PIER 1 IMPORTS INC/DE PIR
June 24, 2010 - 7:38pm EST by
edward965
2010 2011
Price: 6.40 EPS $0.88 $0.74
Shares Out. (in M): 117 P/E 7.3x 8.7x
Market Cap (in $M): 748 P/FCF 7.3x 8.7x
Net Debt (in $M): -169 EBIT 102 127
TEV ($): 579 TEV/EBIT 5.7x 4.6x

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Description

Currently trades for under 7x FY 2010 and 2011 EPS, ex net cash, after a 35% decline over the last two months due to concerns about a recession, and sharp 22% decline the last week even after great earnings and guidance for the quarter to date.   Assuming a 11x forward multiple for FY 2011, PIR should trade at > $11, from today's $6.4.  For downside protection, PIR has $1.4 in net cash today, and will have $2.25 in net cash at the end of the fiscal year.  For upside performance, the home furnishings store count is off 10% from its peak and store count will stay flat, helping keep margins respectable and above what many may think is possible even if consumer spending stays flat.

While everyone focuses on the demand side as the consumer will surely retrace some, the supply side in home furnishings is perhaps where the stocks will be made.  After reversing a severe supply overcapacity in US stores, the home furnishings industry is back in balance.  This balance should allow participants to earn "normal" margins, if they have the right merchandise and price point, and PIR has both. 

Industry oversupply:  From 2000-2006, nearly every 10-K in the industry had the phrase "we expect 10% store growth next year."  From 2001 to 2006 publicly-traded pure play companies in the space added over 50% square feet in the US, or nearly 9%/annum.  Encouraged by a relatively mild impact from the recession in 2000-2002, stores kept growing.    However, by 2005/2006, even with a strong economy and housing market, the companies started posting losses: Kirklands in 2006, Pier One  in 2006, Bombay in FY 2005, CPWN in 2006, etc.   Once the recession hit, an industry already in overcapacity and declining margins got crushed with most companies trading under $1 or going bust (KIRK, PIR, TUES, CPWM, Bombay, Tuesday Morning).    Apart from mortgage lending and insurance, I don't think any other industry got hit so hard.  Really, just knowing this information was probably good enough to short PIR in 2007.

Industry supply reversal:  In 2010, nearly every 10-K in the industry talks about small store closures and tight inventory management.  Managements are pretty shell shocked and are sitting on good sized cash piles.   After shedding between 10%  and 20% of square feet (depends if one counts Linens-n-things as part of the industry), the annual growth rate of sq. feet from 2001-2011E is approaching 2%/year, down from 9%/year in 2001-2006.   Given population growth of near 1%/year and some real gains in income, I'd argue supply is back in balance, or at least close to it.  The 2% also does not include mom-n-pops, which based on casual observation had a tough go at it in the recent recession. 

Demand:  People like to focus on the demand side of the equation. While I'd argue there is some catching up of demand from 2008-2009, as long as supply stays flat then demand doesn't need to grow.

Pier One niche: PIR occupies an interesting niche of contemporary and imported-looking items of a mid price point.  The niche separates itself from the Ikeas and Targets of the world with their low price point and more mainstream looks, and the high-end/conservative look of a Pottery Barn.

Merchandise:  Impossible to quantify or describe to others, but Pier One has really good stuff now.  One can see it in the mid teens same store sales growth the last few months.  They've added items of lower price points from what I can tell, and put compelling merchandise on the floor.  This has/will show up in lower markdowns and higher volumes.    And, it has, with same store sales running + mid teens the last four months.  I go to PIR once a month and feel that they are hitting on all cylinders right now.

Insiders:   Three recent buys at prices around 10% higher than today's quote.  Since last year, over 300K shares have been bought by insiders, including the CEO buying up to $7.5

Margins:   With good merchandise and a lid on new industry supply for the foreseeable future, I would think 9% EBIT margins for FY 2011 are relatively easy.  PIR used to earn 10-11% during the recession of 2000-2004, albeit with a different housing market.   Of course, the housing market wasn't super hot yet in 2000 or 200.

 PIR has many levers to get to those margins:  recent rent reductions and likely lower merchandise costs (sourcing and ocean freight).  I think sources of cost cutting are often unpredictable from the outside, but since they are focusing on cost cutting instead of growth, they should have a couple of years of opportunities to work with post early 2009 when they started, or maybe another year from today.  Kirklands, as an example, has been working on shedding stores and cutting costs for two years now and is just finishing their work.  Based on Kirklands, I wouldn't be surprised to see margins higher than we've seen before.

Bear Case:  People will say the recent ~14% Same Store Sales growth is due to the home tax credit expiration.   Sure, but new home sales this April were barely up sequentially, but were down 42% YoY, so something else may be happening.  I think furniture wears out and people like something new, like they like a new car.  If the home market were to rebound, even better for PIR.  If not, then we should be covered by the net cash.

