hhgregg (NYSE:HGG) is a national retailer that engages in the sale of appliances, furniture, and consumer electronics. The company's stock price currently trades at very distressed bankruptcy level pricing, which doesn't provide investors with much confidence to purchase the stock. However, there is a silver lining to the cloud that has hung over the company for the past few years since it began losing money for several consecutive quarters.
Investors that are willing to be patient with hhgregg could see tremendous gains from current levels moving forward. In a recent Bloomberg article, the company announced their intention to seek "strategic transactions" to improve their liquidity and shareholder value. With a meager $13 million market cap at present, I believe there is substantial upside in the share price in 2017/18, and the likelihood of a takeover is even greater.
hhgregg's stock price traded at $10.55 in March 2014 and a long string of consecutive quarter losses, coupled with a lack of investor confidence, has sent shares sinking to its current levels around 47 cents per share. The company has cited competitive pressures in the electronics division of their company and several impact charges over the past several quarters as the main drivers of their struggles. In the most recent quarter, the company's 10-Q filing demonstrates its past struggles.
The most recent reported loss of $2.10 per basic and diluted share is alarming, and would scare any investor away initially thinking the company is headed for bankruptcy. However, there is a silver lining here, where I believe the company has learned from its past mistakes, and is now beginning to restructure existing stores and reducing costs significantly to regain profitability.
Recently, the company took a $20-$25 million revenue hit due to moving a distribution center to Kentucky, which disrupted stock flow to their stores. In their most recent conference call, the CEO and CFO both acknowledged this as a one-time event, and that the distribution issue was resolved. This loss of revenue impacted earnings by almost $1.00 per share, and the impact made their most recent quarter look worse than it actually was.
Company executives have also been very positive regarding their recent store restructuring efforts for their "Fine Lines" furniture model. In recent weeks, the CEO has commented on the increase in sales they expect to see in the coming months, as the company moves away from the competitive electronic device and TV, and focuses on the strengths of their business in the appliance and furniture areas.
I believe there is great opportunity for the company to capitalize on this move to concentrate on appliance and furniture sales, and greater opportunity for other reasons, which I will touch on later in this article.
THE 2017 TURNAROUND STORY
hhgregg has consistently posted annual revenues between $1.6-1.8 Billion even amongst the struggles of the past few years, which is not indicative of a company on the brink of failure. While annual revenues have fallen over 20% in the last year alone, much of this decline can be attributed to their lack of competitive advertising in the electronics arena.
I believe hhgregg has recognized its mistakes, and is working to move the company in a better direction. While the company will still sell electronics and TVs, it just won't be their main advertising focus. At any rate, the fact remains that people do shop at hhgregg, and they can increase sales with the right mix of products.
In a nutshell, the cost of goods, selling and general expenses, and advertising costs have been the main factors affecting the negative earnings results the company has experienced the past few years. In fact, the company went from having over $35 million cash on hand and no debt, to having just under $2 million in cash on hand, and borrowing $30 million of its $100 million credit facility this past year alone.
While this does seem precarious, the company has the ability to control these costs, and they have begun to make good progress in reducing costs. On February 3, 2017, the company announced it would lay off 100 employees in an effort to save an additional $15 million in expenses while restructuring their workforce. While any decision to lay off employees is difficult to make, this was a needed move by the company to being able to return to profitability.
The next step the company needs to make is to reduce its advertising spend, and find better ways to reach consumers through internet media platforms, which cost much less than traditional TV commercial time slots. The company has reduced its total advertising spend significantly over the past year, which is evident in their recent 10-Q filing, but I believe there is more room to cut costs here, and I believe the company will see this as well, and make the move to continue to reduce costs in advertising.
Finally, the company must try to get better buying power and reduce their cost of goods sold (COGS). In my opinion, the company simply has not done enough to address this area. In fact, if we look at the savings that have already been identified above in advertising and the work force reduction recently announced, the company could easily establish break-even or better earnings, with a 20% reduction in COGS alone. In all likelihood, a big portion of this reduction in COGS could come from the electronics division, as they move away from focus in this area. Upcoming quarterly reports will clearly tell us if this is happening or not.
If the company can address these areas noted above, and they have already addressed several of them, hhgregg can return to profitability fairly quickly this year and the stock price would have significant room to move higher from the current paltry levels it trades. At that point, hhgregg would become one of the top turnaround stories
TOP TAKEOVER TARGET OF 2017
As noted previously, the current market cap of the company is just over $13 million. In a worst-case scenario (bankruptcy, which I believe is nowhere near relevant), the assets of the company are worth between 5 to 10 times the current market cap, and the company has very little debt that they just recently accessed this past year. At these distressed market prices, I believe there are multiple suitors which could easily absorb hhgregg very cheap, and implement their new store restructuring plan into their business.
Even at a 5x premium buyout offer to current stock price, any company could buy out hhgregg for less than $150 million, which is simply ridiculous, but very lucrative for the right buyer. Who wouldn't buy a company with $1.6-$1.8 Billion in annual sales for $150 million, if they have the better buying power and management plan to immediately return the hhgregg stores into immediate accretive earnings power? Some potential suitors that I could see targeting a takeover of hhgregg are: Sears (NASDAQ:SHLD), Costco (NASDAQ:COST), Home Depot (NYSE:HD), Lowe's (NYSE:LOW), Best Buy (NYSE:BBY)... and the list goes on.
Any one of these possible suitors could land a potential home run with a takeover of hhgregg right now. With only 27.8 million fully diluted shares outstanding, a $150 million takeover would price shares at $5.39 per share. It is easy to understand why hhgregg is a strong buy at current trading levels. Alternatively, a $75 million takeover would price shares at roughly $2.70 per share. Both scenarios show how extremely undervalued hhgregg shares are at present.
With the recent hiring of Stifel Financial to explore strategic financial transactions, and the hiring of Morgan Lewis & Bockius LLP as legal advisers, I strongly believe the potential for a buyout of hhgregg is very real and could be forthcoming this year.
Nevertheless, even if a buyout of the company never transpired, the hiring of these individuals should let investors know that the company is serious about turning itself around this year and creating better value for investors.
Disclosure: I am/we are long HGG.
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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