Can Kirkland's Survive a Home Decor Onslaught From Bed Bath & Beyond and TJX?

Shareholders of home-decor retailer Kirkland's had a lot to smile about in 2013, with a rising stock price due to consumers' increasing desire to decorate their new and existing homes. However, with major retailers encroaching on its turf, is it a good bet in the new year?

Jan 11, 2014 at 6:30AM

Investors gave two thumbs up to home-decor specialist Kirkland's (NASDAQ:KIRK) in 2013, pushing its stock price up more than 100% for the year. Kirkland's was a secondary beneficiary of a surge in housing activity, as new homeowners looked to decorate their new digs with items ranging from furniture to accessories. 

Of course, the company has some formidable competition in the space, including forays by megaretailers like Bed Bath & Beyond (NASDAQ:BBBY) and TJX Companies (NYSE:TJX).  So, should investors stick with this small cap's story?

What's the value?
Kirkland's has been around a long time, since 1966, though it is not exactly a household name due to its preference for bare-bones, word-of-mouth advertising. Kirkland's historically relied on mall locations for dependable customer traffic, but it has shifted lately to lower-cost, off-mall lifestyle centers that have allowed it to increase its average store size. The main benefit of this strategy has been a larger and more diverse merchandise mix that keeps the company's primarily fashion-conscious female customers coming back to its stores.

In fiscal year 2013, Kirkland's upped its game, reporting a 6.7% top-line gain that was aided by a return to positive comparable-store sales growth. The company also benefited from a greater online presence, which drove an expansion of its customer base and lessened its need to engage in promotional activity. The overall effect was better operating profitability in the current period and more capital with which to pursue store expansion beyond its Southeast U.S. stronghold.

Smelling profits in the air
Of course, greater spending in the home-decor area by new and existing homeowners has some major retailers, notably, Bed Bath & Beyond, smelling profits. The textiles and home-furnishings juggernaut moved big into the home- decor space with its 2012 purchase of Cost Plus and its 258 World Market stores for roughly $560 million. As with earlier acquisitions of niche retailers Harmon and Buy Buy Baby in the beauty and children's categories, respectively, Bed Bath & Beyond has plans to greatly expand Cost Plus' pre-acquisition operating footprint of 30 states.

In FY 2013, Bed Bath & Beyond has continued building on its long-term track record of growth, reporting a 13% top-line gain that was a function of a comparable-store sales increase and a primarily acquisition-fueled rise in its overall store count. On the downside, though, the company's operating margin slipped in the current period due to a heavier amount of marketing spending needed to get customers through the door. With more than 1,000 namesake stores, Bed Bath & Beyond seems somewhat tapped out in its core business, putting pressure on management to find growth in alternative areas, principally in its Cost Plus home decor franchise.

Also building a large home-accessories business is TJX Companies, operator of the HomeGoods and HomeSense chains in the U.S. and international markets, respectively. While the company derives most of its revenues from its T.J. Maxx and Marshalls domestic apparel businesses, its HomeGoods segment has been gaining prominence over time, accounting for roughly 11% of total sales.

In FY 2013, TJX has been performing well, reporting an 8% top-line increase with gains across its major business units.  Not surprisingly, the company's HomeGoods segment has been its best performer, notching an 8% comparable-store sales gain, partially due to the positive aforementioned trend in housing activity. 

More important, TJX's global purchasing network and financial strength is allowing it to drive further upside in its merchandise margin, leading to higher operating profitability and causing management to recently raise its long-term target for its global store base to roughly 5,000 stores.

The bottom line
Kirkland's has been riding better sales trends to more favorable financial results in FY 2013, leading management to plot a further expansion of its store network over the next year. However, the company really doesn't have a unique value proposition vis-a-vis its larger competitors given that it imports 95% of its merchandise from Chinese manufacturers, many of whom likely also supply competitors' home-accessories units. 

Consequently, Kirkland's has to compete on price, a losing proposition when competitors have greater efficiencies in their supply chains and much better operating margins.  Until the company finds a way to match its larger competitors' profitability, an unlikely event based on its current merchandise strategy, investors should keep this niche retailer on the shelf.

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Fool contributor Robert Hanley has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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