Why Best Buy Looks Attractive and Eddie Lampert Should Buy Circuit City

It’s rare for me to like several competitors’ stocks all at the same time. However, fears of a slowing economy, housing meltdown, and higher inflation have really hurt the consumer discretionary sector so far this year. In fact, it is one of the worst performing groups along with financial services.

Is it silly for me to praise three electronics retailers in such an environment? Some people will absolutely think so, but let me explain why I think they can all be owned. I’ve written about RadioShack (RSH) a lot since January, so I’ll spare you from reading more about them. Do a site search from the sidebar if you need a refresher.

As you may have seen, Best Buy (BBY) shares were hit hard after releasing poor results for their fiscal first quarter. Product mix was the main culprit, pushing down gross margins for the quarter, but the company expects a rebound later in the year. Best Buy also is accelerating their expansion plans in China.

Most people, myself included, believe BBY to be the creme of the crop in the consumer electronics space. Granted, that might not be saying much when you compete with RSH and Circuit City (CC), but I truly believe Best Buy’s success has a lot to do with a good management team that knows what they are doing. Personally, I love shopping there and whenever I get the urge to treat myself to some discretionary spending, it’s one of my top destinations.

What makes the stock attractive right now? Very simply, valuation. The shares are sitting near multi-year lows and look very cheap on a P/E to growth rate basis. Earnings guidance for this year was cut to $3.05 from $3.18 per share. At the current price of $44 and change, BBY trades at 14.6 times this year’s estimates. Given their leadership position in the industry, a below-market multiple, a stellar balance sheet ($5 in net cash per share to use for buybacks), and a double-digit earnings growth rate going forward, shares of Best Buy appear to be attractively priced. Assume 15% earnings growth in 2008 and a market multiple and you can justify a $56 price tag sometime next year.

The situation at Circuit City is a lot uglier. This company has been trying to find a way to get back on firm footing and stay there for a long time. Every so often they appear to be making progress but then falter and change strategies. The same thing is happening now. The stock has been cut in half over the last year, to $15 and change. Why is the stock attractive? I really don’t think it can go much lower and there are some catalysts that could push it back into the 20’s.

If the latest round of restructuring doesn’t work, I really think Circuit City will be sold. There have been interested parties in the past, but the company has resisted. Personally, I think a buyout is the best way for them to turn things around. I would love to see Eddie Lampert buy Circuit City. It looks like his kind of thing, namely a brand name and a bunch of customers, but no consistent profitability.

The stock is really cheap, one of the cheapest well-known retailers I can find. While profits are sporadic, if existent at all, the company trades for 0.2 times sales and has $2 of net cash on the balance sheet. A market cap of $2.7 billion with no leverage issues and nearly $13 billion in annual revenue is about as low as the stock can get, in my view.

If the turnaround works, the stock sees the twenties. If they finally agree to sell to someone who is willing to make dramatic moves to turn things around, the same thing happens. At $15 and change I just think the stock is pretty much near rock bottom. The risk reward is very favorable even if the company’s results have not been as of late.

So, I’m surprised to be saying this, but I think all three of these electronics retailers can be owned. If you are looking for places to reallocate some RadioShack profits, look no further than their competitors.

Full Disclosure: Long Best Buy and RadioShack at the time of writing

Home Depot’s New Stock Buyback Amounts to 30% of their Shares

There are stock buybacks and then there is the new Home Depot (HD) buyback. In case you are wondering why shares of the home improvement retailer are surging $2 this morning to more than $40 per share on news that was leaked to the market earlier this week with little movement in the stock (the company’s $10 billion sale of HD Supply), it’s because of the company’s new buyback program. Home Depot has decided to couple the $10 billion in proceeds from the sale of their wholesale business with $12 billion from a new senior note issuance to initiate a buyback of $22.5 billion. Yes, that’s not a typo, a $22.5 billion buyback.

Regardless of your view on share buybacks, there is no doubt that they are a hot concept right now. Home Depot’s market cap before today was only $75 billion, so this new buyback is truly enormous, representing 30% of the company’s outstanding shares. The company says it will complete the program as soon as is practical.

In case you are wondering how long that might take, Home Depot repurchased 174 million shares in 2006, for $6.7 billion. Given influx of cash they will be seeing shortly, it’s likely they could accelerate that pace a little bit at the very least. It seems reasonable that they could complete the buyback in three years with no trouble, and perhaps faster if they wanted to really be aggressive.

It remains to be seen what type of impact this could have on the company’s earnings. We know it will be accretive but by just how much is more of a question. Home Depot intends to update its guidance (ex HD Supply) in July. We could dig through the company’s past SEC filings to determine the impact from jettisoning HD Supply from their results, but until we hear whether expectations for the core retail business will have to be slashed yet again, we won’t really have a good idea of how much the buyback will boost the stock’s declining earnings.

