Pier 1 Imports Update

Pier 1 Imports reported earnings last week and guided to lower margins and EPS. I ignored the fact that the execs had been had been wildly incapable of meeting their own guidance in the past, because the coming quarter would have been the easiest comps to beat, excluding the financial crisis, in about 20 years.  I was hoping this was going to be a ‘quick pop and move on,’ but that’s clearly not the case, mgmt has guided even lower. While I still do believe the company has a strong balance sheet (It took cash in this past quarter from more inventory deleveraging), and that the company is certainly worth more than today’s current price, this isn’t one that I want to hold through a recession.

I had placed a stop-loss order on Pier at $4.90 good until the end of the month (Jun 30th) – I didn’t want to hold this if it closed below $5 for Q2, and my reasoning on this is simple: Some Mutual/Pension/Sovereign/Hedge Funds have mandates to avoid ‘penny stocks’. Penny stocks, by the SEC’s definition, are stocks that trade under $5. This means that once a stock falls below $5, Institutional Investors that are mandated to avoid ‘Penny Stocks’ will dump this with absolutely no regard to its value. This is the same phenomenon that occurs during spinoffs and some other special situations. Over 90% of PIR float is owned by institutions, so even if a small percentage of them have that mandate, it’s just enough to drive the stock lower for absolutely no reason. The stock closed above $5 on Thursday, the 30th, and I didn’t realize that my stop-loss order executed on Friday when the stock had already rallied, so I decided not to repurchase it.

The short-sale restriction placed on Pier on Thursday I believe aided the rally, I frankly don’t see how it can last without any fundamental drivers, so I’m retiring this one. I’ll take another look during a market downturn.

Pier 1 Pre-Earnings $PIR

Pier 1 Imports reports earnings tomorrow (or later today). I’m keeping an eye on the inventories – If they go out of line with sales I’m selling the stock at any price. If management is able to hold it in line with sales, then I’ll hold on to the stock (or maybe buy more if it falls). Inventories are especially important, because it signals that the industry will only get more chaotic before things turn around. I’ll happily buy the stock again at a lower price at a later date if this is the case.

Pier 1 Imports $PIR

PIR’s competitor, RH Holdings, reported earnings and gave lower than expected guidance. The stock got beaten down along with PIR. At this point, I don’t think the market expects much from PIR’s ER. I don’t think there’s much downside in the event of a miss since it seems that investors are already pricing that in (could be very wrong though). I believe PIR is in much better shape than RH from both a valuation and a balance sheet health perspective. It’s now a waiting game until June 29th.

Update

Hi Guys,

I’ve been a bit sick and also really busy lately, so I haven’t posted anything in about 3 weeks. So I want to update, there will be no ‘Official’ May Performance Report, but I’ll summarize the updates on each position on here as of today’s date (5/5/2016) – Happy Cinco De Mayo btw – Regular monthly performance reports will commence in June. The portfolio rose 0.49% vs 0.39% for the S&P 500. The portfolio is still about 50% invested, it’s difficult to find bargains in this market – most of the ‘cheap’ cyclical stocks are stuffed with overvalued inventories that still need to be written down, so I don’t want to buy something just because it looks cheap. I’ll update for the other indexes later on the homepage, but I believe it underperformed all other indexes except the S&P.

Flanagan Enterprises (BDL)

I want to start with BDL since I purchased this stock mid last month but didn’t have time to post about it. This is going to be a very brief summary of what I would have written. I purchased this at $21.2, the stock trades at about $18/sh so i’m about 15% underwater now.

In a nutshell, the company owns and operates restaurants and liquor stores in the Florida area. The company still generates mid to high single digit comparable store sale numbers and is growing at 10% and yet it trades at about 11x earnings.

The company partners up with other investors on the restaurants and the way the partnerships work is that the company pays the investors with the cash flows and collects no management fees beyond the money required for regular operations. Once the investors receive their invested money back in full, then the cash flow each restaurant generates is split in half between the company and the investors. So, the company is basically guaranteed to increase the bottom-line in the future. This won’t happen quickly, but if you were to model this out, the company should at least trade somewhere around 15-20x earnings. So I believe there’s at least 50% upside from these prices. S&P’s P/E ratio is about 24x, so the current P/E is less than 1/2 of S&P’s.

