7 Russell 1000 Retailers Primed for a Leveraged Buyout

Includes: BBY, GME, GPS, KR, M, RSH, SVU
by: Whopper Investments

With debt markets wide open and a leveraged buy out taking place (seemingly) every day, private equity is clearly back in business after being left for dead during the credit freeze in 2008-2009. And it seems retail is their new favorite place to invest, with recent deals or offers being announced for Family Dollar (NYSE:FDO), J. Crew, JoAnn stores, Gymboree (NASDAQ:GYMB) (among others) and rumors abounding that a variety of other stores are in play, including just about all of the teen retailers (American Eagle (NYSE:AEO) shares surged last week on buyout rumors, and Abercrombie (NYSE:ANF) and Aeropostale (NYSE:ARO) seem to have similar rumors float around once a quarter or so). Multiples are also expanding - Gymboree was acquired for ~7.7x EV / EBITDA in the late summer while the recent offer for Family Dollar was ~10x EV / EBITDA.

With a backdrop of growing private equity interest and expanding multiples, I thought I'd take a look at some of the cheapest retailers in the Russell 1000.

Ticker Company Last Price Forward P/E EV / TTM Ebitda P/B Ratio 5 Year ROE LTG Rate Forecast
RSH RadioShack 15.84 9.05 3.56 1.98 25.25 8.33
GME GameStop 19.93 7.19 3.81 1.09 15.41 11.75
BBY Best Buy 33.24 9.66 4.36 2.19 23.97 11.81
SVU SuperValu 8.71 7.47 4.82 1.46 -4.51 5.00
GPS The Gap 22.93 11.90 4.91 3.25 19.98 10.67
SWY Safeway 22.34 13.60 5.54 1.71 7.72 8.37
M Macy's 23.95 10.99 5.70 2.07 -5.69 8.48
KR Kroger 23.02 12.28 5.84 2.76 19.59 7.99

I've mentioned RadioShack before as the stock remains amazingly cheap relative to its earnings power. The company has a history of extremely consistent earnings power and is strongly levered to the growing smartphone and tablet trend. Their CEO, Julian Day, recently announced he's leaving the company, which has created rumors that they are ripe for a takeover, or that Carl Icahn might be interested in them.

Another company with a strong history of earnings growth, Gamestop shares have been crushed over fears of online video game distribution wiping out their business model. However, a huge new share repurchase plan (over 15% of market cap) could serve as a catalyst to send shares higher, and changes to key executives' contracts have sparked rumors that a takeover could be in the works.

Best Buy
Shares have sold off on weaker than expected earnings and worries over long term earnings power and strategy. The company is undergoing fierce competition from Wal-Mart (NYSE:WMT), Target (NYSE:TGT), and Amazon (NASDAQ:AMZN) and may switch to an "every day low price" model. Despite fears over the business model, the company still enjoys great brand strength and returns on capital.

The company's massive debt load and declines in market share have caused the stock to be among the biggest losers over the past five years. However, the company still has a lot of valuable real estate, strong cash flows, and has recently attracted interest from David Tepper.

The Gap
Revenues at The Gap have undergone a steady decline in recent years. However, the stock trades at low valuation and the company still has several valuable brands. In addition, several prominent hedge fund managers have recently found value in the stock, including Eddie Lampert and SAC Capital.

Another highly leveraged supermarket, Safeway's shares have been beaten down over fears on heavy competition and continued food inflation. However, the company has a steady cash flow history and enjoys strong position in many of its markets.

Macy's shares have sunk on fears of increasing competition and weakness in their core consumer. However, the company's same stores sales have been increasing and management is undergoing initiatives to improve traffic and cut costs. Combined with a discounted valuation and some of their real estate holdings, this could make the company attractive to a private equity firm.

Yet another supermarket chain trading at a cheap valuation. The story here is the same as the SVU and SWY stories above - fears and worries about their ability to pass on food inflation costs. While they haven't been mentioned in PE rumors yet, I think it's interesting that Kroger was a hot LBO name in 2007 before the credit markets shut down. Shares trade for significantly less now, and the company's balance sheet, while not in great shape, is very strong compared to Safeway and SuperValu.

Disclosure: I am long RSH, ARO.