Michaels: Have Low Expectations

Jan. 24, 2020 11:53 PM ETThe Michaels Companies, Inc. (MIK)18 Comments
Jason Tillberg profile picture
Jason Tillberg
1.5K Followers

Summary

  • Michaels' enterprise value blows out the narrative that it is a cheap stock.
  • The company failed to deliver better results during a period of very strong consumer environment.
  • The balance sheet should be the biggest concern for equity holders.

When I was in high school, I had a part-time job at a nursery and craft store called Frank's Nursery and Crafts. This store was a hybrid craft store that also sold plants, shrubs, trees, and had a greenhouse. This was in the mid-1990s back in Long Island. In 2001, Frank's filed for bankruptcy protection, and in 2004, went out of business. It had 170 stores.

A few years ago, a craft store near me called A.C. Moore closed down. A.C. Moore is now defunct and will be closing all its stores soon. In November of 2019, it was announced that Michaels (NASDAQ:MIK) would acquire 40 of Moore's stores and rename them to Michaels, as well as a distribution center on the East Coast of the U.S.

The craft business is very tough and, in my lifetime, has a history of bad endings.

Today, our brick-and-mortar store options for crafts are quite limited to mainly Walmart (WMT), Jo-Ann Stores, Hobby Lobby and Michaels. Online, it's Amazon (AMZN) and Etsy (ETSY) that would make for good shopping destinations for crafts and such.

Michaels' History

Michaels was founded in 1973. In 2006, it was taken private by two private equity firms, Bain Capital and Blackstone Group, for $6 billion. Then in 2014, it went public again with a $500 million stock issue. Today, it operates over 1,250 stores in 49 states.

Here is a chart of Michaels' share price since its IPO in 2014. It's down nearly two-thirds.

Understanding Enterprise Value

Investors in Michaels shares need to understand enterprise value. Enterprise value is generally the cost of the business or enterprise itself. This includes debt, but does not include cash.

You get the enterprise value by taking the market capitalization of the company, which you get by multiplying the shares outstanding by the share price and add the total debt and other minority interests or preferred shares. Lastly, you subtract the cash on hand.

What you end up with is really what you are paying for the business or the enterprise itself.

Michaels has always had a substantial amount of debt on its balance sheet.

ChartData by YCharts

In the most recent quarter, Michaels sits on nearly $5.5 billion in total liabilities, of which $2.675 billion is long-term debt.

The total assets of Michaels look like this:

ChartData by YCharts

The company has nearly $3.85 billion in total assets. This is a $1.65 billion hole relative to liabilities. In other words, if Michaels were to close up and liquidate all its assets, not only would there be nothing left for shareholders, but even the debt holders would also see a massive haircut. $1.65 billion is 30% of the total liabilities of $5.47 billion.

Michaels' only hope of digging itself out of this hole is through operating cash flows as an ongoing business enterprise.

So here is a chart of the enterprise value and market cap of the company over the past five years.

ChartData by YCharts

When you buy shares of Michaels, it may seem like you are buying shares of a company with a market cap of $917 million. What you are really paying is $3.47 billion for the company because you are inheriting the debt with the purchase.

The math is simple here. If the market were to value Michaels at $2.55 billion, then the value of the market cap would be $0. Shares could be $0 and the company would still be worth in the market at $2.55 billion.

There is a lot of leverage here for shareholders. If the enterprise value were to rise from its current $3.47 billion to $4.47 billion, which is a 29% rise, shareholders would see their shares go from being worth $917 million to $1.917 billion or more than doubling.

Inversely, if the enterprise value were to fall 29% or $1 billion, then shareholders could be looking at no equity value at all.

So it's quite important to consider the enterprise value for Michaels when owning shares in the common stock.

Strong Consumer Retail Environment

I tend to write more about inflation and productivity. What I've been noticing is how good the consumer has had it over the past few years as wages have risen faster than the rate of inflation, giving consumers greater purchasing power. Particularly, low commodity prices and a strong dollar have led to such strong gains in purchasing power.

This state of the strong consumer environment can be seen in this chart showing consumer confidence:

Source: Dshort.com

The closest retail sector for looking at industry sales is the sector that includes sporting goods, hobby, music and book stores.

Pretty much even since the last recession, sales in this sector have been flat to down. A big reason for this is a shift to online shopping in these stores. Having a store website is critical, but it still has to compete with the likes of Amazon.

Michaels has experienced a sales slowdown here as well. It has also experienced lower margins, even in this heightened state of a strong consumer environment.

Revenue for the third quarter ending in October of 2019 came in at $1.22 billion and was down 4.09% year over year. Earnings per share came in at 40c when analysts were expecting 49c per share.

Challenging Outlook

There are a lot of risk factors for 2020 that could put the brakes on consumers being confident and for wages to continue to beat the rate of inflation.

In an environment of rising inflation that makes wage gains less likely to beat the inflation rate, discretionary spending in stores like Michaels may be compromised.

My concern is that Michaels still faced a lot of industry headwinds these past three years. Sales and margins saw little to no improvement in an environment of strong wage gains and booming consumer confidence.

Not being able to right the balance sheet and pull its book value per share out of the hole even a little gives me little confidence it can turn things around in the event of a more challenging consumer environment.

When purchasing shares of Michaels, consider the net tangible book value per share:

ChartData by YCharts

Michaels shares are speculative at this point. My bias is to have low expectations.

This article was written by

Jason Tillberg profile picture
1.5K Followers
Maker of hardwood roll top bread boxes, self taught in economics with focus on productivity and inflation.44 years old, married, have two daughters 9 and 11, and a 3 year old son. I live upstate New York near Ithaca.My profile pic is that of Joseph, from the story from the old testament, where he is telling the Pharaoh that he will have 7 years of famine and 7 years of plenty and in order to prepare, he would need to save 20% of his surplus during the years of plenty so that he would have not only grain for his nation, but grain to sell to the other nations.It tells the principle that we need to learn to live within the cycles of nature.Investing and allocating money requires that same understanding.With that said, I focus on what I believe the rate of inflation will be and how it relates to investments. I trust that understanding inflation will make for better informed investment decisions.I've been involved in stocks and investing since I was 13. Have had successes and mistakes, that I've hopefully learned from. I'm a fan of the following people to help give a perspective of my biases I may hold with regards to investment and economics: Adam Smith, Milton Friedman, Charles Schwab (Steel Tycoon), Peter Bernstein (Author), Henry Ford, Jay Gould, Ben Franklin, Aristotle, to name a few..

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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