Pep Boys' Cost-Cutting Needs to Go Further

 |  Includes: AAP, AZO, ORLY, PBY
by: Mark Krieger

Pep Boys Manny, Moe and Jack (NYSE:PBY) announced a $20 million cost cutting program, highlighted by the elimination on 50 store support positions, freezes on merit raises, and the termination of 401k matches. The cost cutting efforts will result in a onetime $600,000 charge against 4th Q results, to account for severance expenditures. This initiative alone could add as much as 40 cents of earnings per share in 2009.

Not too bad of a deal - spend $600,000 to make $20 million. That’s more than 30 times return on investment. But why stop there?

Every bit helps, but PBY management should focus on a bolder, even more aggressive cost cutting campaign, targeting as much as $100 million. One way to achieve this, is through the implementation of a white collar pay reduction program of 5-10%, and issuing stock options in return for the concessions. It is imperative employees are all on the same page, having the same incentive to see the share price driven higher.

CEO and CFO commentary: Mike Odell is confident prospects are beginning to brighten up;

We have taken these steps to accelerate the Company’s return to profitability, which we project will occur in the upcoming year. Our store base remains strong and no closures are planned, nor are any of our stores impacted by the staff reduction”. CFO Ray Arthur’s take dittoed Odell’s optimism: “We expect positive cash flow for fiscal 2009 which, together with our strong balance sheet, provides us with the ability to fund the expansion initiatives of our long-term strategic plan by adding additional service-only locations.

Negative press slams shares: A recent article titled, “ Who’s set to Shutter Stores” apparently spooked investors into a mad dash for the exits. The selloff was another overreaction and unwarranted. The author, Tom van Riper, mistakenly included PBY in a group of discretionary retailers (80% of PBY sales are non discretionary). Van Riper’s ignorance was solidified by the verbiage he used characterizing PBY’s relationship to the auto industry, His caption read: ”PBY remains in terrible shape along with the auto industry.” The statement is the complete opposite to reality.

He just does not get it—When the auto industry is weak, Auto part’s retailers flourish, as more consumers defer purchasing new cars and must deal with the maintenance issues necessary to keep their beaters, jalopies and clunkers on the road. More “wear and tear” translates directly into increased demand for tires, batteries, brake jobs and oil changes. It does not get any more basic than that. The problem is,this additional demand, has yet to show up in Pep Boys' cash registers, while competitors such as ORLY, AAP and AZO all have experienced positive same store sales comparables.

Bottom line: The last time the shares were this low, back on 11/20, the stock catapulted over 70% from $2.92 to $5.00 in just 11 trading sessions. History tends to repeat itself. It might not be a bad time to dip your toes in, to take advantage of the next leg up. For those too “chicken” to buy in at these very oversold levels, a good option is: PBY’s 7.50% senior subordinated notes, due 2014. The bonds sell at about ½ of face value, produce more than a 15% yield and have priority in an reorganization scenario. The problem is, if PBY makes a substantial operational comeback, the best you could make on the bond ,is double your money, while the common could skyrocket as much as 500%-1000%. You know the routine, the more risk, the more reward. Been there, done that, bought the t -shirt!

Disclosure: Long PBY