Michaels Sets a New Course on Stormy Seas

Arts and crafts retailer The Michaels Companies (MIK +0.00%) reported its second-quarter results early Wednesday morning. The company is revamping key parts of its operations under interim leadership, and Chinese tariffs might become a problem in 2020.

Here's a closer look at its latest business update.

Michaels second-quarter results: The raw numbers

Data source: Michaels. GAAP = generally accepted accounting principles.

What happened with Michaels this quarter?

• The company bought back shares worth $25 million during the second quarter. Together with a larger buyback in the third quarter of 2018, the company has retired 12% of its shares over the last four quarters. That explains how Michaels was able to grow its earnings per share while net income posted a decline. The share repurchase policy now has $373 million remaining, with no set time limit. Based on current market conditions, management says that it sees buybacks as "an attractive use of cash" at the moment.
• It is in the process of tweaking many of its business processes in order to boost customer activity in its stores. An inefficient discount program has been canceled and replaced by a new coupon system. Popular brands now get more shelf space in each store, especially in highly visible areas such as near the checkout counters and on aisle endcaps. These decisions come with support from business data analytics.
• Chinese trade tariffs have not yet had much impact on results, but that may change next year. The cost increases would fall under fiscal year 2020, and the company is working on a few mitigation ideas, such as sourcing goods from other countries and negotiating lower prices from Chinese vendors. Even so, higher tariffs could trigger some real pain for Michaels. If the Trump administration implements the so-called List 4 of tariff expansions on Dec. 15, Michaels could see its cost of goods rise by as much as $500 million next year. That would be a 16% increase over the current annual run-rate for cost of goods sold. Michaels' total net income over the last four quarters stopped at $327 million.

Michaels wants to cater to highly engaged crafts enthusiasts, or "makers." Image source: Getty Images.

What management had to say

In the earnings call, interim CEO Mark Cosby provided an overview of Michaels' revamped long-term strategy:

We have defined our target customer as the core maker. This is someone that is interested in DIY, crafting, creating fine arts, or just injecting more creativity into their life. This target customer definition was the result of significant customer research looking at attitudes, behaviors, and needs of our customers.

We divided them into different customer segments, identifying key characteristics and spend. Then we conduct another set of research to learn how the core maker shops with traditional quantitative surveys, immersive interviews of individual customers, and focus groups. This research has led us to believe that we can better focus on this core maker and increase our overall market share. These core makers represent two-thirds of all arts and crafts spend, and importantly indicate a strong desire to spend more on DIY projects.

The existence of these core customers isn't exactly breaking news, but Michaels is shifting its focus to a more tightly defined "maker" market in a big way. Management believes that the best path toward sustainable growth involves supporting the makers at the cost of losing the less-committed arts and crafts hobbyists.

"Our new purpose is: We're here for the makers," Cosby said. "We will not be abandoning categories, just making sure the mix within a category is right. Seasonal products come to mind as a question, but this category is very important to the core maker, as they like to decorate for events."

Looking ahead

Michaels provided the following guidance:

• In the third quarter, comparable-store sales should come in flat to up by 1%. That metric landed at +0.3% in the second quarter after a 2.9% dip in the first quarter.
• Adjusted third-quarter earnings should land near $0.49 per diluted share. For comparison, adjusted earnings came in at $0.19 per share in the second quarter and $0.48 per share in the third quarter of 2018.
• Full-year net sales are expected to land near $5.18 billion. This target stood at $5.22 billion three months ago.
• Adjusted earnings for the full fiscal year are now seen in the neighborhood of $2.37 per share. That's a slight boost from the $2.35 expected in the first-quarter report's guidance.