The water levels are rising, and Pier 1
But first let's put on our waders and slosh through the results. Sales for Pier 1 fell 11.8% to $402 million from $456 million in Q3 2006. For the nine months, sales fell 9.5%. Making matters worse, management boosted its marketing activity to bolster sales, which only aggravated its losses. Lower sales and the deterioration of gross margins, which fell to 49.7% from 52.5% a year ago, translated into a loss of $0.83 per diluted share for the quarter, from a $0.06 loss a year ago. Stock option expensing, which wasn't required last year, cost the company $0.01 per diluted share.
There was also a nonrecurring $0.28 per share charge relating to store-level asset impairments, but regardless of how you slice it, the results weren't good. And they haven't been good for some time, as net income peaked for the company in fiscal 2003. The continued disappointments are surely now discounted into the current share price, which -- below $7 -- is the same price it traded at roughly 10 years ago. However, a new year is approaching and hope springs eternal for better performance at Pier 1.
To start things off, CEO Marvin Girouard is retiring this coming February, which could freshen up management and breathe new life into operations. If by some stroke of genius the incoming management team can get back to generating 10% operating margins, the valuation would significantly improve. Assuming flat sales of $1.7 billion, a 37% tax rate, $12 million in interest expenses, and 88 million shares outstanding, I get $1.13 per diluted share in earnings. A conservative 10 times multiple on earnings translates into a valuation of $11.31 per share.
If it takes management three years to achieve this expansion in operating margins, the potential revaluation to $11.30 would be a 20% compounded average return on investment. Add another year and it's still a 14% compounded return. Sales, which are currently depressed, should also rebound with better operating performance, increasing the upside to any revaluation.
Splash. So much for potential and dreams of optimistic returns. Now let's get back to solid footing. Pier 1, along with compatriot Cost Plus (Nasdaq: CPWM ) , will continue to struggle against big box retailers Target (NYSE: TGT ) and Wal-Mart (NYSE: WMT ) , making progress extremely difficult. Although going private might give Pier 1 more time to turn around, hoping for a private equity buyer to emerge is just that -- hoping. And hoping is not the type of investment strategy I recommend.
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