When Your Business Competes In Price, Advertising
December 19, 2007 | Joe Ponzio | about: TUES
The retail sector has been getting crushed lately. Though that breeds panic in most, it presents wonderful buying opportunities for long-term investors. Let me preface with this: I have heard it grouped in the same conversation with sub-prime loans. Are we really to believe that people will stop shopping? Can we compare that to banks lending money to people who can’t pay?
But I digress. Let’s take a look at a business that seems underpriced, but may not be a buy just the same – even if it is down 75% for the year.
Tuesday Morning Corporation (TUES). Through their 800+ stores, they are a “closeout retailer of upscale home furnishings, housewares, gifts and related items in the United States” (according to their most recent Form 10-K/T. Best I can tell, it appears as though TUES takes the products that other retailers no longer want to carry and sells them for 50%-80% off.
In reality, I think it is a great business model. In my humble opinion, I believe that there are enough people in the US that would want nice things but are willing to wait until after they are no longer on the cutting-edge of fashion or design and are selling at 50% off. Does a coffee maker ever really go out of style?
Still, a great business model doesn’t always make for a great business. Here are some of the problems that I see in Tuesday Morning Corporation.
Competition
“We believe the principal factors by which we compete are price and product offering.” When a business has to be the cheapest provider in order to get the business, it will likely be forced to choose between growth and survival. How can it comfortably allocate its $11.9 million of cash if it may be forced to slash prices (and revenue) on a whim?
Key Operating Strengths
“Our success is based on the following operating strengths…We distinguish ourselves from other retailers with a unique ‘event-based’ selling strategy, creating the excitement of multiple ‘grand openings’ and ‘closeout sales’ each year…”
This is where the art of investing and business comes into play. Anyone who has ever truly studied advertising knows that event-based sales programs drive short-term results. In the long-run, however, they tend to be more expensive and less effective at driving long-term growth.
There is a genius in the field of advertising and I would recommend that everyone (and I mean everyone) read, study, and memorize The Wizard of Ads: Turning Words into Magic and Dreamers into Millionaires
Getting back to Tuesday Morning Corporation.
The Website
You shouldn’t judge a book by its cover. And yet, most people do. The majority of their target customer base (“consisting primarily of women ranging in age from 35 to 54 from middle and upper-income households with a median annual family income of approximately $60,000″) is surfing the web and shopping online.
They likely expect more out of the Tuesday Morning website than is presently offered. For example, the closest location to me is roughly 7 miles away. I am not going to fight Chicago traffic to go to a store when I have no clue what they have today – and at what prices.
The Numbers
Tuesday Morning looks extremely cheap. For example, assuming just 5% growth for the next ten years (ignoring the future beyond that and the equity value), TUES has an intrinsic value of $6.71 a share. I know – this totally strays from my formula. Why? I wanted to throw a quick value down because I knew I wouldn’t be buying TUES as it stands. Why go through any extra work if I don’t like the business.
At $4 and change, TUES appears to be underpriced. In addition, it is paying a handsome 12% dividend. Still, I can’t buy this company today because I don’t know if it will be able to continue growth – even at 5%. It has some major fundamental problems in its advertising that may hurt the business and forever leave it stuck in a pricing battle. (If it fixed its advertising problem, it would be able to build a better customer base and compete less on pricing alone.)
If Tuesday Morning Fixes Their Problems
Tuesday Morning is a difficult business because they have a wonderful model and a great idea, but it is not being executed to maximize long-term growth. At the pace they are going, they will likely be forever putting out fires and trying to stay above water.
In a difficult business, no sooner is one problem solved than another surfaces – never is there just one cockroach in the kitchen.
It’s not a difficult business to understand, but a difficult business to run (read: generate maximum excess owner earnings) as it currently operates. If management proactively begins fixing the company’s weak advertising and pricing structures, the business may have the potential to be great. Still, to do so, the company will have to plow its owner earnings into proper advertising and make a fundamental shift in its direction. That would likely mean greater losses before a turnaround. Tuesday Morning has cockroaches in it’s advertising – and that leads to cockroaches in so many other places.
