Michaels Awaits a Suitor

Michaels Stores' (NYSE: MIK) recent results were nothing to write home about, but investors shouldn't expect any impressive operating developments right now. Management is focusing instead on exploring "strategic alternatives" with advisor JPMorgan Chase (NYSE: JPM).

In the earnings Michaels reported last week, sales rose a modest 1.4%, while same-store sales -- comparable sales at stores open for more than a year -- decreased 3%. Diluted earnings per share came in at $0.38 -- unchanged year over year, if you exclude an inventory accounting change. However, operating earnings results were worse, down about 11%. On a more positive note, inventory was down nearly 10%, and operating cash flow was strong. That was partly due to an increase in accounts payable, meaning the company is taking some more time to pay certain bills. All in all, it was a mediocre quarter to say the least.

Can we expect any better going forward? Based on the guidance Michaels offered, management expects same-store sales to rise 1%-3% for the second quarter, with total sales growth of 5%-7% and diluted earnings of $0.19-$0.20 per share. For the year, it expects same-store sales growth of 2%-3%, total sales growth of 7%-8%, and diluted earnings of $1.92-$1.98 per share, for an estimated forward P/E of about 20. That's a decent outlook, but nothing to do cartwheels over.

Though the stock has lagged the market over the past year in terms of total return, it has outperformed over the two- and five-year timeframes. It hit some rough patches from 1997 to 2002, but it also has an impressive long-term track record over the past fifteen years, thanks to strong growth trends in the company's core arts-and-crafts retailing industry. Sales have grown approximately 10% annually over the past five years, while earnings growth has been even more impressive at 22% annually. The company also paid off all long-term debt back in January, and it sports a 1% dividend yield.

The stock's current rise has been fueled by management's decision to effectively put itself up for sale back in March. The stock jumped 16% the day management announced it was exploring strategic alternatives, but it seems the market is now waiting to see whether a potential suitor shows up.

Is any further potential upside if the company is sold? Based on current fundamentals, the stock appears fully valued at present. There may be further potential for the company to expand by increasing sales at existing stores and opening new ones. However, until we know whether any company is interested purchasing Michaels, or when it might be sold, I don't expect it to trade according to future operating results.

Michael's best-case scenario would resemble what happened yesterday with Kinder Morgan (NYSE: KMI). The pipeline operator traded nearly 19% higher after announcing that the CEO would lead an initiative to take the company private, with backing from Goldman Sachs (NYSE: GS), American International Group (NYSE: AIG), the Carlyle Group, and Riverstone Holdings. Kinder Morgan's stock represents a three-bagger since 2003.

However, Michael's worst case-scenario might be more like European biotechnology concern Serono (NYSE: SRA), which announced it was for sale but saw no transaction consummated. The stock had traded as high as $21 at the height of investors' optimism for a merger or buyout, but it's since fallen to $16 as hopes have faded. If Michaels lags in finding a suitor of its own, investors might want to beware.

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Fool contributor Ryan Fuhrmann has no financial interest in any stock mentioned (that means he's neither long nor short the shares). Feel free to email him for feedback on this article. The Fool has a disclosure policy.