Unless you are from north of the border, you have probably never heard of The Brick (BRKQF.PK). Yet it’s the largest furniture retailer in Canada with 292 stores and a very strong regional brand. The stock remains exceedingly underpriced despite a demonstrated turnaround of the business by the new, high quality management team. The Brick has a $295M market cap and trades on the TSX under ‘BRK.T’ and in the US as ‘BRKQF.PK.' This is one of the most compelling opportunities I have come across in a long time.
Under the former management team, The Brick overextended itself and was on the verge of insolvency in 2009. The Board responded by replacing management and recapping the balance sheet. The new team consists of the former CEO of Walmart Canada and the former CFO of Sears Canada, among others. The recap was sponsored by the Chairman and the large Canadian insurance company Fairfax Financial. This saved the company, but also massively diluted shareholders and saddled it with costly debt.
The new management team significantly improved operations, shuttered weaker stores, refocused the business on higher margin products, rationalized inventory and re-struck vendor terms. The Brick’s gross margin of 44% is now 4% higher than it was at pre-crisis levels, inventory turns have almost doubled and annual cash flows is over $100M. The company has now regained all of the market share it lost since 2008. The Brick derives a competitive advantage through purchasing power, regional economies of scale and customer loyalty from its brand and card rewards program. Despite all this, BRK trades at half the price of its peers.
Why is it cheap?
With the recap came 121M warrants that acted as a weight on the share price. However, these warrants have almost completely been extinguished through a cashless tender in late June. The fully-diluted share count consequently declined from 170M to 129M. On January 1, the company also converted from an income trust to a c-corp. As a result, the shareholder base turned over as yield-centric holders sold. This pressured the stock in a structurally similar way as a spin-off. Though both RBC and BMO both have strong buys on BRK, institutional following of the company is limited.
The stock plunged from $9 prior to the downturn to $2 and has remained a neglected orphan around that level since. But now the dilutive warrant overhang is gone, selling pressure from the conversion has subsided and performance has been demonstrably strong and is improving. The Brick recently initiated a new payment program to capture the $80M in annual sales lost from customers that do not get approved for its existing credit card facility. This should lead to meaningful growth in sales per sq. ft. while not adding any incremental balance sheet risk as the credits are held by HSBC. In addition, management recently announced a 5% share repurchase program and that it's considering calling the expensive 12% notes. It is apparent that the stock will not remain at this price for long.
The Brick has an appealing FCF profile with limited capex, strong margins and no cash taxes due until at least 2013. At $2.28 a share with 129M FD shares outstanding and $132M of net debt, the market cap is $295M and the EV is $426M. BRK trades at an EV/ EBITDA multiple of 4.2x versus 8.1x for its peers BMTC and LNF. It trades at 4.5x EBITDA-capex versus 9.1x for the peers. If you apply these peer multiples to BRK, the implied price is $5.00 - $5.50 per share or 120% - 140% above the current stock price. One could also argue that The Brick should be valued at a premium to its competitors because of its higher margins and scale. BRK trades at a 25% LTM FCF yield and a 26% 2011E FCF yield. No matter what metric you look at, this is a very inexpensive price for a growing, high return business with a top rate management team. In addition to the previously noted catalysts, cash generation and the delivering of the balance sheet alone increase equity value meaningfully.
Canada and Canadian consumers are in a stronger fiscal position than the US. Unemployment is lower, housing starts are growing faster, household debt is lower and GDP is recovering faster. Continued cost improvements at The Brick should insulate it to a degree if demand declines. In the last quarter SSS were down 1.5%, but gross margins were up 2% and EBITDA margins were up 1.4%. The new IT/ routing system should improve these margins even more and alleviate the potential impact of a double dip.
Disclosure: I am long BRK.