6 Retailers With 25% Upside Heading Into Earnings Season

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Includes: AEO, ARO, ASNA, BBY, PLCE, RSH
by: Whopper Investments

With retail earnings set to kick off tomorrow and continued private equity and takeover interest in the retail sector, I thought I'd take a look at the retail sector for potentially undervalued retailers.

Specifically, I looked for retailers trading well below the average take out multiple. Retailers are generally acquired on an EV/EBITDA basis: Jo-Ann Stores was acquired for 7.8x EV/EBITDA, J. Crew for between 8-9x EV/EBITDA, and Gymboree for just under 8.5x. To be conservative, I decided to use a takeout multiple of 7.5x EV/EBITDA.

Because I wanted significant upside, I screened for retailers with 25% or more implied upside from my implied "takeout price." Only six stocks managed to pass the screen.

Ticker Company Price P/E EV/EBITDA Projected Takeout Price Upside
ARO AEROPOSTALE INC 21.58 8.32 3.31 44.71 107.17%
BBY BEST BUY CO INC 30.38 8.77 3.96 60.42 98.88%
RSH RADIOSHACK CORP 16.4 10.01 3.93 31.35 91.14%
AEO AMERICAN EAGLE OUTFITTERS 14.55 14.03 4.72 20.88 43.53%
ASNA ASCENA RETAIL GROUP INC 31.48 14.16 5.53 40.88 29.86%
PLCE CHILDREN'S PLACE 54.07 16.99 5.73 68.54 26.76%
Average 12.04 4.53 66.22%
Click to enlarge

With an average implied upside of over 66%, the list certainly appears cheap. Plus, the companies have already begun attracting private equity interest: ARO, AEO, PLCE, and RSH were all highlighted as potential buy out targets in a recent note from UBS. Best Buy may be too large for private equity interest, but David Einhorn recently purchased a position in the company, saying the shares were way too cheap at current prices.

Even better, they're taking advantage of the discounted prices to buyback shares, which should result in even further upside for today's shareholders. RadioShack, for example, just raised $325m worth of debt to repurchase shares, which would buy back ~15% of shares at today's price. Aeropostale bought back almost 10% of their shares outstanding last year and should maintain a similar pace this year, and Best Buy bought back 3% of shares last year and their strong balance sheet should let them buyback more this year. Children's Place recently announced a buyback for ~8% of their current market cap, and American Eagle is a perennial share repurchaser, buying back ~5% of their shares last year (on top of a 3% dividend!)

Personally, I think an investment in Aeropostale makes the most sense here. The company is trading at a lower multiple than most distressed retailers, but they are still extremely profitable, have a rock solid balance sheet, and have two great avenues for growth in P.S. from Aeropostale and by opening international stores.

Regardless, the whole list looks interesting. With share repurchase, depressed multiples, strong balance sheets, and the potential for a takeover, investors would be well served to take another look at these names. Whether it's an LBO or a strong earnings report, the names are likely to be materially higher in the near future.

Disclosure: I am long ARO, RSH.