If you judged craft-goods seller The Michaels Companies (MIK +0.00%) based on its stock-market interest, you might not guess the company has some pretty loyal customers and high cash flow. The private-equity ownership and serious debt issues, however, might be less surprising.
Every company has its risks. Where does Michaels fall on the value continuum?
In this week's episode of Industry Focus: Consumer Goods, Fool analyst Nick Sciple and contributor Asit Sharma dive deep into the business of Michaels, and why investors might see it as both a value play and a value trap. Learn more about the private-equity involvement, the debt, the buybacks, the strategic initiatives, the threats from e-commerce, and much more.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Oct. 1, 2019.
Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Tuesday, Oct. 1, and we're discussing Michaels. I'm your host, Nick Sciple, and today I'm joined by Motley Fool contributor Asit Sharma via Skype. How's it going, Asit?
Asit Sharma: Pretty good. How are you doing, Nick?
Sciple: I'm doing all right. It's good to have you back in the studio. We're talking about Michaels today. Folks who aren't familiar with that company, it's one of the largest crafts and specialty retailers in the country. Asit, do you do any crafting in your free time?
Sharma: I do crafting of the nature of, when something breaks, I become a crafter for a day. If I'm moving a picture frame at home and drop it, I'm a crafter for that day, because I'm going to find my way to a Jo-Ann's or Michaels or similar store and look for a frame. How about you, Nick?
Sciple: I'm about in the same boat. Much more of a running to Home Depot to do that, that sort of crafting. My girlfriend, however, does do that pretty regularly. Has her Cricut machine, has her Etsy store -- HappyGoLacyGifts, promo, if anybody wants to get some crafts on Etsy.
We're going to talk about Michaels today. The context we're going to talk about them is, this is one of those companies that, if you look at the numbers, it really looks like it could be a value stock; however, we're going to walk through some concerns that could make it a value trap.
Before we dive into that, let's just give some brief history of the company and where it's come from in recent years. Can you walk us through Michael's history as a public company, and where it sits today?
Sharma: Sure. Michaels was founded in 1974 [Editor's note: 1973, according to the company] by a businessman named Michael Dupey in Dallas, Texas. This company began trading on the Nasdaq in 1984 as The Michaels Companies. It was taken private by private-equity firms Bain Capital and Blackstone Group; those are two pretty familiar names if you are familiar at all with the private-equity world. That was in 2006, for a price tag of $6 billion. The company was reintroduced to the public markets in June of 2014. They raised $472 million in that offering. Most of the proceeds were allocated to pay down the company's oversized debt load. At that time, it was $3.7 billion. Debt load is going to be a recurring theme today. Bain still owns 34% of the outstanding stock in this company. Blackstone still has a 13% stake.
I want to note before we move forward, in this second go-around in the public markets, what has their stock performance looked like? Up or down? Now, listeners, I'll take a millisecond for you to guess. The answer is: Shares are down about 42% cumulatively. We will get into the whys of that in just a moment.
Sciple: Yeah. That's why folks might be viewing this company as a value stock. For a little bit more context, Michaels is the largest crafts and specialty retailer in North America based on store count -- 1,262 stores in the U.S. and Canada. We talked about whether we craft. They define their market as, over 53% of U.S. households participated in at least one crafting project during 2018. So, a robust market there.
When you look at some of the numbers here on this company, it can pop out on some traditional value metrics. If you look at their forward price-to-earnings, it's about 4. Their gross margin is higher than what you would expect from the typical store-based retailer. But the big number that really popped out to me, and why I wanted to talk about this company today, is looking at their free cash flow. If you look at their free cash flow from last year, they had about $300 million. If you take that number and divide it by their market cap, which currently is $1.5 billion, that gives you a free cash flow yield of about 20%, which is extremely strong relative to the broader market. When you look at investing in a company, you can generally get a decent picture of what you can expect your returns to be over time by looking at that free cash flow yield, then adding in what your expected growth in free cash flow is over time.
As we've talked about with Michaels, it's in a market that's probably mature, so you can't expect free cash flow to grow in a really significant way over time. At the position that the company is valued at today, the market is clearly expecting that free cash flow yield to decline over time. However, if we can identify some trends that say that will be stable over time, there's a real chance that this stock is overvalued.
