There is no question that Pep Boy's (PBY) second quarter earnings were a disappointment, but a 25% meltdown in the share price was certainly unwarranted. Analysts were expecting PBY to deliver earnings of .07 on revenues of $515 million, but Manny, Moe, and Jack reported revenues of $500 million and earnings of 11 cents. Although revenues were $15 million on the light side, earnings were 57% better than expectations. (Even if you extract a one time tax benefit of $2.2 million, the company still generated earnings of 7 cents, matching expectations.) I have always believed that the bottom line is much more relevant than the top line, so I was cautiously pleased. Management blamed the overall soft economy for the revenue short fall on consumers deferring maintenance and driving less miles. The company is planning a new advertising campaign to combat this problem that has the tag line: "Pep Boys, everything automotive, for less".
Second quarter results analyzed: It's inspiring that PBY was still able to be profitable despite a $50 million loss of revenues. Even though gross margin as a percentage of sales dropped 80 basis points from 26.9% to 26.1%, the company was able to remain profitable from strict implementations of cost controls. PBY's SG&A costs decreased almost 7% from $131,500,000 to $122,600,000, while its interest expense was trimmed 50% from $12.3 million to $6.4 million. The company also benefited by having fewer shares outstanding due to its ongoing stock repurchase program (52.2 million shares versus 53.2 million). The retailer's free cash flow for the second quarter of $46 million was substantially more than it needed to fund capital expenditures, stock repurchases and its quarterly cash dividend.
The liquidation of non core merchandise: Management indicated on its conference call that its non core merchandise had fallen to $1.2 million and would be transferred to its distribution centers for final liquidation. The elimination of this closeout merchandise should have a positive impact on future margins.
Analyst take: The analyst at Kevin Dann Partners recorded in a research note, "overall results were not that bad, but a 7.5% drop in same store sales was disappointing." If the results were not that bad, it's perplexing why the analyst then went ahead and downgraded the shares from a buy rating to a neutral rating.
Improved financial condition: If you compare second quarter 2008 to 2007, you will discover a vast improvement to the company's overall liquidity. PBY's cash position more than doubled from $26 million to $52 million, while its long term debt shrank 40% from $549 million to $336 million. The company has a $230 million open line of credit that is unutilized. PBY still owns the real estate and buildings on over 50% of its locations with an estimated market value near the $1 billion mark.
The bottom line: The stock is extremely oversold and represents compelling value. It's selling near book value and its price to sales ratio of .23 is the lowest in the retail auto parts sector. Its 3.1% dividend yield provides some nice cash flow while you wait for its turnaround plan to gain more traction, or better yet, the prospect of it being acquired by a larger player. The shares offers significant upside potential at this juncture combined with minimal downside risk.