While the company carries about $10 million in debt, it also owns about $20 million of land and property in florida, so there is sufficient equity to conservatively eliminate the debt from any valuation calculations.

Please note that BDI and BDL are different. BDI is Black Diamond Group Ltd, BDL is Flanagan’s Enterprises.

Other Positions

Before doing this, I want to send my thoughts and prayers to the people of Fort McMurray. As some of you may have heard by now, there is a massive wildfire in the Canadian city of Fort McMurray. The city has been evacuated – though no casualties have been reported, people have lost their homes and belongings.

Canadian Trail

(Longs)

The Canadian stocks have basically offset each other over the past few days. Gamehost down 17% because of the Fort McMurray fire (more below) and Black Diamond up 28% today because it has excess capacity for temporary housing in the Oil Sands around that area.

Gamehost Inc.

Gamehost was my largest position just a few days ago. One of Gamehost’s Casinos – Boomtown Casino –  is located in the city of Fort McMurray. With the wildfire causing a complete evacuation of the city, the effect on earnings becomes obvious. Less activity at the Casino – if it even survives -and thus, less earnings for gamehost. I called the company two days ago to get more information before posting about this, but they were swamped with thousands of investors attempting to ask the same question I was – Is the building insured?

Per the company’s filing on Sedar yesterday:

The Company’s Boomtown Casino in Fort McMurray, Alberta is fully insured including property and business interruption coverage. All Gamehost properties and operations are fully insured by a leading multinational property and casualty insurance company. Management has initiated an insurance claim in anticipation of losses at our Boomtown Casino and is currently in discussions with the insurer regarding due process.

I had a 37% equity in the position wiped down to about 16%. I’m going to add more when I trim Black Diamond. I want this position and Black Diamond Group (See Below) to make up 25% of the portfolio. Any more positions on Canadian stocks will be hedged with futures or put options shorting the CAD to reduce currency exposure.

Black Diamond Group Ltd

BDI reported earnings yesterday and shot up 28% today – I don’t believe it was because investors liked the earnings, but because of the fire in Fort McMurray since BDI provides temporary housing. Total equity in this position is +19% and it’s now my largest position after the Gamehost decline.

The company reported:

  • 47% q/q decline in revenues and Q1 EPS of -0.06.
  • Total debt q/q down 20%

As I mentioned in the original thesis, the dividend was cut down to pay down debt and the company will still be cashflow positive even though earnings will turn negative. So that’s precisely what we’re seeing. While the company reported a loss of $2.4 million, it actually took in about $10 million of cash for the quarter. This is because of the discrepancy between the CapEx and Depreciation I mentioned in the original thesis.

The company has historically sold its used fleet for above book prices, but since the industry is depressed. Assuming a conservative 20% haircut on book value, the company will still trade below the new book value – this means we’re basically getting the company for free! The positive FCF and debt repayment should continue while we wait for the industry to recover.

The fire in Fort McMurray is providing support to the price, so as of 5/5, it makes up about 13% of my portfolio after the +28%. Once the stock surpasses book value, I’ll trim it down to 10% of the portfolio.

United States’ Trail

Pacific Health Care Organization

No new news on PFHO, but it has been fairly volatile. The illiquid nature of the stock leads to large swings in price. I’d buy more, but the bid/ask spread irks me. Price target remains the same at about $14/sh

Pier 1 Imports

Pier reported earnings and guided to higher margins as I anticipated in the original post. One mistake I made however, was ignoring the competitors. Piers inventories were so far in line that I thought their competitors would be irrelevant, but they are not. Virtually every cyclical company is stuffed with overvalued inventories that will have to be sold off. The company did guide to higher margins and is first in line for the industry recovery, so I’m holding on for now.

Trip Advisor (Short)

Reported earnings earlier this week. Revenues declined but investors are still not paying attention to the more important declining metrics – Trip’s Revenue per hotel shopper and Expedia’s Revenue per hotel night.

