hhgregg: The End Is Near

| About: hhgregg, Inc. (HGG)
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Summary

Hhgregg could seek bankruptcy protection within a month.

A summary of lessons learnt.

Cigar butts don't always work.

Investment Thesis

I had been so bullish on hhgregg (NYSE:HGG) and had been recommending to investors along the way in this recent article and this older article, I now perform the post-mortem analysis on my faulty recommendation.

Business Overview

hhgregg is a retailer which sells appliances, consumer electronics, home products and computers and tablets in about ~220 brick-and-mortar stores and hhgregg.com.

News last night leaked that hhgregg could be seeking bankruptcy protection. This is obviously very painful for all shareholders and stakeholders of hhgregg.

Were there any objective and unemotional telltale signs that should have kept investors away? Not just the share price falling, but serious fundamental issues that could have offered a glimpse into this disastrous outcome.

Current ratio

The current ratio measure the company's ability to cover its short term obligations (current assets/current liabilities). I had seen that this ratio was coming down very aggressively over the last five years. Back in 2011 it was at 2x, and in the most recent quarter it was at 1.1x. Should the current ratio alone have preventing me from investing? It had definitely been a very strong yellow flag in my radar before investing. Although, Dell, McDonald's Corp. (NYSE:MCD), Wal-Mart (NYSE:WMT) and Amazon.com (NASDAQ:AMZN) also have current ratios that are less than one.

Quick ratio

The quick ratio is a more conservative measure for retailers as it excludes inventory and is focused solely on the most liquid current assets. Having seen that it had declined from roughly 0.61x in 2011 to 0.2x in the latest quarter - maybe that should have sent alarm bells ringing? On the other hand, Wal-Mart had a very stable quick ratio of roughly 0.20x-0.24x and had seen its quick ratio decline 0.16x in 2008. Did that mean Wal-Mart was likely to file for bankruptcy in 2008? Not likely.

Debt

hhgregg had managed to keep debt free until this very last quarter. This had been part of the appeal to buying this stock in the first place. Maybe this was, in the end, the straw the broke the camel's back?

The new CEO, Mr. Riesbeck, had been the old CFO, so management had already had a shakeup. Mr. Riesbeck had drawn on the business' credit line with an interest rate set at 5.5%, which was not prohibitively expensive. The company still had $94.1m available under its borrowing facility, surely it could have tried to make it work? Everyone knows that retail is going through a downturn, it could have tried for better times?

Negative 22.2% Same store sales

Was the negative 22.2% same store sales that killed the company?

Source: 2016 Q3, 10-q; author's calculation

The shareholders had been made aware that consumer electronics were causing a huge drag on performance, that was expected. Management had pinned the company's hopes on its appliances segment as part of its Fine Line departments.

However, it wasn't just the company's appliances segment that had underperformed, as the table above shows, all segments had performed dismally over the three months leading up to Christmas 2016.

Cigar butt investing

In my first article on hhgregg, I inserted a quote from Buffett on cigar butt investing,

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible.

I had been very aware of problems at hhgregg, but I believed that hhgregg could stabilize operations enough through its new focus on its Fine Lines departments and that "the hiccup" in its operations would allow me to offload at a small profit, but I was very wrong here.

Conclusion

It does not give me a lot of satisfaction to say this, but if things didn't go sour from time to time, I would not be able to outperform the market over time by sticking with value investing.

This has been a very expensive lesson to learn. Obviously, the whole point of investing is not to lose capital. Regardless of pride or any other emotion, any time any investor makes a bad investment decision he or she is left searching for answers.

Assuming that the stocks are equal weighted in the portfolio the investor needs to return 100% on a different stock just to be back to break-even. This is without accounting for the loss of time element.

One of all-time favorite investors is Mohnish Pabrai. Mohnish, who, if memory serves me correctly has twice invested in stocks that end up being bankrupt. The more recent one had been Horsehead Holding Corp. and the other one had been Delta Financial Corp. After most generously sharing those investment stories with us, Mohnish has strongly advocated that investors should use a personalized checklist, in an attempt to prevent a repetition of the same mistakes.

It's not supposed to be easy. Anyone who finds it easy is stupid.

- Munger

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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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