Cox: Scope out the bank in U.S. retail camouflage

By Rob Cox
February 16, 2016

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

Customers entering the 185,000-square-foot Cabela’s superstore here on a recent holiday were greeted by staff manning two stations. One could arrange to secure firearms so shoppers could safely take in the hangar-like establishment, with its indoor archery test area, stuffed animal displays and aquariums stocked with local trout. The busier desk urged them to apply for a Cabela’s CLUB Visa card, offering reward points and a free baseball cap.

Cabela’s calls itself the “World’s Foremost Outfitter.” In reality, the $3.2 billion retailer, which on Thursday reports its first set of results since putting itself up for sale in December, resembles a chain of taxidermy museums issuing unsecured debt to buyers of assault-style rifles, hunting knives and camouflage apparel. Most of the company’s profit derives from financial services, and its loan book is ballooning in ways that should give suitors pause.

The company Richard Cabela founded in 1961 to sell his fishing flies through the mail now has some 60 outlets across North America alongside its catalogue business. It’s the company’s Sidney, Nebraska-chartered financial institution, called the World’s Foremost Bank, however, that predators like Bass Pro Shops, Dick’s Sporting Goods or private-equity firms will want to consider closely as they sniff around the company.

When Cabela’s, nearly a quarter of which is still owned by the namesake family, reports its full-year results later this week, investors will have a clearer picture of just how important the bank is to the bottom line – and its future. Indeed, the first three quarters of 2015 give some indication of Cabela’s dependence on finance.

In that period, merchandise sales increased about 8 percent from the first nine months of the previous year. Sales at existing stores, however, declined a worrying 4.2 percent in the third quarter. The composition of the company’s earnings makes clear an increasing reliance on doling out credit to customers. In the first nine months of 2015, Cabela’s reported $111 million of net income. In the same period, World’s Foremost Bank reported net income of $86 million, a whopping 77 percent of the group’s profit.

The fourth quarter is typically strongest for merchandise sales given the holiday and hunting seasons. If Cabela’s hits the median estimate of $1.21 a share for the quarter which analysts are expecting, the company will end the year with about $194 million in profit. Of that, $111 million will have come from the bank, which already reported results. That’s still almost 60 percent of the total, and well above the 35 percent for which the bank accounted in 2014.

Effectively, while World’s Foremost Outfitter has recently spluttered as a retailer, the bank it chartered some 15 years ago has been compensating for it with a credit-extension binge. In the third quarter, growth in the average number of active Visa accounts was 6.6 percent. The book of credit-card loans surged 14 percent to $4.6 billion at the end of September from a year earlier. That’s a lot of free baseball hats.

And Cabela’s may be better at hunting for borrowers than it is at selling them rifles. Despite the rural-seeming demographic Cabela’s targets, it has managed its credit portfolio with the efficiency of upscale Nordstrom. In the third quarter, net charge-offs on credit-card accounts came to just $19 million, or 1.7 percent of average loans. While that was up from the previous year, the national average stood at about 2.9 percent in November, according to S&P/Experian Consumer Credit Default Indices.

World’s Foremost Bank is not the foremost issuer of subprime credit. While five states with large rural populations account for a third of its loans, 70 percent of total receivables are held by borrowers with credit scores, determined by Fair, Isaac & Co – for whom the so-called FICO score is named – of 720 or better. That’s in the same ballpark as American Express. The next 22 percent have scores from 660 to 720.

For a bank, this would all be good news. For a retailer examining alternatives, it complicates matters. Bank regulators generally don’t love leveraged buyouts involving financial institutions. A private-equity firm could promise to sell the bank for around book value, or some $600 million, to a deposit-taking institution with lower funding costs. The retail arm could then do a deal that allows it to keep pushing credit cards without sacrificing all its financial profit.

For a rival like Bass Pro Shops, which farms out its credit-card business, buying Cabela’s could offer an opportunity to take that back, and apply the World’s Foremost Bank’s credit skills to its own shoppers. That would probably require taking greater credit risk than Cabela’s currently assumes with its loyal customer base.

However Cabela’s proceeds, the company’s sale is bound to put this bank in hunting-gear camouflage out into the open.

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Do you work for Donald Trump with your negative tone? Geez. Just remember that Sears, J.C. Penny, every airline, every department store, every Target/Walmart/superstore has been offering their own credit card for decades. At least Cabela’s customer credit card accounts haven’t been “hacked” yet.

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