The TUES Summary
As attractive as the price seems relative to the valuation of the business, there are so many obstacles and stumbling blocks to this business that I do not have the confidence I need to commit money. I’ve said it before: Try to invest in businesses in which you are both comfortable and confident.
I may be sacrificing potential growth; still, I’ll take confidence and low-stress with nice returns over uncertainty with the potential to make a killing. Remember: There is a business behind that stock and price follows value.
Two Additional Points (in case you were wondering)
What is a Form 10-K/T? The Form 10-K filed with the SEC is a company’s annual report. You’ll also see 10-K/A – an amended 10-K. The 10-K/T (which you’ll rarely see) is a transitional report. In the case of TUES, it was used because the company changed its fiscal year end from December 31st to June 30th. The 10-K/T was the “annual” report for the shortened 6-month period. The June 30, 2008 annual report will revert back to 10-K.
Why did I change the intrinsic value calculation? I didn’t. The goal is to find value. If you found a wonderful business selling for less than, say, two years worth of owner earnings, there would be no need to do a full valuation on the company because it would be a screaming, obvious buy. In the case of TUES, I’m not buying today because the business needs work. As such, the valuation doesn’t matter one bit. I showed the valuation above simply because the business is selling for less than ten years worth of owner earnings – a steal in the case of a wonderful business, a pass when the business has problems that need to be addressed.
Filed under: Companies Analyzed (Generals)
Related Stocks: TUES
Joe,
It is interesting that we have been looking at the same stocks / companies and coming to the same conclusions. Specifically, I bought AEO at around the same time (but prior to your postings) because it is fairly valued if according no growth over the next decade and just 5 percent over the second decade. Any level of growth greater than zero, and it is undervalued. Similarly, Tuesday Morning came up on the screen as wildly undervalued at the same time — as did Macy’s, Nordstroms, and some other retailers. For me, the difference was in a visit to the stores.
AEO sells to teens and early 20’s, so we (my wife and I) checked out Abercrombie and Fitch, Aeropostal, GAP, and the others at the mall. Abercrombie shoppers consisted of concerned teens and frowning parents (prices were too high). Aeropostal had everything marked down and a poverty of shoppers (even if not accompanied by parents). AEO was backed up with shoppers and the logos were well represented among the teens hanging out at the mall. Down market or not, AEO was an evident buy.
As for Tuesday Morning, we visited three of their stores and found metal warehousing shelving with the contents in disarray, sales staff that never graduated high school, and only a few customers. This was not just true of one store, but, rather, it was true of each, and one of the three was newly opened (the carpet wasn’t yet stained). If targeting upper-end shoppers possessing the gift of frugality, you had to wonder which motivation would win out. While am sure there are some Robinson Caruso types among the well-heeled, I couldn’t grasp why customers accustomed to luxury would become Indiana Jones when it came finding bargains among the disarray that seemed consistent from one store to the next. More importantly, I couldn’t grasp the means by which senior management could achieve a turnaround that included a change in culture for this geographically diverse business. A local manager can make such a change quickly, but corporate isn’t going to hit the road or the air and do the dirty work of operational leadership at the local store.
Peter Lynch was something of a hybrid investor — combining value with growth — and was a Buffett favorite before retiring from fund management at Fidelity. In his books, Lynch tells the story of visiting the local mall and seeing the foot traffic entering Bed, Bath, and Beyond (which, by the way, appears undervalued today). He bought the stock on the strength of that observation and was well rewarded for the effort. The same approach got me into American Eagle and kept me out of Tuesday Morning. I haven’t been gloriously rewarded for my purchase of AEO, but I am happy to hold it until teens select nudity as a fashion choice. By the same token, if there were no time limit on shorting stocks, Tuesday Morning would be first on my list.
Thanks,
Robert
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I was wondering if you could share your thoughts in TJX. I think it is slightly over-valued, but not horribly overvalued.
I like the company, the repeat business it gets and the fact that if one of their concepts starts to fail, they can sell it off and re-invest the proceeds elsewhere.
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