We are downgrading At Home (HOME) shares from "buy" to "neutral" after a 30% rally since our initiation last month and a 40% rally from our reiteration of our "buy" rating last week. If we include the loss from the put options we recommended buying when we correctly predicted that the company will lower guidance, the net-return would be 30% ($3 per share return from long position and $1.25 loss from Feb 2020 $5 put options that were priced at $2 and now can be sold to $0.75, at the time we recommended our protective put strategy the stock was trading at $6 per share).
Given that our PT of $9 a share has been reached and the lack of positive near-term catalyst, we believe that standing on the sidelines after a 90% run over a one-month period makes most sense to us.
Also, we have not seen fundamental improvement either on the store performance side or the execution side. It's worth reminding readers that our "buy" thesis was purely based on unit growth deceleration. The following is from our initiation report.
Our $9/share price target assumes that management shifts focus to its existing store base and supply chain efficiencies rather than opening more than 30 stores a year. The only reason we are long this stock is that management does not need to make any significant effort for the stock price to reach our price target. We believe that board interference to stall store expansion rate is the only needed action for this investment to be profitable at current levels while addressing inventory turnover, BOPIS initiative, and accountability are a plus.
To date, nothing has fundamentally changed that would push us to increase our PT.
Why the stock is up 34% since beginning of September
Beside the fact that the company significantly reduced the bankruptcy risk with its new unit growth rate target of 10% vs high teens previously, the series of insider purchases, significant increase in a hedge-fund purchases, and executive marketing initiatives were fruitful.
Over the last month, CAS Investment Partners, a boutique NY-based hedge fund, has been building a stake in HOME. The hedge fund now owns 12% of HOME at an average cost per share of $6.22, FactSet data shows.
Prior to the latest earnings release on Sep 4th, CAS owned 6.6 million shares it acquired at around $5-$6 a share . The company bought 1.8 million shares on the 5th and 6th of September, filling data shows.
At the same time, HOME's CEO Bird Lewis bought 64K shares, the CFO bought 10K shares, the Chief Development Officer bought 4K shares, and other directors/officers bought 27K shares.
Not to forget Bird's multiple appearances; Goldman Sachs Retail conference, Yahoo Finance interview, and Jim Cramer's Mad Money (couldn't find the link for the Yahoo Finance interview, but I swear I did watch it).
Why we are downgrading to "neutral"
We believe that the story has not meaningfully changed for the stock price to go north from current levels. HOME enjoyed a perfect (reverse) storm over the last month (stock up 90%) with US-China trade war showing signs of cooling down, CAS purchases, insider purchases, and a not "so bad" earnings call.
However, we believe that none of the positive catalysts are of long-term nature. The US-China trade war is the least of our concerns given that the problems that led to the stock price massive sell-off are mostly idiosyncratic (company do not expect List 3-4 tariffs to affect this year's numbers given that it already bought its inventory which it turns twice a year only), and that valuation is not attractive as it used to be when the stock was trading at the $5-$6 level for the stock to attract further buy-side purchases.
To clarify further on our last point, our model shows that the only way to see significant upside from current levels is for the company to improve comps or margins which was not the case when the stock was trading at $6 a share (remember, as we stated in our initiation, unit growth expansion was the only needed catalyst for the stock price to appreciate).
This means, until we see some improvement in execution, we prefer waiting on the sidelines. Those who are buying at current levels are simply betting that next year fundamentals would improve (remember, traffic was down 4%-5% in the first two fiscal quarters and management acknowledged that pricing environment is "super promotional") and that weather would not be a headwind going forward.
Closing thoughts and blue-sky scenario
We do see HOME shares reaching $15 mark in case the company surprised on its margin/comps. While we believe that a margin surprise is less likely given the highly promotional environment and already low in-store expenses, as seen in our chart below (which are barely surpassing the 4% annual wage inflation in the sector), it is still possible to surprise at the comp level given that the company guided for only a "-1.5% to +0.5%" for the whole year (comps averaged 4.3% for last three fiscal year). Also remember, Home Depot (HD), and Lowe's (LOW) reported solid growth last quarter which may translate to overall macro improvement for names exposed to housing.
Management has been successful in marketing its new strategy of slower growth, leverage reduction, and capex control. However, for us, it's absurd that management was aiming for a 20% store growth all fueled by leverage in a promotional environment which raises question marks around management's ability to turn the ship.
While things have improved over the last few weeks, we remain skeptical around seeing upside from current levels given that nothing has fundamentally changed that would push us to raise our PT.
Lastly, the fact that management has been purchasing shares removes the near-term possibility of any acquisition for HOME, which pushes are more towards the sidelines.
P.S: Momentum can continue over the very short-term as sentiment has turned extremely positive over the last few weeks.
Disclosure: I am/we are long HOME. 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.
Additional disclosure: I personally sold 75% of my HOME shares.