Market cap: $473.4m
hhgregg (NYSE:HGG) is a small-cap retailer of consumer electronics and home appliances. The company caught my eye because the stock has been beaten down almost 50% from the 52-week high and sold at a surprisingly low P/E for its earnings and sales growth.
It has an interesting recent corporate history. The company was recapitalized in 2005 (hence the jump in total debt) and then IPO-ed in 2007 (hence the sudden reduction in debt). Growth in store count was relatively slow until the IPO, with only 4-10 new stores opening per year. After the IPO store openings increased ever year, totaling 42 net openings in 2011.
To get a sense of how this has affected the company, I built this sheet of its performance over the past decade to take a look at its performance over time:
A few things stand out. As others have pointed out, part of the recent decline in ROE comes from the steady decrease in leverage. It also comes from a slight decline in ROA which you can also see reflected in the downward trend in sales and earnings per store. Returns on invested capital remain strong, however, and actually inched upward in fiscal year 2011 due to the reduction in debt.
Returns per store are also surprisingly high in spite of the decline in per store profitability. Capex for 2011 was about $60 million and HGG opened 42 stores, so figure a rough cost per store of $1.43 million. If their stores continue to earn around $0.28 million per year, that’s a 19.6% return on their invested capital for newly opened stores — definitely better than you would expect given the its current valuation and 50% decline from the 52-week high.
A less impressive figure is its record of earnings growth. Over the past 10 years, earnings have increased 64%. That’s a compound growth rate of 5.1%. Store count, on the other hand, grew four-fold from 42 to 173. This comparison is somewhat skewed because HGG was an S-corp in 2002 and distributed its earnings directly to owners for whom it was taxed as income and therefore it incurred no corporate income taxes. Adjusting for taxes using the 2011 tax rate, 2002 income was $18.8 million and 10-year earnings growth improves to 156%. That’s a little under 10% per year against annual store growth of 15%. Earnings growth still lags but the shortfall is much smaller.
With that in mind, growth is a mixed bag for HGG. The general decline in same-store sales means that a moderate amount of growth is required just to maintain earnings and that growth will continuously become less efficient as long as the trend continues. It also means that HGG's substantial expansion has proved less profitable than management might have hoped. On the other hand, growth is now relatively safe for HGG. The company was able to fund its capital expenditures out of operating cash flow in fiscal year 2011 and should be able to do the same in 2012. There’s no need to issue debt — in fact, the company just paid down the last of its debt — or dilute existing shareholders (they’re actually planning to buy back shares). There’s also not much financial risk now that HGG finished clearing out all its long-term debt. This makes it a lot more comfortable risk-wise to wait patiently for conditions to improve.
2011 annual report