Assumptions:   +10% SSS growth this quarter, +5% for the next 6 quarters.  7.3% EBIT margin this year, 9% next year. 

Catalyst

Earnings beats for 2010.  The consumer not falling off a cliff, which is what is assumed by the recent price drop.
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    Description

    Currently trades for under 7x FY 2010 and 2011 EPS, ex net cash, after a 35% decline over the last two months due to concerns about a recession, and sharp 22% decline the last week even after great earnings and guidance for the quarter to date.   Assuming a 11x forward multiple for FY 2011, PIR should trade at > $11, from today's $6.4.  For downside protection, PIR has $1.4 in net cash today, and will have $2.25 in net cash at the end of the fiscal year.  For upside performance, the home furnishings store count is off 10% from its peak and store count will stay flat, helping keep margins respectable and above what many may think is possible even if consumer spending stays flat.

    While everyone focuses on the demand side as the consumer will surely retrace some, the supply side in home furnishings is perhaps where the stocks will be made.  After reversing a severe supply overcapacity in US stores, the home furnishings industry is back in balance.  This balance should allow participants to earn "normal" margins, if they have the right merchandise and price point, and PIR has both. 

    Industry oversupply:  From 2000-2006, nearly every 10-K in the industry had the phrase "we expect 10% store growth next year."  From 2001 to 2006 publicly-traded pure play companies in the space added over 50% square feet in the US, or nearly 9%/annum.  Encouraged by a relatively mild impact from the recession in 2000-2002, stores kept growing.    However, by 2005/2006, even with a strong economy and housing market, the companies started posting losses: Kirklands in 2006, Pier One  in 2006, Bombay in FY 2005, CPWN in 2006, etc.   Once the recession hit, an industry already in overcapacity and declining margins got crushed with most companies trading under $1 or going bust (KIRK, PIR, TUES, CPWM, Bombay, Tuesday Morning).    Apart from mortgage lending and insurance, I don't think any other industry got hit so hard.  Really, just knowing this information was probably good enough to short PIR in 2007.

    Industry supply reversal:  In 2010, nearly every 10-K in the industry talks about small store closures and tight inventory management.  Managements are pretty shell shocked and are sitting on good sized cash piles.   After shedding between 10%  and 20% of square feet (depends if one counts Linens-n-things as part of the industry), the annual growth rate of sq. feet from 2001-2011E is approaching 2%/year, down from 9%/year in 2001-2006.   Given population growth of near 1%/year and some real gains in income, I'd argue supply is back in balance, or at least close to it.  The 2% also does not include mom-n-pops, which based on casual observation had a tough go at it in the recent recession. 

    Demand:  People like to focus on the demand side of the equation. While I'd argue there is some catching up of demand from 2008-2009, as long as supply stays flat then demand doesn't need to grow.

    Pier One niche: PIR occupies an interesting niche of contemporary and imported-looking items of a mid price point.  The niche separates itself from the Ikeas and Targets of the world with their low price point and more mainstream looks, and the high-end/conservative look of a Pottery Barn.

    Merchandise:  Impossible to quantify or describe to others, but Pier One has really good stuff now.  One can see it in the mid teens same store sales growth the last few months.  They've added items of lower price points from what I can tell, and put compelling merchandise on the floor.  This has/will show up in lower markdowns and higher volumes.    And, it has, with same store sales running + mid teens the last four months.  I go to PIR once a month and feel that they are hitting on all cylinders right now.

    Insiders:   Three recent buys at prices around 10% higher than today's quote.  Since last year, over 300K shares have been bought by insiders, including the CEO buying up to $7.5

    Margins:   With good merchandise and a lid on new industry supply for the foreseeable future, I would think 9% EBIT margins for FY 2011 are relatively easy.  PIR used to earn 10-11% during the recession of 2000-2004, albeit with a different housing market.   Of course, the housing market wasn't super hot yet in 2000 or 200.

     PIR has many levers to get to those margins:  recent rent reductions and likely lower merchandise costs (sourcing and ocean freight).  I think sources of cost cutting are often unpredictable from the outside, but since they are focusing on cost cutting instead of growth, they should have a couple of years of opportunities to work with post early 2009 when they started, or maybe another year from today.  Kirklands, as an example, has been working on shedding stores and cutting costs for two years now and is just finishing their work.  Based on Kirklands, I wouldn't be surprised to see margins higher than we've seen before.

    Bear Case:  People will say the recent ~14% Same Store Sales growth is due to the home tax credit expiration.   Sure, but new home sales this April were barely up sequentially, but were down 42% YoY, so something else may be happening.  I think furniture wears out and people like something new, like they like a new car.  If the home market were to rebound, even better for PIR.  If not, then we should be covered by the net cash.

    Assumptions:   +10% SSS growth this quarter, +5% for the next 6 quarters.  7.3% EBIT margin this year, 9% next year. 

    Catalyst

    Earnings beats for 2010.  The consumer not falling off a cliff, which is what is assumed by the recent price drop.
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