This is a past Premium recommendation and is made available for your reference. For more past trades, refer to our trade history.
Tuesday Morning (TUES) operates about 861 stores in US that sell premium brand closeout merchandise. Items include home decor, bedding, collectibles, pet, toys, cookware, kitchen accessories, rugs, and more. These are first quality products, not damaged or used, which means they do not directly compete with the outlet stores but do compete with the likes of TJ Maxx and Big Lots.
Investment Thesis for TUES
The investment thesis for Tuesday Morning is pretty simple and is based on the strength of their balance sheet coupled with possible margin improvements with improving economy. We will start with their most recent balance sheet as of Dec 2011. For this analysis I am using the market price of the stock as of Mar 14, 2012.
- Price: $3.68/share
- Market Value: $157 M
All $ amounts are in millions
TUES stock can be purchased at 58% of its book value and 82% of its net-net working capital, which is current assets – total liabilities.
The balance sheet itself is relatively simple. There are no intangibles to contend with and there is no debt.
|Inventories||239.2||Short Term Debt||0|
|Current Assets||305.9||Current Liab||108.8|
The bulk of its value is tied up in the inventory that it carries. Since they operate their own retail stores, they do not have a receivable entry. Inventory when sold turns into Cash. Retail inventories can be worth a lot less over time if it does not move, but in the case of TUES it is worth noting that the company’s inventory is all purchased at closeouts and therefore has less room to decay.
Even while the debt is non existent, the company maintains a line of credit in the amount of $180 million. Since their business is heavily seasonal (they turn a profit during the Christmas quarter and lose money in other quarters), this line of credit can be useful to even out the cash flows and opportunistically purchase inventory. Their current cash balance is significant enough to support short term working capital needs.
Just based on the balance sheet and the asset quality, the company appears to be undervalued in the market. TJ Maxx stock sells for 9x Book Value while Big Lots sells for 3.6x book. Tuesday Morning itself used to sell for as much as 10x book value in the past when the times were much better. It is not inconceivable that this stock could command 2x to 3x book value in the next 2-3 years. It all depends on their profitability and whether they create or destroy value for the shareholders. Let’s take a look at how they fare in this regard.
Whenever one finds a net-net stock, the first question that comes up is why the stock is so undervalued. Generally, these kinds of stocks come with a host of issues and the value realization depends in many ways on the likelihood of some of these issues getting resolved. Most common of these issues, of course, is an unprofitable business which continues to erode the value on the balance sheet.
In TUES’ case however, the company has been profitable for the last 10 years. Some years, barely so, but they have a good history of profitable operations as the following compilation shows.
|Cost of Sales||451.4||502.5||543.8||559.8||551.7||248.9||544.9||488.1||497.6||490.7||487.2|
|Net Profit Margin||6.05%||6.53%||6.97%||6.55%||4.00%||0.76%||1.64%||0.00%||1.29%||1.17%||0.64%|
Please note that the 2007 FY only includes 6 months as the FY end was changed from Dec to Jun
The company has seen some decline in revenues since 2008 when the recession started but not to any significant degree. They have been able to make up for it by opening new stores and entering new markets. The number of stores increased from 732 at end of 2005 to 861 at the end of 2011. However, this has also meant that their SGA expenses have gone up in absolute terms. With the recession, the per store profitability has suffered as the average traffic as well as average ticket price has gone down.
As a result, their net profit margin is now wafer thin – about 1% or even less. This is in sharp contrast from the early 2000s when they used to extract net profit margins over 6% regularly.
To illustrate, the trailing twelve months of operating income of $10.2 m with 861 stores is equivalent to $11,847 in annual operating income/store. Compare this with an average operating income per store of $131,831 annually at the end of 2005. This is a 91% deterioration in the per store economics.
Not surprisingly the stock price ended the year 2005 at $21/share and currently trades at $3.68/share, a decline of 82%.
Why TUES is an Attractive Buy Today?
It is always hard to justify a stock purchase when the economics of the business have been so bad in the recent years. However, I think at this time the stock is attractive for two reasons
- The stock price has clearly declined less than the level of decline in profitability in the business. Perhaps a –82% vs a –91% comparison is a little disingenuous, but I argue that the stock has very little room to decline any further due to the value in the strong balance sheet of the company. I firmly believe that unless the business worsens appreciably in the next year, the stock price does not poses much risk. (Actually, the stock was down to $0.61/share in 2009, which was a better price to buy at, except there was no reason to believe then that the US economy is improving that will bring the buyers back into the retail stores).
- The company has more stores around the country today than it had in its glory days. As the economy improves, these stores will start operating at a higher level of profitability. If the profitability returns to the 2005 levels in some future year, with the number of stores the company currently has, we are now looking at a total operating income of around $113.5 million, which at 2005 multiples equates to a share price of $25/share. A Price to book ratio expansion can improve the stock price much higher than this.
The thesis to invest in TUES is based on the strong balance sheet that implies limited downside risk (the company can be liquidated at perhaps breakeven to a slight profit), and improving economic conditions which will improve its operating margins and profitability. If the economy does not improve, we should be able to get out of our investment in this stock at a price that at least preserves the bulk of our capital. If the economy does continue to improve and retail environment brightens appreciably, the stock offers rewards that far outweigh the risks.
Buy TUES stock at up to 1x P/NCAV or $4.4/share with a initial sell target of 1x BV, or $6.26/share.
If the P&L shows improvement over the next year, a further purchase may be advisable and I will raise the buy price and the sell targets accordingly.