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Pier 1 Import offers 50% upside potential

June 21, 2014 | About:

"There's nothing particularly earth-shattering about what we try to do. We believe the market often misprices stocks due to neglect, emotion, misinterpretation or myopia, so our value-add comes from bottom-up stock selection. We're trying to buy at low prices relative to our current estimate of intrinsic value and we want to believe that intrinsic value will grow"

The above quote comes from Steve Morrow, who is with NewSouth Capital. In today's brutal retail environment, I found Express (EXPR), which produced about 30% return since I recommended it in my May monthly value idea contest. Again, I have spotted another mispriced retailer, Pier 1 Import (PIR), with 50% upside potential. Its current 12.8x PE multiple is low relative to its high single digit comparable sales growth potential. Once PIR attains its goals of growing its e-commerce to 20% and having 11% operating margins, I believe PIR can trade close to $22 per share.

Company Overview

PIR is a home furnishing retailer focusing on decorative home furnishings, furniture, gifts, and related products. As of March 1, 2014, PIR has 1,072 stores, including 991 stores in the United States and 81 stores in Canada. PIR was founded in 1970 and is headquartered in Fort Worth, Texas.

Pristine Balance Sheet

As of May 31, 2014, PIR has $220 million of cash and cash equivalents and $200 million outstanding under its senior secured term loan. Since PIR is cash flow positive, it can utilize its operating cash flow to pay for capital expenditures. Based on gurufocus.com, PIR has $0.74 per share FCF in 2014, $0.4 per share in 2013, $0.7 per share in 2012, and $1 per share in 2011. For my own calculation, PIR is capable of generating about $100 million free cash flow per year.

Shares Buyback

According to gurufocus.com data, PIR has spent $192 million in 2014, $100 million in 2013, and $100 million in 2012. The total of $492 million has been used to repurchase its own shares. In addition, there remains another $181.9 million available for future repurchases. For a $1.47 billion market cap, the repurchase program has significant impact on the shareholders total return. I foresee that when the numbers of outstanding shares continue to decrease, the earnings per share will disproportionally increase in shareholders' favor.

Management Team

Alexander Smith, the CEO of PIR, has seven years tenures in Pier 1 Import. He saved PIR by implementing a great turnaround plan, which is to get PIR back to its roots as a great merchant, size the business right, and be relentless about execution. In early 2007, when the housing slump began, he closed stores, dropped the kids line, laid off employees, closed down catalogs, cut marketing by half. However, he remained focus on merchandising by tripling staffs in the merchandising group. Eventually, the unique and well-stocked merchandises help PIR to stand ahead of the brutal competition. No wonder that its products resonate well with its customers.

In early 2009, when investors stay away from investing as they deemed cash as king, PIR went bargain hunting and bought its own debt for 34 cents on a dollar. In fact, I would like to give credit to Alexander Smith for helping PIR to navigate the difficult time and position PIR to be stronger for future competitions. For the challenge facing PIR today, I am confident that Alexander Smith is the CEO to help PIR navigating the upcoming challenging time since he had a great track record with PIR.

Valuations

In Millions of USD (except for per share items) FY 2016 Forecast FY 2015 Forecast FY 2014 Actual
Revenue 2,105.00 1,931.20 1,771.74
Operating Income 231.55 212.43 175.50
Interest Income(Expense), Net Non-Operating 11.00 11.00 -
Income Before Tax 220.55 201.43 174.65
Income After Tax 136.74 124.89 107.53

Based on my assumption of 38% tax rate, 11% operating margin, PIR can generate $136 million net profit in 2016. Applying 16x PE, PIR will be worth about $2.18 billion providing 50% upside potential within 2 years.

Peer Comparisons

  PIR Williams-Sonoma (WSM) Restoration Hardware (RH)
EV/EBITDA 7.05 10.26 21.48
Forward P/E 10.69 19.27 31.54
PEG 0.81 1.57 1.37
Price/Sales 0.87 1.46 2.16

As PIR, SWM, and RH share some similar clientele, it is good to do a comparison in regards to their valuations. As we can see from above, PIR compares favorably against both WSM and RH in all four different valuation matric. Although some might argue that WSM and RH delivered better recent earning results than PIR, the bad news have already been reflected in PIR's depressed stock price. As I pointed out above, if we look out 2 years to FY 2016, PIR has a good chance to produce 50% upside potential and thus bring its valuation more in line with its peers.

Technical Analysis

Source: stockcharts.com

The RSI indicator shows that PIR has been oversold. Based on the mid point of FY 2015 financial guidance, which is $1.18 EPS, the implied P/E ratio is 12.8x. With the comparable sales growth, which includes e-Commerce, in the high-single digits, the expected sales growth rate is high relative to the earning multiples we are paying today.

Risks

First, PIR is expanding its e-commerce business. As of the latest earning release, PIR derived 9% of total sales from e-commerce. Any disruption in e-commerce will significantly reduce the sales growth potential of PIR, so does its valuation. Second, the health of the consumer market has a great impact on the sales of PIR. If the macro environment deteriorates, the business of PIR will be adversely affected. Third, PIR operates in a highly competitive and promotional retail environment. It is very volatile, and any increased price competitions will negatively affect sales and profitabilities of PIR.

The Bottom Line

PIR has been on my radar for a while. After its recent below-consensus 2015 guidance, I take a look again at its valuation and find that the bad news have already been incorporated into today's share price. At today's depressed valuation, PIR might be like EXPR with hedge funds or private equity funds interested in investing since its intrinsic value is far above today's share price. Since PIR is a volatile stock, I would only recommend it to those investors who can tolerate the risk. Nevertheless, the risk/reward profile is favorable, and the 50% upside potential is achievable.

Note: The quote from Steve Morrow comes from the book "The Art of Value Investing: How the World's Best Investors Beat the Market"

Disclaimer: I am not a securities broker/dealer or an investment adviser. You are responsible for your own investment decisions. All information contained should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.

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