Amid Tuesday's strong broad market gains in the stock market, Barnes & Noble (BKS), Johnson & Johnson (JNJ), Motorola Mobility (MMI), Proctor & Gamble (PG) and Zale Corp (ZLC) all finished lower on the day. Each stock underperformed the broad market and their peer groups. Investors should fight the urge to put too much emphasis on a single day's stock performance but there are reasons to worry about some of these disappointing stocks. Investors should take a closer look to separate fact from fiction. Here is a closer look:
Barnes & Noble (BKS) - The brick and mortar bookstore chain traded as high as $20.46 but eventually closed at $18.94 on average daily trading volume. The sharp reversal followed the release of worse than expected previous quarter and fiscal 2011 results earlier in the day. During the quarter ending April 30, 2011, revenues rose 4% to $1.371 billion compared to $1.318 billion last year. Fiscal year 2011 sales increased 20% to $6.998 billion in large part because of the inclusion of acquired revenues.
On a slightly smaller store base, the company's Barnes & Noble retail segment's quarterly revenues declined 3% from $973.46 million to $942.73 million. Stores open at least one year had an average revenue decline of 2.9%. This decline is not good, but it is not surprising considering the cannibalistic secular trend toward ebooks as well as the near term pricing pressures related to liquidation sales at around 200 Borders stores.
The company faces difficult headwinds and it operates in a retail industry with limited (if any) protections against competitors. We have been contrarians on the stock. Because of the stock valuation and intriguing opportunities in both the brick and mortar retail space as well as the electronic retail space, we have owned this stock and been cautiously bullish of this company for months. Despite the perceived disappointments in the recent financials, we see tremendous upside. BKS continued to grow its market share in the ebook market from around 25% to 26 or 27%. To understand the importance of this gain, we need to look at the marginal benefits of the revenues. Headlines focus on the 54.4% growth in quarterly revenues at the BN.com segment, but those headlines actually understate the benefits to investors because the revenue gains actually led to a 122.11% increase in BN.com's gross profits. These are exciting gains in an area with secular growth potential.
Barnes & Noble will report its first quarter earnings around August 30, 2011. As such, this will represent the next major fundamental story, but in the meantime, there are various potential catalysts related to the Liberty Media buyout as well as other potential suitors that could move the stock.
Going forward, we continue to remain optimistic about Barnes & Noble. As long as the company remains flexible with the product mix at its stores (this is an important caveat), its brick and mortar presence can actually be a strength. In addition, the company's strong market share of the secularly growing ebook market is an attractive asset at a company with more than 1,300 stores and an enterprise value of around $1.5 billion. We think BKS could see additional upside, but investors should understand the risks. In addition to the risks if NookColor loses its niche as the market's cheapest tablet device, the shareholder structure is highly concentrated. It is very possible that the shareholder structure will lead to an outcome that does not fully benefit passive minority shareholders.
Johnson & Johnson (JNJ) - The blue chip stock traded flat to slightly lower on Tuesday despite a strong move in the Dow Jones as well as in other large capitalization healthcare stocks. Considering that the SPDR Dow Jones Industrial Average (DIA) was up 0.87% on the day, Novartis AG (NVS) was up 0.43% on the day and Abbott Laboratories (ABT) was up 0.46% on the day, JNJ's lack of upside appears to accentuate a lack of investor enthusiasm. Still, even at 52-week highs, the company trades at a reasonable trailing P/E of 15.08 and a forward P/E of 12.57. Investors should not make too much of relative stock weakness. It is likely just an artifact of investors' rush to higher beta names as well as names that have been subject to stock price weakness over the last few weeks.
Motorola Mobility (MMI) - The company encompasses Motorola's mobile device and home network technology segment. The company declined 2.86% on nearly double the average daily trading volume. The stock has been under pressure following analyst downgrades and market concerns related to competitive pressures. In this sense, Tuesday was more of the same as the stock dropped after Credit Suisse downgraded the stock to "underperform" and lowered earnings estimates for 2012.
Following the separation of Motorola Mobility (MMI) and Motorola Solutions (MSI), MMI has drawn pessimism, while MSI has accumulated a formidable list of notable shareholders, including Soros Fund Management, Icahn Capital, ValueAct Holdings and NWQ Investment Management.
Procter & Gamble (PG) - The blue chip consumer staples giant traded lower on Tuesday. The stock dropped 1.34% on average daily trading volume. As we mentioned with JNJ, the market activity for both the broad market and comparable large-cap names was positive so PG's activity stands out. The company did not have fundamental stock moving headlines and it appears that the price weakness is a continuation of the stock's decline since mid-May from $67.46.
Considering the company's tremendous global reach and premium brand portfolio, PG is not expensive at a trailing P/E of 16.92 and a forward P/E of 15.04 but it is not necessarily cheap either considering the depressed valuations of other large capitalization companies.
Zale Corp (ZLC) - The mall based diamond jewelry retailer has struggled recently after bouncing back from distressed stock price lows. But on Tuesday, the company lost 6.84% on trading volume around 150% of the previous three month average. The stock move was based on no negative fundamental headlines. It may very well be a continuation of the stock's negative price trend this month after peaking above $6. As we previously wrote, the recent negative headlines do not explain the stock's price decline. If anything, the company may have received modestly positive news when the Russell 3000 Index decided to add ZLC in its next reconstitution.