Private equity and consolidation interest in the retail space has been picking up over the last year, and low valuations and an improving economy are likely to lead to an intensification over the next few months. I read a very interesting article by Tara Lachapelle and Matthew Townsend on Bloomberg regarding one potential candidate, American Eagle Outfitters (AEO). I thought their analysis was excellent, but I would add the very large inside ownership as well as perhaps some focus by Jay Schottenstein after consolidating Retail Ventures (RVI) and DSW (DSW).
The authors use J. Crew Group (JCG) as a template of sorts. I had shared my perspective on bargains in the retail sector in early November with my friends at TradeKing. I hope that someone else benefited from my work, as I didn't! As I disclosed in that article, our models had (and still have) exposure to Chico's (CHS) and Skechers (SKX). JCG received a buyout offer from private equity shortly after I had profiled it.
When I look at the space, I pay attention to near-term sales trends and to margins. I would rather bet on a stock that is growing rather than shrinking (in case that bid doesn't arrive!). I also like to find low PE ratios on low margins that could improve rather than on high margins that must be maintained. With that in mind, I wanted to run a screen of retailers and retail brands to see what might be among the most attractive. Here is what I did:
- Russell 3000 member
- Market Cap > $900mm
- Net Debt to Capital < 10%
- EPS Growth TTM > 0
- PE F12M < 20
- EV/EBITDA < 9
We narrowed the universe to 36 companies (click to enlarge image):
A few big picture observations:
- Some of these are rumored to be "in play" (or have received offers) - 99 Cents (NDN), Steven Madden (SHOO), Big Lots (BIG), Children's Place (PLCE) all come to mind
- Short-interest is very high among these names (they have blown it on NDN, apparently)
- The group trades at its 5 year average margin, with a lot of variability - remember, these numbers include 2-3 tough years
- The stocks, on average, are in line with the market over the past 2 1/2 months, perhaps trailing slightly (median return is 1%)
- Most of these stocks have more cash than debt - I eliminated that column
I color-coded to help me focus on a few variables. Everything less than 7X trailing is green. I highlighted the stocks that trade at less than 2X tangible book value. I coded the stocks with EBITDA margins below 10% green and above 18% red. I also coded green the stocks trading at less than their 5-year average margin and as red those at a 50% or greater premium.
Working up from the bottom and adding any insight I can provide, I like Skechers (SKX), but it is working through a big inventory issue that seems more than priced in. It has very large inside ownership, but I don't put a high likelihood that they will be acquired by private equity.
RadioShack (RSH) has been in secular decline that may be bottoming. CEO Day leaves in May, with the CFO taking over. This one is so ugly that I am sure not too many people even want to look at it - a sure contrarian sign!
Aeropostale (ARO) is one that has higher margins than its peers. Still, it sure is cheap. Management just lowered the bar in time to award themselves annual equity grants.
Rival American Eagle (AEO) has been boosting margins but suffering negative same-store-sales growth. This is a good example of my lead comment regarding understanding margins and margin trends. While it's hard to expect it to get back to where it was in the go-go days, it seems like they could get in line with peers.
I follow Men's Wearhouse (MW) closely and believe that the company will restore its margins as it improves its tuxedo rental business that it bought a few years ago. It's a fantastic company in the way it treats its employees and customers.
I have been interested in the past in Buckle (BKE), which I have held in my models previously. This too is a great company, with massive inside ownership and almost flawless execution. The bull story is expansion in the Northeast, but bears can point to a couple of issues. First, the margins are sky-high. Second, they are very dependent upon denim. With all that said, I find the stock to be stupidly cheap.
Chico's (CHS) is in the midst of a turnaround engineered by a great CEO, Dave Dyer. We added this one to the TOP 20 Model Portfolio and the Conservative Growth/Balanced Model Portfolio in August and continue to hold a position. Dyer, just starting his third year, has brought in talent and is now opening stores at a heightened pace. He was running Lands End when it was sold to Sears (SHLD) and got Tommy Hilfiger sold to private equity. He has a good record of turnarounds. I characterize this one as just getting started really. I don't see them fitting with a strategic buyer, but there could be private equity interest (there have been rumors over the past year off and on).
Footlocker (FL) is another one I have followed closely. We have bought it a few times in the Conservative Growth/Balanced Model Portfolio but sold prematurely. This too is a management change story, with a former big-shot from JCP coming in. The stock really took off a year ago when he laid out his long-term vision.
My final company comment is regarding Jo Ann's (JAS). Don't spend too much time on it, as it will soon be acquired by private equity. An interesting sidebar is that the whole senior team all worked together previously (at Fred Meyer). When I evaluate management teams in conjunction with my work with Management CV, this is one attribute I like to see - a guy recreates a successful team. This is way off topic, but it's going on at Savient Pharma (SVNT).
This looks like a nice starting place to try to identify the next take-out target. JCG went to private equity at 21 PE this week. Their EBITDA margins were at an all-time high for the company of 18%. NDN ran up to 17 PE on the news Friday. While acquisition is nice, it's not necessary. A lot of these companies have solid long-term performance and a bright outlook with cheap valuations.