Remember when BBBY was a great company?
MIK has been thrown into the ‘junk-tail that should go away’ pile of ‘stuff’. Stock down 11% for the ytd, and off 38% from the mid’16 peak. I was always in the camp that I wanted to own this at a price…you know, the whole ‘loyal customer, in store experience is critical, blah blah…’. That’s simply wrong. When I added this to my short TAIL list earlier this week, I had several people reach out to me with something like “nice timing McGough…the stock has been crushed and it’s trading at 9x earnings.” #fairenough. But hear me out on this one…
This is a very negative TAIL call, though, I’m not making a big push on this YET (ie pitching Keith to get it into Hedgeye’s top 10 best ideas)…until I get an edge on the TREND. With short interest at 14%, then a penny beat on an ‘ok guide’ is likely to be a painful day for anyone short it on Nov 30th—especially given that it’s been beating to a lesser magnitude on a weaker earnings algo over the past five quarters. Expectations don’t look ridiculous – though 4Q looks VERY tough, which makes me inclined to think we see a gnarly guide. But the reality is that my conviction is low that I know more about that than the short interest that tripled over six months.
The “it’s cheap” argument is ridiculous – at least to me. Here’s why…
- I definitely think the business model has a need to exist, but not at either a) 1350 stores, or b) a 13-14% EBIT margin.
- Brands don’t matter in this space – arguably less so than any other part of retail. Therefore it has to be all about in-store experience and/or price. You want to bet on that long side? In the wise words of the dude who tried to not get annihilated by Liam Neeson in the movie Taken… “Good luck”.
- It’s simply not a good business model. Too concentrated ($35bn space w 10% share for MIK), too easy to syphon off profit centers, becoming the ‘Bed Bath’ of couponing. Michaels has the largest store count of 1,367 while Hobby Lobby has ~750, AC Moore has ~130, and JoAnn Stores has ~850. NONE of these companies have backed off of couponing.
- When half of its transactions come from customers who visit once a year the coupons are not effective. Michaels most common coupon is 50% off a single item. Recently it has offered 25% off the entire purchase which makes traffic trends in the market seem more difficult.
- The online penetration of crafts is low which is due to several factors including the low ASPs, myriad number of SKUs, and slow inventory turns. That likely makes the economics of free shipping unattractive to the craft retailers. The average ticket is only $22 in the store so a $49 threshold for free shipping is limiting factor. Amazon Prime is free regardless of price point.
- Customers that are new to a particular craft may indeed prefer to shop in store, but many high spending crafters may need replenishment items which online shopping would make much more convenient.
- This is not particularly an ‘Amazonism’ phenomena – as maybe 10% of the business is at risk of going to Bezos. That stinks, but is borderline manageable.
- The issue is the framing business – which is the cash cow. Roughly 10% of revenues, and upwards of 25-30% of profits. Like with StitchFix, there are simply are too many custom framing models coming to market at similar (ie value) prices, that are simply too attractive to a sub-35 year old shopper.
- Management is no joke, but as it relates to the risk associated with nearly 40% of EBIT at risk, it is simply in denial.
- Company is at peak margins AND it’s already 3.2x levered.
- At a 9% margin, this thing earns $1.10 instead of $1.80.
- If $175 in productivity at a 9% margin, it’s down to $0.75 – or a buck miss. Then it’s at almost 30x earnings today instead of 9x on the Street numbers.
- And yeh…in that scenario MIK levers up to 5.5x. AND that’s before leases come on balance sheet (ie are no longer free) starting next year.
- Actually…as I’m typing this I’m asking myself why the heck short interest isn’t even higher?
As noted, expectations are so low right now for MIK over TRADE/TREND duration. If it pops if it hits the quarter, it could be a really interesting idea across durations.
Next step is to pinpoint the proximity to every one of its own stores, exposure to strip malls by type (Ie hopefully more ULTA anchors than WMT), and then overlap by category w employment (teachers) hobbyists (we have this by MSA) and online buying habits by MSA by FICO store by category, by inclination via channel. We’ll have this for auto parts and other ‘battleground’ parts of retail as well in 2 weeks time. Great proprietary data coming down the pike.
