It's only a matter of time before the legacy Stage Stores (SSI) business comes to an end. Under nameplates like Stage, Bealls, and Peebles, Stage Stores has focused on small-town brick-and-mortar retailing. Per the 10-K, 61% of its 795 stores (at the end of fiscal 2018, which ended February 3) have less than 50,000 people within a ten-mile radius. Another 24% have fewer than 150,000 people within the same distance.
For years, that business was solid, as Stage's locations provided rural customers with name-brand merchandise they couldn't get elsewhere without traveling greater distances to the likes of JC Penney (JCP) or Sears (OTCPK:SHLDQ). But as it has for those larger rivals, e-commerce has breached Stage's moat. Comps turned negative, and profitability collapsed:
source: author from SSI filings and press releases. FY18 and FY19 net income figures adjusted for impairments by author calculations. Previous years are Stage's own non-GAAP calculations
Management long tried to blame the decline on the impact of the oil bust on the Texas-heavy chain. (Texas alone accounts for over one-fourth of stores; add in Louisiana and Oklahoma and the total gets above one-third.) But improved O&G employment has done little to improve the top-line trend. Oil patch stores, per management commentary, have returned to performance in line with rest of the chain. And yet department store same-store sales continue to fall, with a 2.9% decline on a shifted basis in fiscal 2018. It's almost impossible to believe at this point that those sales will ever come back.
Meanwhile, Stage Stores has a balance sheet problem. It closed its fiscal second quarter with a whopping $298 million in net debt. That figure will come down as the year progresses: Stage still is guiding for positive free cash flow for the full year after a ~$60 million burn in the first half. Still, full-year Adjusted EBITDA guidance of $20-$25 million suggests that Stage will exit the year levered at roughly 10x. Its credit facility (which accounts for all of its debt) will mature less than two years later, on December 16, 2021.
Between the pressure on the department store business and the crushing debt load, it would seem almost guaranteed that SSI is headed for zero as the company enters a restructuring in 2021. But the company, and the stock, have one out: its Gordmans off-price chain, purchased out of bankruptcy in 2017. Thanks to that acquisition, Stage finally is making a concerted effort to get away from its dying legacy model. The question at this point is whether that effort will prove to be too little, too late.
How Strong Are Gordmans Comps?
On its face, the strategy to acquire Gordmans and convert legacy stores to its nameplate seems to be working well. Same-store sales in off-price increased 6.4% in FY18, per the K, against a 3.2% decline in the department store business. Revenue in the Gordmans locations operated since the acquisition on April 7, 2017 rose 31% year-over-year in fiscal 2018. In the first quarter, according to the 10-Q, Gordmans sales increased another 9% year-over-year. (The second quarter 10-Q hasn't been filed yet, and sales weren't broken out to that level in either the Q2 release or on the Q2 conference call.)
That strength has helped reverse the concerning trend on Stage's top line. Shifted comps (accounting for the change from a 14-week to a 13-week quarter) increased in last year's fourth quarter. FY19 guidance is for a 1% to 3% increase - even with, by year end, Gordmans accounting for barely 20% of the overall store count.
It appears at first glance as if Gordmans sales are rising nicely - and indeed outpacing those of off-price giants like Ross Stores (ROST) or TJX Companies (TJX). But that's not quite the case. Stage keeps converted stores in the comp base - and those conversions tend to lead to a huge jump in sales.
In FY18, for instance, nine stores were converted to Gordmans locations. On average, they posted a 60%+ increase in sales, according to the 10-K. Based on the company's description of timing, those stores likely were open for about half the year, including the key holiday season - and accounted for 9 of the 67 (13.4%) locations in the year-end comp base.
Gordmans' reported comps, then, likely got a four-point-plus boost from conversions last year (.134*0.5*.60 gets right to four points). The stores owned from the date of the acquisition did see a 31% increase in fiscal 2018, as noted above - but over 23% more days, with likely some help simply from comparing against the initial post-acquisition period.
