Tuesday, July 19, 2011

Kirkland's: Right Back Down

Kirkland's (KIRK) sits comfortably on the Value In Action page, having increased in price by about 50% between November and February. Since May, however, the stock has lost more than 30% of its value, increasing the likelihood that it will once again qualify as a value Stock Idea.

Kirkland's is a retailer of various home decor items. It operates some 283 stores throughout the US. The reasons for the lackluster stock performance are plain to see: profits and same-store sales are down compared to last year. The company has had to deal with higher costs and some merchandising misses. Same-store sales were down more than 8% in the most recent quarter, leading to low profits and low expectations in the eyes of Mr. Market.

Mr. Market's expectations are so low that the company trades for just ten times this year's low earnings estimate, even though the company has net cash comprising more than a third of the company's market cap! Taking the company's $90 million cash balance out of its $225 million market cap gives Kirkland's an ex-cash P/E of under 7.

For a company like this, the key to profits is merchandising. Management is always going to be trying to fix areas where sales are down (e.g. recently it was frames, now it's mirrors). Sometimes they will miss in getting the items consumers want (as per the 8+% fall in same-store sales last quarter) and other times they will nail it (same-store sales rose 12+% in the year-ago quarter). The opportunity for value investors arises as a result of the market's shortsightedness; when the company goes through a slump, as it is now, the company likely trades at a discount to its long-term earnings power.

Kirkland's does plan on spending about $25 million in store expansion and IT requirements to increase its flexibility (compared to depreciation of $13 million), which puts some of its cash at risk. However, recognizing that the company's cash balance is rather large, management did note that it is also considering a number of options to return cash to shareholders.

The market has recently soured on this company. However, there's no reason to think Kirkland's problems are permanent. The company has a strong balance sheet and a capable management team that has proven its ability in exploiting potential profit opportunities.

Disclosure: No position

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