The company has investors convinced that their ‘successful expansion’ in China will fuel growth will 2017 while 2016 ‘will remain muted’. The same China where iPhone sales just fell (-25%) off a cliff?  They have been deceived into pricing a company with declining revenues at 45x earnings. The company will have to fight an uphill battle with growth since the price of the service is in a deflationary spiral.

CarMax (Short)

CarMax’s inventories remain elevated. One mistake I made on this one was buying short-term (1 year, January 2017) puts. I regret that and will get rid of all 2017 put options on the portfolio next time we have another volatility stint.

Recovery rates y/y fell from 54.2% to 51.2%. Inventories fell relative to sales, which is actually good. Past due accounts and LTV ratio trickled up a bit. The U.S. economy continues to slow and I believe we will likely see easy credit slow, which is bad for CarMax.

LuluLemon (Short)

Lulu reports earnings later this month. I’m going to address the company after that happens. I’m still yet to add my January 18′ put, but if the stock sees $65 again, I’ll add January 18′ put options.

Mind CTI Ltd

Reported earnings this week as well. Revenues fell 19%. This was expected. As I mentioned, the company’s sales has historically risen over the long-term but have wildly fluctuated, which is why it trades at 5x its Enterprise Value. Its 10% yearly dividend is basically a unicorn in today’s market.

 

Pier 1 Imports: Margin Expansion Enroute

Purchase Price: $6.38 (3/11/2016) Market Capitalization: $534 Million
Enterprise Value: $667 Million EV/EBITDA: 4.17
Price Target: $11.17 (75% upside) Time Frame: 6-12 months

This is one that I literally watched ascend from $4 earlier this year to the $6.36 I purchased it for. This was the stock I called a “fairly attractive long” in the February performance report. I was expecting the earnings report in April, but management got a bit excited and reported preliminary; the stock remains attractive even at $6.38.

Pier 1 Imports (NYSE:PIR) is a specialty retailer of imported home furnishings and decor. The merchandise largely consists of items that feature a significant degree of handcraftsmanship and are mostly imported directly from foreign suppliers. The company operates under two merchandise groups:

  • Decorative Accessories – Includes decorative accents and textiles, such as rugs, wall decorations and mirrors, pillows, bedding, lamps, vases, dried and artificial flowers, baskets, ceramics, dinnerware, candles, fragrance, gifts and seasonal items.
  • Furniture – Includes furniture and furniture cushions to be used in living, dining, office, kitchen and bedroom areas, sunrooms and patios.

5-Year Price YCharts

Note: The Company’s fiscal year grossly differs from the common calendar year. Fiscal Year 2016 ended in February 2016, and Fiscal year 2017 goes from March 2016 to March 2017 so the quarters ending between March 2016 and 2017 are Fiscal Year 2017.

What Happened?

Net Income peaked at $169 million in 2012 and stands at $59 million Trailing Twelve Months (TTM). On September, 19th, 2013, the company reported:

For the second quarter ended August 31, 2013, the Company reported net income of $17.8 million, or $0.17 per share, compared to $26.2 million, or $0.24 per share a year ago. Adjusted net income (non-GAAP) for the second quarter last year, as described below under Financial Disclosure Advisory, was $20.7 million, or adjusted earnings per share of $0.19. Total sales for the second quarter were $395.6 million, a 7.6% increase versus $367.6 million in the year-ago quarter. Comparable store sales increased 3.5% during the second quarter compared to last year’s comparable store sales gain of 6.7%.

This was the beginning of the fall beyond the day-to-day fluctuations. The same happened on January 9th, 2014 when the company reported even more disappointing numbers and then reduced guidance. Gross margins peaked in May 2013 quarter (Fiscal Year 2014) and have been on free fall ever since. The stock followed and is down 76% from its peak in 2013.

RISKS

Weaker U.S. Dollar

The company sources 59% and 14% of its inventory from China and India and likely settles it in U.S. Dollars. Any swift movement of the Yuan or Rupee would send gross margins falling. Given that the gross margins are already low and are likely to increase because of the more favorable inventory levels, the impact of this should be cancelled out in a worst-case scenario.

