FotoDuets/iStock via Getty Images

FotoDuets/iStock via Getty Images

Build-A-Bear Workshop (NYSE:BBW ) is an interesting company that—in my opinion—perfectly captures much of today’s culture including desire for experience, DIY and customization. And from a financial perspective, the company appears undervalued. In this article I use a residual earnings framework based on EPS consensus estimates until 2023, a WACC of 10.5% and a terminal growth rate equal to GDP growth. My calculation concludes that BBW’s fair target price should be approximately $27.68/share, implying more than 40% upside potential.

The Build-A-Bear Workshop is best described as an interactive retail-entertainment company. Build-A-Bear offers kids the opportunity to design and build their own stuffed animal. BBW operates three segments: direct-to-consumer (DTC), commercial, and international franchising. The DTC business accounts for most of the company’s sales and includes BBW retail stores. BBW operates 352 stores in the United States and 127 stores internationally. The company also operates an e-commerce business, which includes the “Bear Builder 3D Workshop”. Notably, BBW’s online business has grown 36% CAGR from 2016 to 2021 and now accounts for approximately 20% of the company’s total retail sales. The commercial segment accounts for less than 5% of its revenue and is responsible for BBW’s transactions with other businesses—transactions such as licensing agreements and partnerships with regards to BBW’s wholesale and entertainment activities. As of early 2022, Build-A-Bear helped build more than 200 million stuffed animals.

In 2021, BBW generated $411 million in revenues, increasing 61.2% year-over-year. However, the company lost -24.6% of revenues in 2020 as a consequence of the Covid-19 pandemic. That said, I propose to focus on the cyclical adjusted CAGR since 2019, which is 10.3%. Build-A-Bear is quite profitable. In 2021 the company achieved a net-profit margin of 11.49% and generated net-income equal to $39.5 million or $2.45/share. Cash from operation was recorded at $28.1 million. BBW ended the financial year 2021 with $32.8 million of cash and cash equivalents and $98.6 million of total debt. For reference, Build-A-Bear’s market capitalization is $305 million. While the financial position is not best in class, the leverage is healthy and sustainable. If we extrapolate 2021 cash from operation into the future, and assume that the cash is fully allocated to deleveraging, then BBW would need approximately 3 years to become debt-free.

For the current year analysts expect BBW to grow revenues by approximately 11% and remain profitable with estimated EPS of $2.60. Similar growth rates and profitability metrics are expected for 2024. That said, if BBW will be able to maintain 2024 numbers, then the current valuation appears very cheap. Estimating 2024 revenues at $476 million and EPS at $2.73/share BBW would trade at a P/E of 6.92 and P/S significantly below 1.

What could be a fair per-share value for BBW? To answer the question, I believe a discounted earnings framework is the best framework to assess a cash-cow asset such as BBW. That said, I have constructed a Residual Earnings framework based on the EPS analyst consensus forecast until 2025, a WACC of 10.5% and a TV growth rate equal to nominal GDP growth of 3.5%. And based on my assumptions, the calculation returns a fair share price of $27.68/share, implying an undervaluation of 43.4%.

I would also like to share with investors a sensitivity analysis based on varying WACC and TV growth combination, so investors can value BBW based on the scenario that best reflects their fundamental view on the company. For reference, red cells imply an overvaluation, while green cells imply an undervaluation as compared to BBW's current valuation.

Investors should note the following downside risks to BBW achieving the target price as calculated in the valuation section: First, amidst inflation and slowing consumer confidence, BBW's sales and margins may decrease. Second, as BBW is looking for international expansion and investing into new business opportunities (e.g., entertainment), the company is exposed to execution risk and business uncertainty. Third, BBW’s business is quite cyclical and, in the past, the company’s stock has suffered significant declines. As analysts are discussing the potential of a global recession going into the second half of 2022/early 2023, investors should closely monitor BBW’s financial performance. Fourth, rising interest rates may cause BBW’s WACC to increase, thus pushing down net present value from future earning and thereby decreasing the company’s valuation.

Although BBW’s market position and outlook may be hard to analyze, the company’s fundamentals indicate an undervaluation. Specifically, my valuation based on a residual earnings framework calculates a fair price per share of $27.68. Thus, based on BBW’s current accounting numbers and estimated analyst EPS consensus until 2023, I conclude with a buy recommendation. However, investors are advised to closely monitor the company’s business performance in challenging macro-economic condition—and, if necessary, be prepared to sell.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: not financial advice