As the stock market falls and investors debate whether the global economy is headed towards a recession, the dollar and thrift stores offer an intriguing recession play. If the economy does slow down, these type of stores should benefit from consumers with tight budgets looking for quality products at a discount.
One such store that is currently under the market radar is Epic Stores (OTCQB:EPSC). The small retailer runs a chain of thrift stores in multiple states that offer second-hand goods at affordable prices. With fast growth, the company is already interesting without any benefit from a recessionary environment that might further drive consumers to the category.
The question is whether the financials can improve enough in order to secure the necessary capital to ensure the resale chain reaches epic potential.
The company opened the original Epic Thrift Store in Phoenix back in 2011. The original stores were focused on the Phoenix and Las Vegas markets with some of the stores generally much smaller than the target store size of close to 30,000 square feet now.
The stock is a product of a reverse merger that is generally a turn off in the stock market. Last year, Epic Stores utilized a reverse split to reduce the share count and increase the stock price above $1. At the same time, the company completed a merger with Epic Stores Corp. and changed the name from Be At TV Inc. The new entity is now moving forward on an growth plan.
The company has an interesting business model that relies on consumer donations that the company recycles or turns into inventory for the stores. Epic takes these donations and turns 95% of the items into something reusable with 50% used as product to stock stores.
Source: Epic Stores presentation
Surprisingly Intriguing Industry
Currently, the textile goods sector in America only recycles roughly 15% of the goods produced. The sector has huge expansion opportunities as the average individual is still more likely to throw away a clothing item than attempt to recycle it even with existing Goodwill donation locations.
According to the National Association of Retail Thrift Stores, the resale industry has shown some of the fastest growth in the retail industry. For the last two years, revenues have grown at a 5% clip that outpaced the general retail sector. In addition, the data shows a shift in consumer spending from department stores that are generally in decline.
Part of the growth seen in the resale industry is a general increase in the quality and volumes of the donated inventory. Take that along with the process of Epic Stores that promises to take in donations and recycle the unused products makes for a winning combination.
At this point, the company history is more impressive than the stock history. The sector though provides a more promising future.
Epic Stores continues to grow at a rapid pace. The company has grown to 10 stores, with a goal of adding another six to eight stores during 2016 along with the relocation of two smaller stores.
The retailer operates stores in four states that include Arizona, Colorado, Nevada, and Texas. The current plans include the opening of stores in Houston and San Antonio in the next couple of months that are currently under construction. Other target sites include Dallas, Tulsa, and Central Valley California. The interesting part is that Epic Stores was able to secure the Texas locations near Wal-Mart (NYSE:WMT) Supercenters in order to leverage the large traffic flows to the giant retailer.
For the last reported quarter, Epic generated roughly 21% growth for the retail revenues generated directly by sales in the stores. The wholesale business is under pressure due to the rising dollar pressuring export markets. The growth rate should pick back up after opening the new locations in the Spring and adding more stores later in the year.
Due to the size and small valuation of the stock, the opening of the new Houston and San Antonio stores in a timely fashion is crucial to an investment. Epic Stores lacks the cash cushion for any struggle in opening stores on time and in an efficient manner.
The initial concern with any small company and especially one in the discount sector is whether the financials will produce returns for shareholders. The company estimates that every store will produce up to $1 million in annual revenues.
Source: Epic Stores presentation
At this point, Epic Stores is more on pace for the $700,000 per store estimate, with revenues of $5.1 million in the first nine months of 2015. At that pace, revenues will fall slightly below $7.0 million for the full year.
With limited costs for inventory, Epic Stores only needs to sell the goods at a large enough price to cover rent and payroll. For Q3, gross margins were an incredible 70.8% that is relatively impressive in the retail sector.
The retailer still needs to scale in order to cover the administrative costs of building a large domestic operation that covers multiple states. The company had a very sizable $1.5 million loss for the quarter, spending nearly double the amount pulled into the business. Even more concerning, the loss grew along with the revenue growth over last year.
Source: Epic Stores Q3'15 report
The company recently undertook a process to improve operations by shifting towards the bigger stores and relocating two smaller Phoenix stores. The move along with some logistics changes is intended to save roughly $100,000 in operating costs per month. The quarterly savings of $300,000 will cut into the losses, but the company will need to improve operations and increase leverage in order to generate a profit in the future.
With such weak financials and large growth ambitions, Epic Stores recently borrowed $500,000 from Old Main Capital, LLC at a 10% interest rate. Without improved operations, the company will need to secure additional financings at huge costs to fund growth.
The biggest risk is that a recession reduces the willingness for investors to provide the capital needed to fund operations.
Enticing Sector Investments
For those generally not interested in the thrift sector, one only needs to review the success of Winmark Corporation (NASDAQ:WINA) to understand the possibilities. Over the last 5 years, the franchiser of the resale brands such as Plato's Closet and Play It Again Sports has produced a large 177% gain. The stock has easily outperformed the S&P 500 index over that time period.
WINA data by YCharts
One of the reasons for the big gains in Winmark are the large profits the company produces. As a side note, the stock once traded for around $2.50 in 1999 so the $1.10 stock price for Epic Stores doesn't preclude large gains in the future. Winmark even had a market cap similar to the $40 million of Epic Stores before the large rally of the last decade.
Another prime example of the return possibility in the sector was Savers buying Unique Thrift, LLC for a phenomenal $180 million back in 2011. At the time, Unique Thrift only had 18 stores providing a deal valuation of $10 million per store. Private Equity firm Leonard Green & Partners turned around and bought Savers the following year.
Even Goldman Sachs (NYSE:GS) has gotten into the thrift and resale sector with a fund raising for ThredUp that raised a whopping $81 million. According to this report, Goldman Sachs Investment Partners took the lead in a Series E investment. In total, ThredUp has raised $125 million.
The company focuses on selling like-new clothing items via an online consignment store. Consumers can send in clothing items and obtain payments for those sold while also shopping online for great clothing items at a discount.
For what it is worth, Vista Partners issued a $2.25 price target on Epic Stores. Along with the previous investment examples, the resale and thrift sector is clearly capable of generating sizable returns for investors despite selling deeply discounted goods.
Investor Takeaway Defined By Risks
The key takeaway is that Epic Stores is an intriguing investment in a sector likely to benefit if the U.S. economy goes into a recession this year. In addition, the company is in a major growth phase providing opportunity to invest in a growing company in a solid industry.
The risks are substantial, though, with the retailer reliant on securing growth capital to fund losses and expansion efforts. In addition, online consignment retailers like ThredUp could derail the growth opportunity by grabbing all the quality inventory and stealing the best customers. Not to mention, management isn't proven in the retail sector.
Due to the risks, any investment is only recommended for a small portion of a diversified portfolio with the willingness to accept a complete loss in the position. Other investors may prefer to watch the concept from the sidelines and allow for the story to develop more before making an investment. Watching from the sidelines can provide meaningful insights into the quality of the management team. The ability to open the two new stores in a timely manner along with implementing the costs reductions are two very crucial steps in Epic Stores turning into a long-term growth story.
At the end of the day, the stock provides an opportunity for an epic move either way. More data points and capital are needed to ensure the move is positive for investors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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