk-Hudson. By 1960, Belk consisted of an incredible 362 independent corporations, lacking any cohesive strategy or discipline.

The following decades saw relentless jostling and deal-making among family members over Belk companies and stocks. Some family members had financial motivations, while others were attempting to preserve prestige and influence for them and their children. Gradually, however, John and Tom Belk (sons of founder William Henry Belk) achieved majority control of most Belk corporations and set about merging them. 1989, the number of independent corporations had been reduced to 112. The process was rancorous, involving many lawsuits, court rulings and appeals along the way.

While Belk's complexity had been reduced greatly, John Belk realized Belk had no chance against ever more competitive national department stores under what was still a highly unwieldy and unmanageable structure. Uniting as a single corporation was the only way, though it would be several years before that goal was accomplished.

Finally, in 1997, a full consolidation of the company was ready to be enacted. Bankers and lawyers worked thousands of hours to put a value on each of the 112 remaining corporations and determine what portion of the new enterprise each of over 500 shareholders would own. When all the work was done and the SEC gave its stamp of approval, the modern Belk, Inc. was born. (For anyone interested in the behind the scenes inter-family and financial workings that went on during the process, Belk's site has an entire free book on its history. It's an entertaining read, if you're into that kind of thing.)

Consolidation complete, Belk went about modernizing and expanding, eventually buying 47 stores from Saks in 2005. Belk's expansion is ongoing. In Spring 2014, Belk will open a three-story flagship store in Dallas, replacing Saks. Also in 2014, Belk will open a Huntsville, Alabama store and expand or remodel seventeen other stores.

Belk brought in nearly $4 billion in revenue and $188 million in profit in 2012, both records. Belk's revenue growth has surpassed its competitors, both recently and over the last decade.

Belk's financial position is among the strongest of its competitors. Belk is both more liquid, as measured by its current ratio, and less leveraged, shown by its high degree of equity financing and lower debt/EBITDA and debt/assets ratios.

Despite its superior growth rate and stronger financial health, Belk trades at a large valuation discount.

The P/E comparison is less useful, due to Macy's' unusually high trailing P/E. The EV/EBITDA and EV/EBIT values, on the other hand, show that Belk is heavily discounted by the market.

On one hand, the valuation discount is entirely legitimate given Belk's extreme illiquidity and wide bid/ask spread. Acquiring shares is extremely difficult and may get tougher given Belk's appetite for its own shares. Over the last decade, the company bought back 25% of shares outstanding. In the long run, however, Belk will almost certainly become more liquid. The liquidity may show up suddenly through a buyout or slowly, as Belk's shares once again become diluted as ownership passes to the next generation. A look at some of Belk's form 4 filings reveals that extensive estate planning schemes have been put in place. The elder members of the Belk family are using an extensive array of trusts to pass on shares to their children and grandchildren. Simple math precludes all of these heirs from becoming involved in the business, and opportunities to acquire shares may arise as they sell their holdings.

Belk is definitely not a company for short-term investors. However, investors with a truly long time horizon might find a lot to like. Unlike some of its competitors, Belk is still very much a regional operation with plenty of opportunities to expand into new markets. Belk may be able to maintain its superior revenue growth for years to come.

Of course, that assumes rosy outcomes. What happens if the economy sputters or Belk's merchandising strategy misses a major shift in tastes? Belk is better positioned to handle such a disruption than most other retailers. Belk owns a great portion of its stores, rather than leasing them. (I've been searching for the exact number, but in vain.) Owning rather than leasing much of its real estate lowers Belk's operating leverage, decreasing the possibility of hemorrhaging cash in a bad economy. For an example of what over-dependence on leasing can do to a retailer in a crisis, pull up stock charts for Foot Locker or Tuesday Morning.

I don't plan on making Belk a large part of my portfolio. Even if I wanted to, the shares are simply tough to acquire. However, one could do worse than holding a cheap, well-financed and quickly growing retailer like Belk. After all, a company that has been in business for 125 years is doing something right!

No position, may add opportunistically.