The Best and Worst
Stocks of 1997
Winner -- Trans World Entertainment Corp.
(Nasdaq: TWMC) Price -- $18 38/64 (post split)
The Company's Biz. Trans World Entertainment is a leading retailer of music and video products. In October it acquired Strawberries, a privately owned music chain with 90 stores concentrated in New England and Washington, D.C. As a result, Trans World now operates 551 freestanding, strip mall, and mall stores in more than 30 states, mostly in the eastern half of the U.S.About a third of these outlets are full-line mall stores operating under the Record Town name. Its specialty mall stores operate as Music World and Tape World, while its video-for-sale stores use the Saturday Matinee name, and its freestanding stores are called Coconuts. Nearly half of the company's sales come from compact disks, with another quarter coming from audio cassettes and the rest split between video and other items.
The Story. After years of frantic store openings, retailers of music and video products found that overexpansion had ruined the business. Trans World was one of the first retailers to recognize that this meant strategic downsizing was the way to survive. The company took a $21 million restructuring charge in 1994 to close 179 stores. In January of 1996, it took an additional charge of $35 million to close another 163 stores. (So far, it has closed around 300 stores.) The near-term pain was severe, sinking the shares from a split-adjusted $7 to $1.50 in early 1996. Yet as less profitable stores were shut down, the pain led to improved margins. Same-store sales began rising in early 1996, and the quarterly losses kept declining. After Trans World delivered earnings of $1.51 per share in the fourth quarter of FY97, the stock doubled to $6 1/2.
By March, Trans World had its turnaround while industry giant Musicland (NYSE: MSG), which had failed to take the restructuring poison, was staring at bankruptcy. Indeed, survivor Trans World was positioned to benefit from industry consolidation, both in terms of acquiring weaker players (like Strawberries) and enjoying incremental sales gains.
Same-store sales have risen 5.3%, 8.7%, and 12% in the first three quarters, respectively, as Garth Brooks has apparently helped the music business recover from its doldrums. Sales for the first nine months rose 9%, cutting the weak season loss to $0.07 per share compared to the loss of$0.78 in the first nine months of 1996. Gross margins have widened by 1.3% to 37.2% while SGA expenses have fallen to 32.9% from 33.3%. Most important, tighter inventory controls and a July debt refinancing at below the prime rate have cut interest expenses in half to just $4.4 million as the company has reduced its long-term debt by 22%. Improving margins have doubled the trailing EPS to $1.43 in just the last three quarters. As a result, Trans World has enjoyed the kind of rock solid success investors dream about.
How Could You Have Found This Winner. Sometimes the smartest move is to know when to fold 'em. Trans World's systematic restructuring didn't leave shareholders very upbeat, but it was a smart move. Investors might have noticed the company's tune had changed as early as the April quarter of '96. Overall sales were down, but same-store sales shot up 6.1%. That was the first of seven straight quarters of rising comparable-store sales, an important industry measure that's easy to follow. Gross profits were also stabilizing and would improve over the next two quarters along with the rest of the financial picture.
The gangbuster January '97 quarter left Trans World looking strong in an industry where behemoth Musicland and others were still reeling. Plus with net margins up to just 1.5%, there was plenty of room for further improvement. The early August announcement of the Strawberries deal added more fruit to an already fruitful turnaround.
The Future. In announcing third quarter results, Chair/CEO Robert J. Higgins (the company's majority owner) commented, "To date, the Company's performance has exceeded our initial expectations for fiscal 1997. We enter the holiday season extremely optimistic due to a strong schedule of new releases in both music and video. Additionally, the acquisition of Strawberries, completed in October, will have a positive impact on the fourth quarter."
First Call shows that analysts are now looking for a split-adjusted $0.95 per share for the January '98 fiscal year and $1.25 per share for next year. With a P/E of 25.4 and forward growth projected at about 57%, the stock still PEGs out favorably at 0.45. On other hand, YPEG fair value based on long-term growth estimates of 10% for Trans World and 19% for the industry put YPEG fair value somewhere between $12 1/2 and $23 3/4. The new revolving credit facility should cut interest expenses even more in the year ahead.
Still, even in the strong FY93, the best year in recent memory, Trans World delivered just 2.9% profit margins. Although Strawberries' annual sales were not announced, it seems likely that Trans World will have to make more than three and half cents on the dollar to beat these new earnings estimates. That may be possible, but in a competitive retailing space, Trans World would have to become a colossus for 1998 to bring another six-bagger.
[Fool Articles: Daily Double, 03/31/97: Trans World Entertainment ]
-Louis Corrigan (TMF Seymor)
Next Article: Winner -- Reliability Inc.