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Hello again from the lonely land of deep value, where I bring you a new guest to unloved and cheap stock territory: discount retailer Tuesday Morning (Nasdaq: TUES ) . Deep value stocks are in relatively short supply these days as the stock market continues to defy gravity. Investors globally remain encouraged by the pace of the economic recovery from the financial crisis and are chasing stocks with high multiples and earnings potential -- should the recovery stay on track.
With stocks at such lofty levels, I'm more comfortable searching for discounted stocks that have a margin of safety priced into its shares using value investing legend Benjamin Graham's Net Current Asset Value model. The screen is a bit more complex than looking at book value, which measures assets less liabilities. Graham's value screen only looks at current assets and subtracted all liabilities:
Cash and short-term investments (0.75 * accounts receivable) (0.5 * inventory) - total liabilities
The idea here is to look for companies that trade near or below their liquidation level if the company were to go out of business. In the event of liquidation, the cushion is the cash and other assets the shareholders still own. Graham liked stocks that traded at about two-thirds or less of their NCAV.
Just a guest?
Tuesday Morning recently became a member of the deep value club after posting weak holiday sales and guiding below analyst estimates for its fiscal second quarter, which includes December. The results were bad, and a 3.2% decline in same-store sales during the important holiday months is troubling, but the massive sell-off might present an opportunity for patient investors.
Tuesday Morning's "discount" retail label has it often compared with discounters such as The TJX Companies (NYSE: TJX ) and Kohl's (NYSE: KSS ) , but also against dollar-store retail chains like Dollar General (NYSE: DG ) or 99 Cents Only Stores (NYSE: NDN ) . However, Tuesday Morning really doesn't fit into either category. The company sells high-quality products made by well-respected brands at closeout prices. These are products that are often found at high-end stores but are generally an older model or didn't sell as well, so Tuesday Morning buys the products at much lower prices.
Even as many discount retailers have benefited from a sluggish economy as consumers traded down, Tuesday Morning's business, which is heavily concentrated in home goods and furnishings, has not gotten the same boost. Homeowners remain nervous about their homes and unlikely to spend money on an asset they don't believe will increase in value anytime soon. The same phenomenon has hit the top line of home improvement retailers Home Depot (NYSE: HD ) and Lowe's (NYSE: LOW ) .
Much like these home-improvement retailers, I don't expect to see much top-line growth from Tuesday Morning until the housing market really starts to improve. However, I believe management has done a good job of weathering the storm. Over the last 6 months of 2010, Tuesday Morning closed 17 underperforming stores and relocated 15 stores to improve traffic, store size, and layout. The company has been aggressive in relocating underperforming stores to areas with higher visibility and more space. That has certainly increased costs associated with rent, but the relocated and enhanced stores have seen double-digit increases in sales, as well as improved operating margins in the first year. More importantly, management has maintained a healthy balance sheet, buying the company time as it awaits a turn in housing.
Tuesday Morning shares closed at $5 on Tuesday, which is about 126% of its NCAV of $3.89. So the stock is still a little pricey by Ben Graham's standards. However, as I mentioned previously, this deep value screen isn't yielding many good companies at compelling valuations right now.
One area of concern is that much of this asset value is stored in the company's $277 million of inventory. While that inventory is certainly valuable, I'd prefer to see more of the assets in cash. However, the company has no debt.
While the stock is relatively cheap, the fundamentals of the business and the housing market make me want to wait until NCAV is closer to Ben Graham's specified buy levels to get into a name like this. Tuesday Morning's management has set the company up for success when the housing turn comes, but the wait could be longer than most expect.