Gander Mountain Company (GMTN), headquartered in Minneapolis, Minnesota, is a specialty retailer that offers its outdoor lifestyle customers a broad range of hunting, fishing, and camping equipment and related accessories. The company's merchandise was originally offered to customers via a catalog operation, from 1960 until 1996, when the initial retail stores opened. Approximately 80% of sales are of national and regional branded outdoor equipment. Roughly two-thirds of its sales come during the second half of the year. The company has adopted a series of strategic and operating initiatives aimed at improving its merchandise offerings and enhancing profitability, while aggressively opening stores. It is in the process of transforming its market position, by opening new, larger-format stores, and by increasing the selling space within its existing stores. The company currently operates 115 stores in 22 states. The company's initial public offering was closed on April 26, 2004. At that time, the preferred stock was converted to common stock.
Our negative view of the stock is based on the company's negative comp-store sales, contracting profit margins, and weak balance sheet. Gander Mountain is solid retailer that caters to the outdoor sportsman. For the last few years, the company was opening new stores at a rapid pace, increasing its store base from 57 at the end of fiscal 2003 to 115 at the end of the third quarter of 2007. For the most part, this strategy was sound. Gander Mountain was going after market share in an attractive, profitable, and fragmented market. After rapidly opening new stores and increasing market share, the company would have likely shifted its focus to operating profitable stores and not simply expanding its store base. Unfortunately, that scenario hasn't played out. The company is up to 115 stores, up 102% since 2003, and well-positioned to improve its same-stores, which were negative in fiscal 2004, 2005, and 2006. The company was making progress on this front with positive comps in four straight quarters, beginning in the third quarter of 2006. However, the consumer took a turn for the worse in fall of 2007. For a multitude of reasons (see our Industry Outlook), consumers have been tightening their belts and making less discretionary purchases. This is negatively impacting Gander Mountain's same-store sales much more than we previously forecasted. In the third quarter of 2007, Gander Mountain had a comp-store sales decrease of 8.4%. Our forecast called for flat comps. We are now forecasting additional negative comps in future quarters. In addition, the company's contracting profit margins are also a source of concern. The combination of weak sales trends and higher operating expenses is pressuring the company's operating profit margins. Also, Gander Mountain will have about $19 million in interest expense in fiscal 2007. This should easily exceed its operating profits in fiscal 2007 and 2008. We estimate that in 2009 Gander Mountain's operating profit will exceed its interest expense by about $5 million. That said, we think it is a longer-term positive that Gander Mountain is scaling back store growth in order to focus on its operations. Its operating margin should improve next year, but our forecast is for thin 1.4%. Lastly, we are concerned with the company's weak balance sheet. Gander Mountain's rapid store expansion used a sizable amount of cash. Meanwhile, the company's cash flow from operations was negative in 2004 and 2005 and barely positive in 2006. Gander Mountain's losses and negative cash flow have saddled the company with $26 million in long-term debt and $308 million borrowed on its credit facility (short-term debt), compared to cash on hand of $2 million and equity of $163 million. We note that Gander Mountain's short-term debt typically climbs in the third quarter to purchase inventory for the holiday season. We also note that Gander Mountain's short-term debt balance has been trending higher in other quarters as well. Our forecast assumes that its short-term and long-term debt balances will continue to climb in future quarters. We believe the company needs to take steps to shore up its balance sheet and generate positive cash flow. That strategy, however, will lead to slower growth and lower estimates for the near term.