Wednesday, October 13, 2010

Trans World Entertainment

Would you want an interest in a retailer that sells music CDs? Neither would I. But what if the price of that retailer is just a fraction of the company's inventory? Mr. Market is still not interested, which is why you might be.

Trans World Entertainment (TWMC) trades for $60 million but has inventory of $237 million. Even if you subtract all of the company's liabilities from its inventory, the retailer still trades for much less than this conservative valuation.

We've actually discussed this company last year, but found it risky because of the large operating lease obligations it had. But the company has done well to cut costs through this rough period.

First, it has let a great many leases expire, shutting down hundreds of unprofitable locations. Operating lease obligations have fallen from $220 million a couple of years ago to around $130 million today.

The company has also focused on its more profitable lines, as it dramatically cut sales of video game products, and has increased its share in DVD and Blu-Ray devices. Efficiency has also been improved, as inventory per square foot is coming down, and new, more profitable pricing schemes are being rolled out after successful runs in test stores.

Unfortunately, the company continues to lose money, as the company suffers from both cyclical (the economy) and secular (electronic sales of music) problems. As such, while it may trade at a discount to assets, those assets are being eroded. But for a retailer such as this one, the Christmas quarter is the most important. For this company, that's also the quarter where almost half of the store's locations appear to be at the end of their lease. As a result, this company bears watching over the next few months, as it will have an opportunity to generate cash and cut expenses, which could strengthen its case as a potential value investment.

Disclosure: None

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