Orchard Supply Hardware (OSH) is very cheap on most metrics relative to larger peers. Though the company is an unseasoned spin-off with some uncertainty ahead of it, and significant leverage, it could perform well as same store sales growth continues. Those with risk tolerance and believe in the sector may consider re-allocating some exposure from the larger players to Orchard Supply.
However, after a spin-off earlier in the year, there is another player in the space at a potentially more attractive valuation. It is tiny in relative terms, only about 1% the size of its larger competitors and operates in California rather than nationally. In addition, it is dealing with increased costs as a result of the spin-off from Sears (SHLD). It also has same store sales growth that is relatively low at 0.9% as of last quarter but that was a significant improvement from -3.1% in Q1. Nonetheless, on a valuation basis the company appears attractive, appearing as a good value on price to sales, price to free cash flow and price to book. On EV/EBITDA is it less compelling as Lowe's appears cheaper:
Key Metrics - cheap on cash flow
|Orchard Supply Hardware||Lowes||Home Depot|
|Price/Free Cash Flow||5.3x||12.8x||16.0x|
|Sales Store Sales Growth (mrq)||+0.9%||+2.1%||+2.6%|
Source: author's analysis, Yahoo finance, company disclosures (created 8/19/12)
Forecasting 2012 Earnings For Orchard Supply Hardware - Better But Still Not Pretty
It is relatively early to forecast Orchard Supply Hardware's 2012 earnings. 2011 was a loss of $14M, and Q1 results showed a slightly higher loss than 2011. However, with plans to open three new stores in 2012 and management's commitment to achieving same store sales growth and 53 weeks in their 2012 reporting year earnings may turn less negative in 2012, this may position the company for positive earnings in 2013.
|2011 Net Income||-$15M|
|Elimination of 2011 Loss on Property Sale (tax adjusted)||+$13M|
|Contribution from 1% Same Store Sales Growth||+$2M|
|Contribution From New Stores (3 new stores for half the year)||+$3M|
|Contribution from extra week of the year (53 vs. 52)||+$3M|
|Incremental costs from operating as standalone entity||-$10M|
|Forecast 2012 New Income||-$4M|
Note: figures are author's estimates only and don't sum due to rounding
Events to monitor - same store sales critical
- Same store sales, Q1, was the only negative quarter in the past four, but for the investment case to play out Q3 and Q4 should ideally exceed 2%.
- Cash flow - Orchard Supply Hardware was cash generative last fiscal and in Q1 and this should continue for the remainder of the year, without this the company will be unable to pay down debt.
- New store openings - Fresno and Torrence opened in April and September of 2012 respectively, and one more opening is expected before February.
- Contribution from new formats - management is converting its fleet of stores to a new format, and it is important to see that these new format stores are contributing ahead of the older format.
Orchard Supply Hardware is much smaller that Lowe's and Home Depot and 2012 is an uncertain year, but given good cash flow and assuming strong execution from management the stock could show strong upside and potentially become a bolt-on acquisition candidate.
I wrote about Orchard Supply Hardware earlier in the year here, since then the price has fallen to relatively attractive levels.
- Very small company operating only in one state - more exposed to singular bad events because of its size.
- Leverage - debt is a significant part of its capital structure and falling sales would eventually wipe out the equity.
- Negative earnings - earnings were negative in 2011 and will likely still be negative in 2012, this is a mature business and should be making profits as it is not in an investment phase.