Pier 1 is a stock that I literally watched ascend from $4 earlier this year to the $6.36 I purchased it for. This was the stock I called a "fairly attractive long" in the February performance report. I was expecting the earnings report in April, but management got a bit excited and reported preliminary. The stock remains attractive even at $6.38.
| Purchase Price: $6.38 (March 11) | Market Capitalization: $534 million |
| Enterprise Value: $667 million | EV/EBITDA: 4.17 |
| Price Target: $11.17 (75% upside) | Time Frame: Six to 12 months |
Pier 1 Imports (PIR, Financial) is a specialty retailer of imported home furnishings and decor. The merchandise largely consists of items that feature a significant degree of handcraftsmanship and are mostly imported directly from foreign suppliers. The company operates under two merchandise groups:
- Decorative Accessories:Â includes decorative accents and textiles, such as rugs, wall decorations and mirrors, pillows, bedding, lamps, vases, dried and artificial flowers, baskets, ceramics, dinnerware, candles, fragrance, gifts and seasonal items.
- Furniture:Â includes furniture and furniture cushions to be used in living, dining, office, kitchen and bedroom areas, sunrooms and patios.
Note: The company's fiscal year grossly differs from the common calendar year. Fiscal year 2016 ended in February 2016, and fiscal year 2017 goes from March 2016 to March 2017, so the quarters ending between March 2016 and 2017 are fiscal year 2017.
What happened?
Net income peaked at $169 million in 2012 and stands at $59 million for the trailing 12 months (TTM). On Sept. 19, 2013, the company reported:
For the second quarter ended August 31, 2013, the Company reported net income of $17.8 million, or $0.17 per share, compared to $26.2 million, or $0.24 per share a year ago. Adjusted net income (non-GAAP) for the second quarter last year, as described below under Financial Disclosure Advisory, was $20.7 million, or adjusted earnings per share of $0.19. Total sales for the second quarter were $395.6 million, a 7.6% increase versus $367.6 million in the year-ago quarter. Comparable store sales increased 3.5% during the second quarter compared to last year’s comparable store sales gain of 6.7%.
This was the beginning of the fall beyond the day-to-day fluctuations. The same happened on Jan. 9, 2014 when the company reported even more disappointing numbers and then reduced guidance. Gross margins peaked in May 2013 quarter (fiscal 2014) and have been in free fall ever since. The stock followed and is down 76% from its peak in 2013.
RISKS
Weaker U.S. dollar
The company sources 59% and 14% of its inventory from China and India and likely settles it in U.S. dollars. Any swift movement of the yuan or rupee would send gross margins falling. Given that the gross margins are already low and are likely to increase because of the more favorable inventory levels, the impact of this should be cancelled out in a worst-case scenario.
Falling/flat comparable sales
Comps for the first three quarters of FY 2016 have hovered around the low single digits, the risk is that it might actually turn negative in the coming quarters. For fiscal year 2013, 2014 and 2015, comps were 7.5%, 2.4%, and 4.7%, and yet the stock is down 76%. This tells us that Wall Street is more worried about the profit and gross margins than they are about comps.
WHY BUY NOW?
Inventory deleveraging and margin expansion
Inventories got ahead of sales in fiscal 2014, 2015 and so far this year. This led to the falling margins we have seen thus far. Gross margins fell 407 and 452 basis points to 34.8 and 37.8 for the quarters ending August and November 2015.
In the quarter ending November 2015 (third quarter), however, sales fell 2.5%, but inventories fell 6%. In the preliminary earnings report for the fourth quarter and year-end, management said that inventories ended 15% lower than they were at the beginning of the fiscal year, while sales were up 0.3%. This means that the inventory/sales ratio going forward is now approximately 21.7. The long-term average is 21.9. The company will now be relieved of the pricing pressures they faced over the past few years, and we should see the gross, operating and profit margins revert to the mean.
What is the mean?
Dating back to 1996 and excluding the four housing bubble negative margin years of 2006, 2007, 2008 and 2009, the average profit margin is 6%. Applying that to the current TTM revenues of $1.87 billion, we have a net income of $112.2 million, meaning that we're paying just 4.77x normalized earnings. The EV/EBITDA number I have up top is also overstated and should be sliced in half.
Easy margin quarter-over-quarter comparable growth
The 34.8% and 37.8% gross margins for August and November 2015 I mentioned above are the lowest gross margins the company has posted for those quarters dating back to 1996, excluding the four housing bubble years from 2006 to 2009. This means posting a net income increase for Q2 and Q3 should be feasible. This is also true for the first quarter gross margins that came in at 38.1%; the margin of safety in the August and November quarters are much higher, however. This all means that there is a 16/20 or 80% chance that gross profits and net income will increase over the next few quarters provided that the company maintains its average SG&A as a percent of revenues of 30%. The only risks to this is that they plan on closing 100 stores over the next few years and may incur some severance and general expenses. This is going to happen through natural lease expiration, so we should not expect to incur any costs from breaking leases. Investors will likely cut them some slack on this.
As I mentioned above, comparable store sales have been positive over the past few years, and the stock is still down 76%. Investors clearly care more about margins than comparable store sales, and margins are more likely to increase going forward.
Share repurchases and dividends
For the fiscal year ended February 2011, the company had 117 million shares outstanding. For the fiscal year ended February 2014, the number stood at 104 million. As of the November 2015 quarter, that number stands at 83 million. Management has been immensely aggressive with these repurchases. In fact, over the past two quarters, they repurchased $55 million worth of shares, and this is about 10% of the total shares outstanding at today's prices! Given the volatile markets earlier this year when the stock fell below $4 per share, the company likely purchased more in the fourth quarter (we'll find out next month). This will provide support for the EPS estimates going forward.
They also pay a decent 4% dividend. S&P 500's average dividend is approximately 2.2%. Once the market realizes that Pier 1 Import's dividend yield is actually sustainable, the stock should run higher.
