Pep Boys (PBY) missed third quarter earnings estimates and the market had no mercy, sending the shares down 35% in just two sessions. PBY was expected to generate sales of $480 million and a break even for the quarter; instead, sales came in $20 million light, causing the auto parts retailer $7 million of red ink.
Although the company lost $7 million, the market chopped off more than ten times that amount, as its market cap saw $90 million vanish into thin air. The company blamed the shortfall on reduced consumer spending, lower vehicle miles driven and deferral of maintenance.
PBY’s main driver of sales is “wear and tear” and fewer miles driven does not help this category. The company stressed that 80% of its business is non discretionary, enabling the auto parts retailer to avoid too much exposure to an overall downturn in consumer spending. Management is optimistic that sales should start to pick up as the deferral of required spending begins to abate, as (1) miles driven starts to improve as fuel prices continue to drop, (2) the weather turns cold, (3) people continue to hold their cars longer, and (4) dealerships and small shops continue to close.
Management pointed out that its biggest disappointment was soft tire sales. This segment, PBY’s single largest, is the company’s primary focus. The consumer appears to be letting their tires get balder and balder before replacing them, and management acknowledged that they need to keep better tire inventories, especially for newer model cars.
Plan to get on the right track: The key to its turnaround plan is getting back to “basics”, and its number one priority is enhancing customer service. The company also decided to place its service advisors on an incentive plan. The idea is to pay them 60% base and 40% commission, as this will enable them to be paid in direct relation to how hard they work, kind of a novel concept, but way overdue. The locations where the incentive pay has been implemented have already seen a 2% sales lift, so optimism is warranted. On the parts side, management stressed that it is not practical to put these folks on an incentive basis, but they should find a way to do so. The company’s new mantra is to have right people, at the right place, with the right product, doing the right things.
Going on the acquisition trail: The company intends to purchase 20 to 40 service centers per year over the next five years so it can leverage its infrastructure. PBY already has the marketing, IT systems, training and governance in place. The logic is that it might as well take advantage of it, through thoughtful expansion. Mike O’Dell, CEO, said the company’s aim is to acquire small chains in close proximity to its super centers. “The truck is still coming for replenishment and a lot of inventories are already in the super center.” Service expansion should help alleviate one of the company’s key weaknesses, its "lack of market density.” O’Dell indicated that the purchasing of service centers is a definite “game changer.”
New bank credit facility: PBY’s credit line of $300 million expires in December of 2009; however, a syndicate of banks led by BofA (BAC) has entered into an agreement with the company to launch a replacement facility expected to close next month. The willingness of these lenders to propose a new credit facility in these harsh economic times is a testament to PBY’s current financial muscle.
Cost cutting actions: The company expects to reduce its marketing budget in 2009 by $20 million, while trimming its capital expenditures well below depreciation levels. Management also anticipates savings of $10 million in non merchandise expense reductions. Although PBY’s Selling, General and Administrative costs dropped 10% for the quarter from $134 million to $120 million, these costs still crept up as a percentage of sales, increasing 30 basis points from 25.5% to 25.8%. The good news is, on a sequential basis, the company saw it SG&A costs drop 20 basis points on the quarter. The company’s interest expense plummeted a substantial 38% from $11.5 million to $7 million due to lower loan balances and the result of a $2.5 million gain associated with debt repurchases.
Bottom line: PBY’s share price dive is reminiscent of what happened just after it reported disappointing second quarter results, however that fall eventually prompted the shares to more than double from its lows. Will history again repeat itself? Probably so, as the stock, by every metric appears too cheap. It possess a price to sales ratio of .08, a price to book calculation of .35 and an annual cash dividend of 28 cents, yielding an impressive 8.5% return. Gabelli and Co. seem to agree, as they upgraded their opinion yesterday from a hold to a buy rating, citing (1) its real estate value could be worth more than $1 billion, amounting to roughly $10 a share even after a 20% appraisal reduction, (2) the company has strong liquidity and is in the process of closing a new $300 million revolving credit facility, and (3) a catalyst exists in the form of a new management team that could significantly improve operations.
Manny, Moe and Jack have been beaten up again, beyond recognition, but time always has a way of healing , as the boys will be back!
Disclosure: Author holds a long position in PBY