Monday, July 29, 2013

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.

I can understand why this one scared investors. Retailers have high operating leverage (as a result of fixed lease requirements and minimum labour requirements), so when a retailer is barely breaking even, fears mount any drop in revenues could lead to financial disaster. But that's exactly the kind of thinking that may push Mr. Market to near suicidal levels. He was willing to sell you this company's cash/receivables/inventory (less all liabilities) for 30 cents on the dollar!

What also gave me confidence in the stock was that I believed in the turnaround plan. To me, management was doing all the right things operationally: closing unprofitable locations, raising its hurdle rate for new stores, using data to implement regional pricing, using software to improve efficiency of distribution operations etc. On that front, it's unfortunate we won't get to see how it would have turned out, as it could have a been an interesting case study.

But don't get me wrong, I'm happy with the short-term gain; I'd much rather study the cases of the companies I don't own, such as JC Penny and Sears, in order to avoid the financial risk!

Disclosure: No position


Anonymous said...

you're erroneously implying that high operating leverage is preferable to low operating leverage as a general rule; perhaps you're reaching this conclusion from the false assumption that operating leverage has any relationship to a firm's ability to generate cash flow. as a general rule, it doesn't.

high operating leverage usually is accompanied by barriers to entry. and low operating leverage usually is accompanied by super low margin and high competition.

one isnt better than the other wrt a firm's ability to generate free cash flow, which incidentally is the only relevant metric as far as ncav investing is concerned.

Anonymous said...


That's not exactly true. All else being equal, the free cash flows generated from the low operating leverage firm will have a higher present value than those of the high operating leverage firm.

Saj Karsan said...

Hi Anon1,

A company with high operating leverage is riskier because a small change in revenue can produce a drastic change to the bottom line from which the company may not be able to recover.