Meanwhile, Stage actually cut full-year comp guidance for FY19 after the second quarter, moving to 1-3% against a prior 3-5%. That follows a negative consolidated print for the first half (-3.1% Q1, +1.8% Q2). Even the cut guidance does seem to suggest more strength at Gordmans, with positive same-store sales in that concept offsetting expected declines in department stores.
But here, too, the results aren't quite what they appear. After Q4, management guided for roughly 500 basis points in full-year comp lift from the conversions and from higher home category sales in department stores. The figure in Q1 was higher than that - and yet comps still fell 3.1%. The 1.8% increase in the second quarter was driven by ~150 bps of benefit from conversions, and presumably more is on the way as conversions accelerate in the second half.
The key question is what Gordmans same-store sales look like for stores that actually were under that nameplate the year before. It seems likely that they're positive - but they are not in line with the reported 6%+ last year, and won't be nearly as high as the mid-single-digit increase I'd expect Stage will report this year. This is a hugely important point that means that the story isn't quite as intriguing as it appears at first look.
Can Gordmans Save Stage?
That said, comps even excluding the benefit of conversions do appear to be positive. And, finally, Stage is making a concerted effort to get away from the department store business. I wrote last year that SSI was uninvestable under its CEO Michael Glazer, but Glazer finally seems to have seen the light when it comes to the legacy stores.
Stage announced in July that it would convert an additional 250 stores (100 higher than previously planned) in 2020 on top of a planned 89 in 2019. And the company finally is closing stores as well. The July announcement also noted that closures would increase to 55-60 from a previously guided 40-60, up from 41 in FY18 and 21 the year before.
Stage's only chance is to become Gordmans. That doesn't necessarily mean faster conversions will work - but they at least increase the odds of avoiding a 2021 restructuring. And it is helpful to the bull case that Glazer finally seems to understand that fact, even if he is about five years too late. (As I noted last year, Stage's total operating lease commitments stunningly increased between the ends of fiscal 2014 and fiscal 2017, a period during which time pretty much everyone else in the U.S. realized that brick-and-mortar retail was in serious trouble.)
Under the new plan, a majority of Stage revenue will come from Gordmans as soon as next year:
source: Stage Stores Q2 earnings slides
Stage hasn't detailed exactly what it expects Gordmans sales to be in FY20, but the figure probably is in the $850 million range, assuming sales next year dip to ~$1.4 billion (-~10% year-over-year, as department store closures and comp declines continue).
Stage, at the moment, has an enterprise value right at $320 million - and thus a forward EV/revenue multiple of 0.4x or so based on Gordmans alone. TJX is at 1.7x. Burlington Stores (BURL) is above 2x, while ROST and Ollie's Bargain Outlet (OLLI), even after the latter's post-earnings plunge, are near 3x.
Those multiples elsewhere in the off-price space matter for two reasons. First, they show the discount at which Stage/Gordmans is trading relative to ostensible peers. An investor could argue that if Stage were to get half the EV/S multiple of even TJX, with (wisely) zero value accorded to the department store business, the stock could get to ~$14. (Yes, $14 - about 1,600% upside.)
Second, those multiples show that investors still highly value the off-price space. Specialty retailers, particularly in apparel, are lucky to get 0.5x revenue valuations. And that optimism toward Gordmans' category is a big deal for a company facing a dicey refinancing for which negotiations likely begin ~16 months from now (presumably after the 2020 holiday season).
No lender is going to refinance debt backed by 15,000-square foot department stores. But an off-price retailer might be different. And Stage has another potential advantage: recovery value on Stage's debt in a liquidation probably isn't close to 100%.
The Stage concept almost certainly doesn't get a buyer: the consolidated business generated less than $1 million in Adjusted EBITDA last year. Four-wall cash flow likely is positive for most department stores, but annual comp declines will end that soon enough. Total assets are $800 million excluding operating leases. $700 million of that is inventory ($500 million) and property and equipment. P&E has little value, as it is almost entirely fixtures and leasehold improvements (land and buildings totaled $13 million at the end of fiscal 2018). Inventory is going to be sold at a huge discount.