Full Disclosure: No position in Home Depot at the time of writing

Goldman Sachs Buys Huge Stake in RadioShack

Through SEC documents filed Monday we learned that Goldman Sachs Asset Management has bought a 12.6% stake in electronics retailer RadioShack (RSH). Normally this would not be very newsworthy, as the largest asset management firms usually have big stakes in companies that require reporting. Fidelity is the largest mutual fund manager and is on top ten institutional holders lists all the time. What is interesting about this Goldman disclosure is that they bought a lot of RSH and did so very quickly.

As of March 31, 2007, with RadioShack trading at $27 per share after being the best performer in the S&P 500 during the first quarter, Goldman owned just 1,755,884 shares (about 1% of the company). In a little more than two months they have increased their holdings by a factor of ten to become the second largest holder (behind Fidelity’s 15%) and that news helped send the stock up nearly 2 percent on Monday.

Should investors go out and buy RSH on this news? Not at all. Such heavy buying explains why the stock has remained strong in recent weeks. Given that Goldman filed with the SEC, we can assume they are done buying large blocks of stock. Investors in RSH who own it for the potential for further earnings per share gains (above current estimates) are justified, but a purchase just for the sake of following Goldman is a bit too late.

Recently I trimmed some RSH positions in accounts where it got to be a top holding. I still expect the stock to move toward $40 per share, but the bulk of the gains for 2007 are likely behind us, unless something unforeseen happens. Interestingly, I have been looking closely at the other electronics retailers recently and RSH is not the only one that looks attractive from an investment standpoint. Perhaps I’ll go into more detail in a future post.

Full Disclosure: Long shares of RSH, as well as January 2009 $10 LEAPS

Despite Harsh Words from Critics, Share Buybacks Remain a Great Way to Boost Earnings and Share Prices

You might know Herb Greenberg, an often quoted columnist for MarketWatch and a frequent guest on CNBC, as someone who focuses on telling the bearish story on the market. Although I’m about to refute one of Herb’s recent blog posts entitled “AutoZone: Sustainable Model?” regarding auto parts retailer AutoZone (AZO), I will admit that there are not enough people out there telling people what could go wrong. Wall Street is too often about selling stocks to people, and with that comes a bias toward making the bullish case for an investment, not the bearish one. Although betting against stocks stacks the odds against you, Herb makes it his duty to tell the other side of the story.

In the case of AutoZone, here is what Herb had to say about the company on May 22nd:

“Earnings per share beat estimates, yet again, thanks to buybacks. Who cares about sales missing estimates? Who cares about sales per square foot that are either down or flat year-over-year for 12 consecutive quarters? Or inventory turns at a multi-year lows? Or sliding sales per store? Or continued weak same-store sales? All that matters, in a buyback story, is earnings per share. “The point,” says one longtime skeptic, “is whether that’s a sustainable business model. Anybody can do this for some finite period of time, but only the ‘productivity loop’ (as exemplified by Wal-Mart in its heyday and others) has proved sustainable.”

Herb does have his facts right, AutoZone has not been greatly improving their sales or inventory turns for a long time. However, when trying to judge the merit of a bearish argument, you have to ask, does any of this stuff matter? From reading Herb’s post, it is obvious that he, as well as the long-time skeptic he quotes for the piece, believe that it does matter in terms of the future for AutoZone stock.

Noticeably absent from the piece, however, are any reasons why sales, sales per square foot, inventory turns, sales per store, and same store sales do matter, or why share buybacks are bad. He simply states that a business model that focuses on buybacks, and not sales or inventory, is not sustainable. There is nothing there that explains why it isn’t sustainable. Why may that be?

If you do some digging into AutoZone’s financials over the last fifteen years, you will see that the model is sustainable. The company has been focusing on stock buybacks since 1999. This year will mark the ninth straight year that choosing buybacks over sales growth has worked for them. The argument that the model isn’t sustainable simply does not hold water because the evidence, which I will detail below, points to the contrary.

Now, why has the model worked? Why has it proved wise for AutoZone to reinvest excess cash into its own shares rather than new stores, or other projects focused on traditional retail metrics? Because buying back stock will boost AZO’s earnings more than opening a new store, or implementing new inventory management software will. And when it comes to getting your share price higher, earnings are what matters, not sales, or comp store sales, or sales per square foot, or inventory turns.

Herb writes “All that matters, in a buyback story, is earnings per share.” That is only partially correct. All that matters, in the stock market, is earnings per share. Stock prices follow earnings over the long term because owning a share of stock entitles you to a piece of the company’s earnings. Not sales, but earnings.

