Eddie Lampert's Retail Cold Streak Continues
Eddie Lampert is one of Wall Street's most respected asset managers. After starting out at the Goldman Sachs risk arbitrage desk under future Treasury Secretary Robert Rubin, Lampert went on to manage hedge fund ESL Partners and become chairman of iconic retailer Sears Holdings (SHLD).
Recently though, Lampert has been on a retail cold streak. Sears Holdings has struggled, especially with weakness in their consumer electronics business. Lampert's newest position in Big Lots Inc (BIG) just readjusted their 2011 guidance to the downside and their recently initiated position. The Gap Inc. (GPS) has been under tremendous pressure related to falling sales and rapidly rising input costs. Despite these negative headlines, investors would be wise to check out this retail stock clearance rack
BIG LOTS INC.
During the last quarter, Lampert initiated a 1,300,105 share position in discount retailer Big Lots Inc (BIG). We written bullish articles about the company in the past. The company initiated an auction process in February 2011 after management was approached by private equity firms about a possible sale. During this auction process we wrote positively about the stock especially against the backdrop of Trian Group's failed bid for Family Dollar (FDO). We argued that even in the absence of a deal, the company was reasonably priced as a standalone entity but if Big Lots were acquired at the same valuation as Trian Group's offer, Big Lots could be worth around $56 per share in a buyout.
Big Lots management wasn't happy with the auction results and they decided to stay public. The decision caused the stock to drop from $37.74 to $33.77. To add insult to injury, the stock is down around 2% today because of lower earnings guidance. The company reported slightly stronger than expected results for the quarter, including $0.70 per diluted share of income from continuing operations compared to $0.68 per share in the year ago period. In addition, the company opened 9 new stores and generated $106 million of cash flow (operating activites less investing activities)
Management lowered their Q2 outlook from $0.38 to $0.48 per share versus $0.48 per share for the same period last year. The fiscal 2011 outlook for continuing operations is $2.75 to $2.90 vs. $2.83 per share last year. They also expect cash flow guidance to come in at $185 million
If Pershing Square Likes Family Dollar, He'll Love Big Lots
The retail industry has been a mixed bag. While we think that Big Lots' low valuations provide margin of safety, management guidance for flat to 2% decrease in same store sales is reason for concern especially if energy prices stay elevated. Bill Ackman of Pershing Square discussed his passive stake in Family Dollar, stating that it was worth more than what Nelson Peltz had offered. Among other things, Ackman believes that Family Dollar has upside, even if they are unable to attract private equity buyers, because the company can grow earnings by achieving margins similar to those of Dollar General (DG). While Big Lots is not a perfect comparison, we think Big Lots has a better defined niche. In addition, Wal-Mart Stores (WMT) is set to roll out their Wal-Mart express concept which will focus on smaller stores in previously untapped markets. This will likely be a formible headwind for Family Dollar and similar chains
Lampert purchased another 24,237,741 shares of GPS, bringing their total stake to 27,075,997 shares. On May 19, the stock dropped from $23.29 to $19.22 after the clothing chain cut its full year profit outlook by 22% based on expectations of skyrocketing input costs. The company's problems are not solely attributed to costs. For years now, the company has had a hard time with their namesake chain. Gap North America has posted revenue declines for six straight years
While the retailer's problems are stubbornly persistent, the company is still enticing. Valuations are cheap. The company trades at a trailing P/E of 10.35, a forward P/E of 10.8, price/sales of 0.70 and profit margins of 7.76%. Gap has stuggled for years to regain the cache that it had during the late 1990's but the company's brands (Old Navy, Banana Republic, Gap) are still ubiquitous and well known standbys. The company has focused on cost cutting by reducing square footage. This should be positive for the company, though obviously it won't produce revenue growth.
Finally, the company has real avenues for growth both domestically and abroad. Their Athleta brand is an interesting upstart active women's clothing line. Considering that competitor Lululemon Athletica (LULU) is worth nearly $7 billion, there is tremendous upside if that brand gains traction. Many retail companies dream out loud about hopes of global expansion, but the harsh reality is that few retail brands have the global awareness abroad. Gap is one of the exceptions. Even modest success in Europe and Asia could provide shareholders with significant leverage to the upside
It didn't take long for Eddie Lampert's recent retail stock picks to find their way to the sale rack, but investors would be wise to take a closer look. Lampert's successful track record alone should cause investors to do at least cursory due diligence of these stocks, but the opportunities at BIG and GPS are intriguing. We would be particularly interested if Lampert decided to take active role at either company.