Lenders presumably could sell Gordmans and liquidate the department store assets to get back some of what they've lent, but they almost certainly wouldn't get their money back in that scenario. As such, they might be incentivized to kick the proverbial can down the road and take a shot on Gordmans, refinancing on a secured basis.
SSI Looks Like a Lottery Ticket
To be sure, refinancing still looks questionable. The legacy business still is going to have 300 stores heading in the wrong direction. The cost of conversions is going down to $125,000, with potential for as little as $40,000 in spend per recent commentary. But the capex required probably still offsets some of the near-term free cash flow benefits of inventory liquidation through both closures and conversions (as the off-price model requires much less inventory).
Meanwhile, operating lease commitments are substantial. Stage closed FY18 with $483 million on the books - $190 million of which is spend required in FY22 and beyond. (That's a unfortunate legacy of Glazer's continued belief that comp improvement was just around the corner.) It might seem conservative to value the legacy business at zero - but in fact, its valuation likely is negative if Stage continues as a going concern, as Gordmans profits (if and when they arrive) will have to fund either four-wall losses and/or lease termination fees.
There's also the question of just how valuable, and even viable, Gordmans is. Again, Stage bought the concept out of bankruptcy - for just $36 million. It had 102 stores as of fiscal 2016; Stage is aiming for 400 next year. And that count isn't necessarily rising because management sees this grand opportunity. It's rising because Stage's legacy business is so poor, and has so many operating lease commitments, that relatively low-cost conversions are preferable to the status quo.
In other words, we have little evidence right now that the new Gordmans markets are necessarily good markets. Changing concepts might make sense, but the difficulty in small-town brick-and-mortar still holds. Meanwhile, Ollie's seems to be moving onto Stage's turf. That company is constructing a new distribution center in Dallas, entering Oklahoma, and has obvious room for expansion into the Midwest, where Gordmans growth seems likely to be concentrated based on recent commentary.
There are real questions here. From a near-term standpoint, the question is if Stage will be able to refinance its borrowings ahead of a maturity that sits 27 months out. The longer-term question (though it obviously bears on the first question) is whether Gordmans materially changes the outlook here.
Same-store sales in truly comparable stores don't seem to be all that impressive. Initial bursts - such as the 60%+ increase cited in the nine conversions last year - may well come from curiosity, rather than suggesting a notable and permanent change in sales trajectory. Gordmans still is going to have to sell in what seem like substandard locations, and Stage still is going to have managers that literally were years behind in understanding that problem in the legacy business. We don't know what current or go-forward margins are in the concept, and Stage already has struggled with much higher distribution costs in recent quarters which have pressured gross margins (though SG&A levels are lower and have offset some of that pressure).
The easy back-of-the-envelope case here is that Gordmans at even 0.2x sales keeps Stage viable, allows it to refinance its debt, and suggests SSI can soar. A return to fiscal 2012 EBITDA of ~$50 million does the same. That case is possible - but it isn't easy. Gordmans now is going headlong - again, 340 openings in two years - into what are likely Stage's weakest markets (or else the stores wouldn't be converted). That is a breathtaking pace of expansion that probably leads to at least some operational disruption. And it's a pace that is coming because it's basically a Hail Mary from Stage: it needs to prove Gordmans' viability within the next 18 months, or else the company is going into a restructuring.
Where that leaves the equity is as a binary play. The market cap here is $22 million. If Stage manages to get through 2021, and can post sustainable positive margins on Gordmans revenue, it doesn't take much for enormous upside. Again, 0.4x revenue gets the stock to the mid-teens, and $10+ even marking down the valuation for Stage losses/exit costs. Even 4% EBITDA margins at Gordmans and an 8x multiple, with some modest debt reduction along the way, suggests at least a double from the current price of $0.78.
That upside potential makes SSI an admittedly intriguing lottery ticket. Personally, I see enough risk in current Gordmans comps and have far too little faith in management to play. The conversions planned for FY19-20 are a monumental undertaking from a company that has shown no reason for confidence it can pull it off. But, if it somehow does, SSI could be one of the best stories in the market.
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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