Be Careful Buying Into The Tuesday Morning Story

Aug.26.14 | About: Tuesday Morning (TUES)

Summary

Discount retailer Tuesday Morning produced solid comparable store sales growth in FY2014.

The company's sales growth has raised expectations for better future profit growth, which has undoubtedly been a catalyst behind its positive stock price performance over the past year.

With adjusted operating profitability still at a roughly breakeven level, Tuesday Morning's story has too much downside risk.

Shareholders in discount retailer Tuesday Morning (NASDAQ: TUES) have enjoyed a good run over the past year, with the company's stock price up nearly 30%, a performance that was likely propelled by better than expected top-line growth, including a solid 6.1% increase in its comparable store sales during its latest fiscal year. More importantly, the company is anecdotally starting to show some traction from its cost savings initiatives, which have included exiting unprofitable merchandise categories and closing unproductive stores. On the downside, though, Tuesday Morning is still finding profitability a hard goal to achieve, due to omni-present competition from larger, off-price retail players like TJX Companies (NYSE: TJX) and Ross Stores (NASDAQ: ROST). So, after some solid stock price appreciation, is Tuesday Morning still a good bet at current prices?

What's the value?

Tuesday Morning is a sizable player in the off-price segment of the discount retailing industry, operating a network of more than 800 stores in 41 states that are focused on housewares and seasonal product categories. Unfortunately, that size has proved to be of little benefit, due to the company's inability to efficiently manage its inventory, which has led to a need to engage in promotional activity, saddling it with relatively low profitability, evidenced by a 1.2% average adjusted operating margin over the past five years. As illustrated in the below table, both TJX Companies and Ross Stores enjoy inventory turnover rates that are twice the level of Tuesday Morning, a superior level of efficiency that not surprisingly produces higher operating profitability.

Latest Fiscal Year COGS Avg. Inventory Inv. Turnover
Tuesday Morning $563 M $210 M 2.7
TJX Companies $19,605 M $2,990 M 6.6
Ross Stores $7,361 M $1,233 M 6.0
Click to enlarge

Source: Tuesday Morning 2014 10K Report, TJX Companies 2014 10K Report, Ross Stores 2013 10K Report

In its latest fiscal year, though, Tuesday Morning showed some positive progress in its battle for inventory efficiency, reporting a 2.7 inventory turnover rate versus the 2.1 rate in the prior year period, ostensibly due to the aforementioned exit from slow-moving product categories and the company's ability to drive higher average customer traffic volumes and transactions at its stores. The net result for Tuesday Morning was a slight gain in adjusted operating profitability, 0.2% compared to 0.1% in the prior-year period. More importantly, the combination of better inventory management and overhead cost savings led to improved cash flow, helping to fund the company's investments in greater inventory assortments in its core product categories, a strategic move that will hopefully lead to further increases in customer traffic.

Looking into the crystal ball

Of course, the question for investors is whether Tuesday Morning can deliver sustainable profit growth in the foreseeable future, a vital ingredient for future stock price appreciation. While management seems optimistic about its ability to produce future profit growth, the company's track record is weak on that score, evidenced by an approximately 25% decrease in adjusted operating income over the past five fiscal years, a performance that was hurt by a reduction in the size of Tuesday Morning's store footprint and its overall profitability.

As such, investors should probably avoid the urge to buy into the story at this juncture, instead opting for the off-price retailers that continue to deliver solid results in the current selling environment, like TJX Companies. The operator of off-price retail stores, mostly under its TJ Maxx and Marshalls brand names, continues to post solid financial results, highlighted by a 6.2% increase in revenues in FY2014. More importantly, TJX Companies continues to run a lean operation and pursue efficiencies through its global purchasing organization, which allowed it to maintain a solid level of operating profitability, 11.9% during the period. The net result for the company was strong cash flow, helping to fund a further expansion of its store base, including a larger presence for its HomeGoods unit, a major competitor to Tuesday Morning in the housewares category.

Likewise, Ross Stores continues to post solid financial results, reporting a 7.9% increase in operating income in FY2014. In much the same way as TJX Companies, Ross Stores uses an efficient corporate overhead structure and no-frills stores to underprice its competitors and drive incremental customer traffic, leading to relatively quick inventory turnover that positively impacts its operating profitability, which improved 20 basis points during the period to 14.5%. The ultimate benefit of the company's operating model, though, is strong operating cash flow and a rock-solid balance sheet, characteristics that allow it to be opportunistic and growth-oriented, even in challenging selling environments.

The bottom line

Tuesday Morning has seen nice stock price appreciation over the past year, likely due to rising expectations for margin expansion and profit growth in the near future. However, with the company still operating at close to a breakeven level on an adjusted operating profitability basis, Tuesday Morning seems to have more downside risk than upside potential at current prices. Therefore, investors should probably avoid this discount retailer for the time being.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.