Getting Comfortable at Pier 1

Investopedia Advisor submits: Pier 1's management is finally showing signs of life, and new initiatives should increase traffic and increase the bottom line.
Retailing is a tough business; less so if you are one of the big boys. Primary retailers – Wal-Mart (WMT), Target (TGT), Home Depot (HD), Lowe's (LOW) et al. – sport difficult-to-penetrate economies of scale. These advantages are the product of enormous investments in capital and management that insulate them from the primary retailing bugaboo – ease of entry.

Secondary and tertiary retailers, unlike their primary confreres, aren’t so insulated, for they rely less on economies of scale and more on management acumen. An ability to portend (or even create) consumer trends is vital to long-term success, while one misstep can undo years of superior performance.

Pier 1 Imports (PIR) is a penetrable secondary retailer of imported furniture collections, decorative accessories, housewares, and seasonal assortments whose market has been penetrated. Once recognized as a niche retailer renowned for its imported merchandise, the company lost its identity when other retailers began stocking similar offerings.

For years, Pier 1 out-merchandised its competitors: from 1997 through 2005, annual sales growth averaged 9.1%, book value growth averaged 11.6% and dividend growth averaged 24.3%. But that was then and this is now. Pier 1’s operating and financial performance has deteriorated markedly across all valuation metrics thanks to a few missteps. Today, Pier 1 is in a slump that features net losses in the past five quarters and declines in same-store sales – a widely used gauge in retail performance – in 35 of the past 43 months. The company’s problems are manifested in the stock, which is trading near seven-year lows.

So why should an investor consider a struggling secondary retailer?

For starters, management is finally showing signs of life. Pier 1 recently buttressed its balance sheet with the sale of its propriety credit card operations to J.P. Morgan Chase (JPM) for $155 million. The transaction should net roughly $40 to $50 million in after-tax cash proceeds after eliminating about $100 million in underlying securitized debt.

New initiatives should increase traffic and further boost the bottom line. Pier 1’s catalog offering (it shipped 10 million catalogs in June) should renew interest in the company’s products as it transitions away from middle-tier pricing and quality and challenges Williams-Sonoma (WSM) and Restoration Hardware (RSTO) for top-tier clients.

On that front, Pier 1 has launched a new advertising campaign and merchandise lines, including Modern Craftsman. In addition to wicker and rattan, the Modern Craftsman line offers fabric-covered couches and chairs. Loft 21, launched in mid-July, is aimed at the sophisticated urban crowd.

The history of retailers successfully remaking themselves is spotty at best: Woolworth couldn’t do it; J.C. Penney (JCP) could. A Pier 1 investment will require fortitude and patience. The company has many balls in the air and no one is sure how they are going to land.

But investors will be compensated with a 6.4% dividend yield and the company of one famous investor. Warren Buffett, according to Berkshire Hathaway’s (BRK.A) latest 13-F filing with the SEC, retains a 4% stake in the struggling retailer.

By Stephen P. Brown, Contributor - Investopedia Advisor

At the time of release Stephen P. Brown did not own any shares in any of the companies mentioned in this article.