Falling/flat Comparable Sales

Comps for the first 3 Quarters of FY ’16 have hovered around the low single digits, the risk is that it might actually turn negative in the coming quarters. For fiscal year 2013, 2014, and 2015, comps were 7.5%, 2.4%, and 4.7%, and yet the stock is down 76%. This that tells us that Wall Street is more worried about the profit and gross margins than they are about comps.

WHY BUY NOW?

Inventory Deleveraging & Margin Expansion

PIR Inventory to Sales

Inventories got ahead of sales in Fiscal 2014, 2015, and so far, 2016. This led to the falling margins we have seen thus far. Gross margins fell 407 and 452 basis points to 34.8 and 37.8 for the quarters ending August and November 2015.

In the quarter ending November 2015 (Q3), however, sales fell 2.5%, but inventories fell 6%. In the preliminary earnings report for Q4/year-end, management said that inventories ended 15% lower than they were at the beginning of the fiscal year while sales were up 0.3%. This means that the Inventory/Sales ratio going forward is now approximately 21.7 – The long-term average is 21.9. The company will now be relieved of the pricing pressures they faced over the past few years, and we should see the gross/operating/profit margins revert to the mean.

What is the mean?

Dating back to 1996 and excluding the four housing bubble negative margin years of 2006, 2007, 2008, and 2009, the average profit margin is 6%. Applying that to the current TTM revenues of $1.87 Billion, we have a net income of $112.2 million – meaning that we’re paying just 4.77x normalized earnings. The EV/EBITDA number I have up-top is also overstated and should be sliced in half.

Easy Margin Q/Q comparable growth

The 34.8% and 37.8% gross margins for August and November 2015 I mentioned above are the lowest gross margins the company has posted for those quarters dating back to 1996, excluding the four housing bubble years of 2006, 2007, 2008, and 2009. This means posting a net income increase for Q2 and Q3 should be feasible. This is also true for the Q1/May gross margins that came in at 38.1%; the margin of safety on the August and November are much higher, however. This all means that there is a 16/20 or 80% chance that gross profits and thus, net income will increase over the next few quarters provided that the company maintains its average SG&A as a percent of revenues of ~30%. Only risks to this is that they plan on closing 100 stores over the next few years and may incur some severance and general expenses. This is going to happen through natural lease expiration and so we should not expect to incur any costs from breaking leases. Investors will likely cut them some slack on this.

As I mentioned above, Comparable Store Sales have been positive over the past few years, and the stock is still down 76% – Investors clearly care more about margins than comparable store sales and margins are more likely to increase going forward.

Share Repurchases & Dividends

For the fiscal year ended February 2011, the company had 117 million shares outstanding. For the fiscal year ended February 2014, the number stood at 104 million. As of the November 2015 quarter, that number stands at 83 million. Management has been immensely aggressive with these repurchases. In fact, over the past 2 quarters, they repurchased $55 million worth of shares, this is about 10% of the total shares outstanding at today’s prices! Given the volatile markets earlier this year where the stock fell below $4/share, the company likely purchased more in Q4 (we’ll find out next month). This will provide support for the EPS estimates going forward.

They also pay a decent 4% dividend. S&P 500’s average dividend is approximately 2.2%. Once the market realizes that Pier 1 Import’s dividend yield is actually sustainable, the stock should run higher.

Missed this one..

The long I mentioned that I wanted to add to the portfolio in the February Performance report was Pier 1 Imports. The stock is up 20% today after reporting earnings. I completely forgot to look out for the earnings date and did not prioritize the company. I still feel it’s undervalued, but there’s this psychological part of me that no longer wants to touch it. Nonetheless, anyone of you that want to grab it, these prices still represent a 4.2% yield, and inventories look like they are now in line with sales, so the next few quarters should be positive. I may or may not still add this, but for any of you that want a head start, there you go. I’m sorry about the delayed Lululemon short thesis. I’ll be posting that up tonight. I had also mentioned that I was going to be adding more money to the portfolio, and thus, evenly increasing all positions. I haven’t added money, but I did increase the positions. The portfolio is now 66% invested. I’ll update the new ‘average costs’ tonight as well.

Update: The P/E ratio on Pier 1 is overstated, make sure you normalize earnings/ cash flows. Also, I haven’t done any due diligence, etc.. so make sure you do that as well.

Mazi Ume