Let’s take a look at AutoZone in more detail. The company’s history since its IPO in 1991 tells two distinctly different stories. From 1991 through 1998, AutoZone focused on traditional retail metrics, the ones Herb and his skeptic friend believe are important when evaluating a stock’s investment merit. During that time, sales compounded at a growth rate of 22 percent per year, with same store sales averaging 8 percent growth. Stock buybacks were not used, resulting in total shares outstanding rising each and every year due to option grants.

However, in 1999 AutoZone began to focus on stock buybacks, an effort that was very much an idea from a relatively unknown hedge fund manager by the name of Eddie Lampert, who had begun to amass an investment position in AutoZone stock. Lampert understood the retail sector well, and knew that industry experts loved to focus on same store sales and other metrics like that. But he also knew that such metrics had very little correlation to stock market performance, and as an investor, that is all he really cared about.

As a result of pressure from Eddie and other investors, Autozone began to implement a consistently strong buyback program. Total shares outstanding peaked in 1998, fell year-over-year in 1999, and have fallen every year since. Not surprisingly, with a new focus on share buybacks, there was less cash flow left over to improve store performance in ways that would be reflected in same store sales, sales per share foot, and inventory turn statistics. Not surprisingly, since 1999 sales have only averaged 8 percent growth per year, with same store sales compounding at a 3 percent rate. Both of those are far below the levels achieved before the buyback era began at AutoZone.

So the punch line of course lies in what happened to AutoZone stock during these two distinctly different periods. Herb Greenberg and other long-time skeptics would have you believe, without evidence to support their claims, that sales and inventory matter to Wall Street. I am writing this to prove to you that such arguments are wrong.

AutoZone’s stock ended 1991 (the year of its IPO) at $10 per share and reached $26 by the end of 1998, for an increase of about 150 percent. The buyback program reduced share count for the first time in 1999 and today the shares fetch $127 per share, an increase of about 390 percent from 1998. How could this be the case if sales growth and other metrics of retailing health were so much stronger in the earlier period?

The answer lies in the effects of the buyback program. Share count peaked in 1998 at 154 million and now sits below 70 million. So, if you bought 10% of AutoZone at the end of 1998 and held those shares until today, you would now own 22% of the company, without buying a single additional share. And although AutoZone’s sales growth has slowed in recent years, the company is still larger now than it was then, so shareholders not only have seen their ownership stake more than double, but the entire company is worth more today than it was in 1998.

Hopefully this explains why retail metrics like sales don’t really matter when it comes to share price appreciation. Earnings are all that counts, not just in a buyback story, but in any story involving the stock market. I believe Herb when he characterizes his source as a “long-time skeptic” of AutoZone. He likely has been bearish on the company ever since they decided to put buybacks ahead of sales on their priority list eight years ago. However, the skeptics have been wrong for many years and the reason is pretty simple; the buyback model has proven to be quite sustainable.

Full Disclosure: No position in AutoZone at the time of writing

AutoZone vs S&P 500 Since Market Peak in March 2000

I’m Not Holding My Breath for a Dell-RadioShack Deal

I get a kick out of some of the ridiculous deals that are rumored on the Street. Did anyone really think Sears Holdings (SHLD) would buy Anheuser Busch (BUD)? The latest story comes to us from Business Week, speculating that Dell (DELL) could buy RadioShack (RSH) in an attempt to reinvigorate its business after Hewlett Packard (HPQ) has kicked their butt for a while now.

How does this rumor get published? There is no evidence whatsoever that Dell would even consider buying an electronics retailer. Did RadioShack shares really jump 6% Monday on this story? It’s insane. Remember the Gateway Country store concept? Huge bust. That was nearly as bad as waltzing into large corporations trying to sell computers in cow boxes.

The current market environment is very conducive to spreading M&A rumors. After all, the sheer volume of deals right now is astounding. That said, don’t put stock into the stories that don’t really make any sense. If you are looking to sell some stock, use these temporary bumps to sell into the rumors if you don’t think they have merit. A client of mine did that with BUD when merger rumors surfaced, and it proved to be the top in the stock.

I didn’t sell any RSH Monday into the rally, but that is because I like the stock for other reasons, not based on a silly buyout rumor. If anyone was going to buy RSH, you’d think it would be Sears, not Dell.

Full Disclosure: Long shares of RadioShack and Sears Holdings at time of writing

RadioShack Earnings Prove Naysayers Wrong Again

Despite bearish stories out of Barron’s and the Wall Street Journal in recent weeks, electronics retailer RadioShack (RSH) shook up those betting against the stock this morning by reporting first quarter earnings that more than doubled analyst estimates. Shares are up nearly 10% this morning.

