Tuesday, November 16, 2010

Kirkland's: Operational Excellence

Kirkland's (KIRK), a US retailer of home decor, has seen a dramatic operational turnaround in the last 3 years. As a result, the stock price moved from under a dollar in 2007 to $25 in April of this year! Since then, however, the soft retail environment and lower than expected results have cut the stock price in half. It now trades with a P/E under 6 after backing out the company's net cash balance, making it a potential value investment.

The company's turnaround is nothing short of amazing. Over a period of two years, it went from operating losses of $26 million during an otherwise strong economic period to operating profits of $47 million during a recession! Several changes were implemented by the management team that helped boost results:

- Underperforming stores were closed
- A major shift from mall-based to cheaper, larger and more productive off-mall locations
- Unique, differentiated items from competitors
- A focus on items over themes
- A more value-oriented price focus

As a result, the company now sits on $65 million in cash, compared to $5 million two and half years ago, while the company trades for $250 million. With the holiday season coming up, that cash position is likely to increase significantly, as Kirkland's currently expects similar results to those of last year.

It should be noted, however, that while the company has no balance sheet debt, its stores are financed by a large number of operating leases. While leasing costs have decreased due to the recession, should the competition figure out what Kirkland's is doing right or should some other factor cause the company's results to falter, the risk is there that the company will find it difficult to meet its obligations.

Until then, however, the race is on. Kirkland's plans to expand quickly and apply its now successful model to new locations. Capital expenditures will come in at around $25 million this year, which is well above the company's depreciation rate. As a result, shareholders may not see as much cash returned as they would like. On the other hand, management has recently shown that it has a formula for success; with an ROE north of 30%, shareholders may be better served with management deploying that capital to drive profits even higher.

Disclosure: None


Anonymous said...


I love your blog; keep up the great work. I have a suggestion: perhaps you would consider doing a post on how you decide when to sell certain positions. It seems like the value community has a great grasp on when and how to buy, but even Graham gives almost no guidance on when to judge a good sale position. What rubric do you use?

Paul said...

Interesting. Insiders own over 14% too.

Saj Karsan said...

Hi Anon,

It's a nice idea, but I don't think I can add any value to the process. It's difficult to know what a business is actually worth; often, you can determine a range between which its intrinsic value lies. Therefore, it will probably always be difficult to know when to sell, and I have no special insight into this particularly difficult area.