Alco-Stores Bites The Dust

I've had a few people ask me about ALCO Stores (ALCS) recently, so I thought I would answer the questions here. ALCS used to be a net-net that eventually ended up chewing through all its assets and finally declared bankruptcy. I haven't followed it very closely over the last year, but even so I think there is a lot to be learned from this situation.

Alco Stores Gets Bought Out

In the last two years and change, Alco Stores has been brought up on this site five separate times. Each time, the large discount at which the company traded relative to its net current assets was brought up. Last week, the price of the company's shares soared 60% as the company received a friendly buyout offer.

Alco-Stores: Large Shareholder Disappears

As previously discussed on this site, shares of Alco-Stores (ALCS) trade at a deep discount to the company's net current assets. While that discount started to narrow late last year, it started to widen again over the last few months. At the same time, a large shareholder (who previously owned more than 15% of this illiquid stock), started to sell piecemeal! My guess is that the latter may have been causing the former.

Alco Goes Big On Buybacks

Today, ALCO Stores reported that it has purchased 12% of its shares in one fell swoop. If you haven't looked at this company already, you may wish to do so. This is a profitable net-net that traded at a 58% discount to its net current assets. Following this large repurchase, that discount now rises to 62% by my calculations!

Alco Stores: Net-Net Buybacks

Stocks trading at discounts to their net current assets often look cheap. But investors fear what the the company is going to do with its capital. Companies often trade at such large discounts when they have made poor acquisitions or can't control expenses relative to revenues. But what happens if a company trading at such a discount buys back its shares at the discounted price? Such a company offers the potential for great returns for shareholders.

Running Into A Duckwall

About a year ago, Duckwall-ALCO (DUCK) was discussed on this site as a high-risk, turn-around situation. Since then, the company's value has stabilized while it's price has fallen some 30%. As a result, it trades at a 50% discount to its net current assets and is therefore much more compelling from a value standpoint.

Duckwall-ALCO: Turnaround In Progress

Turnarounds can be a great source of returns for investors. When the market counts a company out, its shares can trade at extremely low levels, allowing investors the opportunity for tremendous upside potential. The shares may also trade at large discounts to book value, allowing the value investor some downside protection in the form of assets. Duckwall-ALCO (DUCK) may be just such an opportunity.

Duckwall-ALCO operates a chain of 200+ retail stores throughout the central US. The company attempts to avoid competition by operating in small towns with populations under 5,000 where no broad line retailers exist.

But the company has had a rough go of it in the last few years. Profits have fallen as the company has struggled with its merchandising, causing management to believe many customers are driving some distances away to make their purchases at competitor stores. As a result, the company trades at a price-to-sales ratio of just 0.1 and a price-to-book ratio under 0.5.

But things appear to be turning around. A new management team took the helm in early 2010, and they implemented a number of new measures to improve the company. Merchandising was re-organized, technology systems were implemented to better track inventory, distribution centre flow was re-designed, and a line of unprofitable stores was closed.

As a result, the numbers have started to improve. Over the last few months, same-store sales are actually increasing, the company's shrink ratio has fallen (and there is still room for significant improvement to the bottom line if the company can eventually achieve industry average shrink ratio levels) and costs have been cut. Investors who buy now may be on the cusp of a turnaround story that drives up the stock price significantly.

However, this investment is not for the conservative investor. Downside protection is not as strong as it may appear to be because of the company's debt level. DUCK's recovery is still in its nascent stages, and if it doesn't gain traction, the company's debts will start to pull the company under.

Against a book value of just over $100 million, the company has debt and operating leases approaching $200 million. Unfortunately, these aren't short-term leases either, so if things don't go well, the company is still obligated to pay tens of million of dollars per year for the next ten years. Considering the company has had positive free cash flow only once in the last four years, the risk of financial trouble is certainly present.

Furthermore, the cash flow that does come out of this business appears earmarked for expansion. Though management has said it may pay down debt with free cash flow, which would make the company safer, it appears clear from their actions that management would rather open more ALCO stores with any money that's freed up from the business. You can't really blame management for this viewpoint, considering their bonuses are based on DUCK's return-on-equity (ROE). The bonuses can be as much as 150% of salaries if certain ROE targets are hit, and nothing increases ROE like a ton of leverage. Unfortunately, it is shareholders who bear the risks of leverage.

If DUCK's turnaround proceeds on its present course, shareholders will likely be rewarded enormously. However, there isn't a whole lot of leeway if things turn south. The company's financial position is such that a premature expansion or an economic downturn could raise doubts about the company's future.

Disclosure: None