Asit, you've had a chance to look through some of these free cash flow numbers and those types of stats coming out of Michaels. What's popped out to you about this company when you take a high-level look?
Sharma: I love the margins. Gross margin of 35%. Free cash flow, again, as you stated, that pops out at me. For listeners, those of you who are unfamiliar with this term, free cash flow is operating cash flow -- the cash the company generates from its operations -- minus the physical assets that it buys during the year, or any small acquisitions. So, you subtract equipment, fixed asset purchases from this operating cash, you get free cash flow. After that, whatever money is left over is to pay your debt service, to maybe pay investors in the form of a dividend, or reinvest further in the business -- that's all gravy. So, the company has this high free cash flow yield. That popped out to me, as well.
I like the stability of the sales, given this really bad retail environment. Comparable sales this year in fiscal 2019 are expected to be flat versus the prior year. That means that the average store in the company's store base isn't going to increase sales at all. But, compared to many physical-store-based retailers -- listeners, you probably heard the news a couple of days ago that Forever 21 is the latest retailer to declare bankruptcy -- I'll take flat comps. I don't think that's such a bad number. It shows that at least the sales are stable and can be improved. So, that also jumps out at me.
Net margin, they average in the low to mid-single digits. That, again, is pretty decent for a retailer in this day and age.
Now, some of the stuff that's not so appealing is that debt on the balance sheet. Before we talk about the debt, though, I do want to point out -- if we look at the asset side of this company, if it's a stable company with very stable operating cash flows, you'd expect, over time, if the cash flows are rising even slightly, the company would be building up a big cash balance. But, like many retailers, Michaels has most of its assets in its inventory. It's got these 1,200-odd stores that Nick told you about. It constantly has to buy inventory. It has its balance between payables to its vendors, cash that it needs to pay down its accounts payable, and this big inventory balance. The inventory as of the last quarter was $1.25 billion. I'll return to that number in just a bit during this segment.
Now, debt. Debt's at $2.7 billion. Nick, you and I were crunching what this means when we talked earlier today. Versus its equity, you really can't get a read, because Michaels has negative equity. It's got a shareholder deficit. This is from losses that it sustained years and years ago. Over the course of decades, it's actually built a shareholder deficit. For those of you listeners who like to hear the debt-to-equity [ratio], we can't really give you that number. We can say that the company is able to cover its interest obligations. Its "times interest earned" ratio is roughly 4. That means that net earnings cover the interest burden about four times over during the year. That's sort of thin, but on the other hand, I've seen worse.
Final note about the debt. If you look at a very widely used metric, which is debt to EBITDA -- that is, debt before interest, taxes, depreciation, and amortization -- that ratio sits at around 3.5. That's another number that we crunched just before taping today. That's actually moderate leverage, although, relative to its own balance sheet, it's got a big debt load that needs to be addressed. If you look at what this means in the big picture, the leverage is moderate. It's acceptable. It's a problem that can be solved. One of the questions that we'll toss back and forth is, does the company want to solve this debt problem?
What jumped out at you, Nick, about the balance sheet?
Sciple: Taking a look at the balance sheet, as you said, that high leverage number obviously pops out to me. You expect to see that from a company that has been brought public in recent years by private equity. But, to the extent that we should be concerned about the debt, it comes back to that free cash flow number that we talked about before. At the current amount of cash that the company is turning out, we shouldn't be too concerned about their ability to at least sustain their interest payments on the debt, and that sort of thing. But where it does become a concern is if we see the business continue to deteriorate over time, and we see that cash flow begin to drop.
I think we should talk a little bit about some of the tactics and strategies the company is using to try to stabilize the business and maybe get to some growth over time. This year so far, sales are down about 4% through two quarters. However, we see net profit up due to some tighter SG&A [sales, general, and administrative expenses] control and a little bit [fewer] restructuring costs. We've also seen new management come in place this year. Kind of strange circumstances. The CEO who had been in place up to February of this year, Chuck Rubin, resigned somewhat abruptly -- had mutually agreed with the company to step down. Had been in the position since 2015. However, Mr. Rubin has been replaced, at least on an interim basis, by board member Mark Cosby, who has 30 years of retail experience at Office Depot and other retailers. He has put in place some tactical and strategic initiatives to try to stabilize the company, and possibly return to growth. Can you give us an overview of what management is trying to do, and maybe your thoughts on whether that can sustain its current performance, at least, going forward?