If this sounds familiar, it is exactly what has propelled shares of Sears Holdings (SHLD) from $15 to more than $190 each. Analysts, reporters, and industry experts will always sound the warning bells when they see overall sales declines, especially same store sales. Although many believe SSS to be the best indicator of a retailer’s health, stock prices reflect earnings, not sales.

We are likely to continue to see naysayers complain about poor sales at RadioShack. After all, they did the same thing with Sears and even continue to do so, despite the stock’s astronomical move. I would expect analysts to continue to underestimate the earnings power of RSH, just as they have done with SHLD. As a result, neither stock is ripe for sale yet despite the fact that negative press will continue to cause temporary worries and sell-offs along the way.

As I have written about before, RadioShack is imitating the Sears Holdings model of ridding itself of unprofitable sales. Over the last three months, RSH has shrunk its business from 6835 retail locations to only 5205. The result of closing underperforming stores has been declining sales, as one would expect, but gross margins jumped to 52% from 48% last year and earnings soared to $0.29 per share, more than doubling the consensus forecast of $0.14 per share.

Full Disclosure: Long shares of RadioShack and Sears Holdings at the time of writing

The Saks Turnaround is Worth Watching

Followers of Peridot Capital are well aware that I am a big fan of turnaround stories in the retail industry. Historically poorly run retailers can be revitalized if the right management team is brought in to oversee the turnaround. Not every instance will result in the 1,200 percent return Kmart shareholders have earned since the company came out of bankruptcy and merged with Sears (SHLD). However, RadioShack (RSH) was the best performing stock in the S&P 500 during the first quarter, and other retailers like Eddie Bauer (EBHI) and Pier One (PIR) have been run into the ground in recent years, so there is a lot of upside potential if the right people are hired to run the business.

One other retail stock I think warrants value investors’ attention is Saks (SKS). The company unloaded its lower end department store brands last year to focus more on its upscale luxury offerings. A new management team is trying to boost merchandising in order to get margins up to the level of competitors such as Neiman Marcus and Nordstrom (JWN).

The early results have been positive. Investors were slightly disappointed with the company’s March same store sales growth of 10% (expectations were for a few percentage points more), but after a dismal performance in recent memory, comps at Saks are accelerating. When you focus on the high end of the market, as Saks does, you have far more pricing power, so margin expansion is highly likely if management continues to do a good job merchandising.

After trading down to $19 after releasing March sales this morning, SKS shares have rebounded to more than $20 each. I think they are interesting in the teens. Despite a rally lately as the turnaround has taken shape, the stock still trades at less than one times sales. The P/E looks high due to depressed margins, but the leverage there could result in exploding earnings in coming years. If you look at what type of price Neiman Marcus was able to garner when it went private, you can see that Saks is a prime comparison and trades at a very attractive level. Shares could easily fetch a price in the mid to high 20’s if the turnaround continues to be successful.

Full Disclosure: Author was long shares of Eddie Bauer, RadioShack, and Sears Holdings at time of writing

Sears Holdings Securitizes Its Brand Names

According to a story in Business Week magazine, there is more evidence that Eddie Lampert’s Sears Holdings (SHLD) is a lot more than just a company that has supposedly lost its relevance in consumer retailing. A move to securitize the Kenmore, Craftsman, and Diehard brands for $1.8 billion shows just how creative Lampert and Co. are at creating value for shareholders, or in this case, the potential for future value creation. Read about how they could monetize the Sears Holdings brands.

Full Disclosure: Long shares of Sears Holdings at the time of writing

Moodys Does What to their RadioShack Credit Rating?

NEW YORK (AP) — Moody’s Investor Services downgraded RadioShack Corp.’s long-term senior unsecured rating and short-term commercial paper Monday on lackluster sales and operations. The ratings agency lowered the electronics retailer’s senior unsecured rating to “Ba1” from “Baa3.” The move means the company’s senior unsecured rating is no longer investment grade. Moody’s also cut RadioShack’s commercial paper rating to “Not Prime” from “Prime-3.”

Sometimes you have to wonder what exactly rating agencies like S&P and Moody’s are looking at when they change corporate bond ratings. This news isn’t material for RadioShack (RSH) common stockholders, but still, it doesn’t make sense.

As I pointed out recently, the RadioShack turnaround is on solid ground. Despite the surge in earnings at the company, Moody’s is looking at sales numbers, not profitability and balance sheet metrics when rating the company’s debt. Not only have most equity analysts missed the huge run in RSH shares, but it appears debt analysts are pretty clueless as well.

RSH has had a huge run, so I wouldn’t be aggressively buying at the current price above $26 per share. That said, a credit downgrade to below investment grade seems to be a strange thing to go ahead with when operations are improving.

Full Disclosure: Long shares of RSH at time of writing