FOOL ON THE HILL
An Investment Opinion
How Good Does Talbots Look? Warren Gump (TMF Gump)
October 5, 1999
Talbots (NYSE: TLB) seems to have once again found the right clothes to sell. The company announced that same-store sales for September shot up 16.6%, continuing a trend of improvement that began earlier this year. These higher sales, combined with rising margins, caused management to increase earnings per share (EPS) guidance for the current quarter to $0.56-$0.60, much higher than the $0.40 earned last year and the current consensus estimate of $0.51.
Taking a quick glance at the September same-store sales numbers makes me salivate, since it makes it look like Talbots has shown tremendous improvements in its operations. It is important, however, to put that number into context, as one isolated piece of information can easily be taken out of context. We've all been strolling through a department store where we see a sign shouting "50% off" that grabs our attention. When we get to the bin and do some more investigation, we will often find that much of the merchandise is still more expensive than at other stores even when marked down to half price. At the same time, we continue to look in that bin because every once in a while, we're able to snatch up a great deal.
One of the first pieces of information I look for when trying to put a same-store sales number in context is how the company performed in the prior year. This number represents the "base" off of which the current year's sales are being measured. If the prior-year number is high, the comparison is considered to be tougher. On the other hand, if results from last year were weak, the company will have easier comparisons.
Let's say that Successful Retailer's same-store sales in September 1998 were up 10% to $55 million. For Successful Retailer, which is not adding new stores, to record a 10% gain in same-store sales in September 1999, the company would need to record sales of $60.5 million. Attaining that 10% sales increase in September 1999 is tougher for a couple of reasons. Since the "base case" sales level is higher, the sales improvement needed to produce the same percentage increase is also higher. In September 1998, Successful Retailer needed to increase sales by $5 million to report a 10% comparable-store sales improvement; the company needed to boost September 1999 sales by $5.5 million to achieve that same percentage increase.
On top of needing to post larger sales improvements, companies with high sales in the prior year are also faced with the task of maintaining their base business. Although it is natural to assume that a company can maintain the business it acquired in the past, that assumption is not a given. Big gains in same-store sales are often driven by new products, advertising campaigns, or promotions. Many retailers find it hard to maintain the same level of excitement in their offerings the year following such an introduction. Improving on strong prior-year sales from the prior year is often a sign that management is really doing things right.
Let's look at another example. Out of Favor, another chain of stores that isn't adding new locations, finds itself in a different position than Successful Retailer. Instead of strong September 1998 sales, Out of Favor's same-store sales fell 10% to $45 million. Assuming that the decline was caused by temporary problems rather than a negative secular demand shift, the company should be able to fairly readily recoup some of those lost sales in the following year. If in September 1999 Out of Favor recovered to its 1997 sales level, the company would post an impressive-looking 11% sales increase in September 1999 (the joys of math... it takes an 11% increase to recoup a 10% loss). While that sales improvement indicates that the company has bounced back from a stumble in the prior year, it shouldn't be forgotten that the company has just returned to the sales level achieved two years ago. It hasn't really made progress.
If you were to see only the September 1999 same-store sales flash from Successful Retailer and Out of Favor, you would likely conclude that Out of Favor's 11% improvement was better than Successful Retailers 10% rise. Putting that number in context with results from the prior years, however, and observing that Successful's sales were off a strong base and Out of Favor's were off of weak results would probably change your perspective. Successful Retailer has demonstrated that it can grow its sales off of strong bases, whereas Out of Favor has simply rebounded to its sales level from two years ago.
Talbots' 16.6% increase in comparable store sales looks impressive, until you see that it is compared against a 14.7% decline in sales during September 1998. If you combine results from those two years, comparable-store sales are still just a tad under their level in September 1997. A big part of the reason for the September 1998 sales slump is that a major sale was moved from September in 1997 to October in 1998. Sales plunged without the sale in September, but jumped a whopping 26.3% in October when the sale occurred. Due to the change in timing of the fall sale, company management correctly encouraged investors to look at combined results of September and October -- a comparable-sales increase of 3.5% -- to get a better handle on overall business trends. This year, combining results from both months isn't an issue since the sale again occurs in October.
Sales are only one part of the profitability equation of a retailer. In addition to that figure, it is extremely important to also consider the margins that are being earned on the merchandise sold. If all of your sales are occurring at marked-down prices, margins and profitability will likewise be lower. On the other hand, greater sales of regular-priced merchandise will boost margins and profitability. The good news for Talbots' investors -- at least this quarter -- is that this month's sales increase was produced from selling merchandise at regular prices. These higher margins are a big contributor to the substantial earnings gains that the company expects for the quarter.
Given strong sales of full priced merchandise, Talbots is well positioned to achieve success over the rest of the selling season. The big question Foolish investors need to ask, however, is whether the company has laid the foundation for years of solid earnings and sales gains. Looking at the company's results over the past few years does not leave a pretty picture. In fiscal 1996, the company earned $1.82 per share. Last year, EPS were only $1.15. While this year's earnings will likely rise above the current $1.61 estimate, they will still probably fall short of the bogey reported four years ago. Investors only looking at results over a short timeframe may find some very interesting characteristics in this stock. If you're trying to find an investment that you can buy and hold onto for several years, however, I'd hold off a while longer to ensure that these positive results can be sustained for more than a year or two.