Sharma: Mark Cosby is a retail veteran. He's had about 30 years of experience in the industry. He's put a fresh set of eyes on the company. One of the things that Cosby has done with the management team is to eliminate the company's Everyday Value program. Of course, Walmart is the company that popularized the notion of "everyday value." That means, you walk into the store, you're not looking for big signs that say, "Huge Sale!" or "Red Tag Sale!" Everything on the shelves should be at a lower price than you'd find elsewhere. This is a tricky initiative for a company which has traditionally brought in its customers through a lot of discounting and coupon offers and specials. Customers actually perceived a little bit loss of value when this Everyday Value program was put forward. They stopped seeing as much of their promotions. It backfired. Cosby went in and said, "Look, let's just can this program for now, and go back to what was working in terms of our regular promotional cycle."
He's also moved higher-price-point items away from the front of the store. Now, that seems like a very basic thing to implement, but it's one of these things [where] simple is genius. When you walk into a Michaels store, and you're one of these core customers -- a crafter, or, as they like to term it, a maker. Their definition of "maker" is a little bit narrower, maybe, than some of ours. We're not talking about Arduino circuit boards and robotics instruments; we're talking about craft makers who do pasteboarding, who do scrapbooking, things of that nature. But he decided that this emphasis on trying to sell higher-ticket items, which existed just before he came on board, was actually turning customers away. So they've moved those higher-price items back to the back of the store, and they put more emphasis on the end caps, to put the items that core crafters want on these end-of-aisle end caps.
They've also mined their customer database. One of the things which has been extremely successful for companies with a forward tech focus is targeted offers to loyal customers. Michaels is getting into this game. They've really only scratched the surface on their capability. They've got such a fanatic cadre of customers who come there on a weekly basis, and they've got a ton of data which, if utilized properly, is going to lead to a higher lifetime value for customers. I like that.
Last thing that I'll say about the tactical things they're doing is this emphasis on private-label brands. In this industry in general, Nick, as you pointed out to me earlier, there's not a lot of huge name brands. Michaels tactically is doubling down on its private-label brands because those have a higher profit margin than stuff it merely resells.
Sciple: That focus on private-label also colors the extent to which they could possibly be disrupted or gone after by third-party companies. When most of these brands are undifferentiated or basic -- so, a paintbrush, or something like that -- it's hard for a lot of these things to get moved online. On the other side of that, you could say these are products that the folks don't care that much whether they get Brand X or Brand Y. But it allows Michaels to have a higher margin, more control of its inventory, that sort of thing.
Focusing on its core customer obviously makes sense. You want to control those high-value customers and have them come to Michaels versus other places. On the Everyday Value issue, this is an issue that even other retailers have seen. I was reading about how Bed Bath & Beyond tried to push into this issue, and also had a revolt from its customers. When you have people that have been extreme-couponing and have gotten used to that behavior as part of their shopping habits, when you take that sort of thing away, it can actually backfire on you. It's surprising; you would think lowering prices across the board might bring folks in. But it's one of those things that can be counterintuitive. But I like the push from the company. To my eyes, I can see how this could at least bring stability to the company and keep those cash flows stable over time, which would color the narrative that this company could be a potentially attractive value.
However, as we've touched on a little bit, on this front of the show, there are a few red flags -- maybe pink flags -- that might say that this company has some value-trap characteristics to it. We've talked about its high leverage. One issue we haven't dived into deeply is that major private-equity shareholding.
First off, Asit, when you see a company that has nearly half of its stock held by private-equity holders, what are the first things that come to your mind? What are the light bulbs that go off that you should start looking at when you see a company like this?
Sharma: The first light bulbs that go off in my mind are, why does this company have a partial float of shares that's public? Maybe I'm a cynic, but often, that can mean that the private-equity company has looked for a way to get its share. It's made an investment in a struggling company. Most of the time, it's encumbered the balance sheet. It'll take control of a private company, leverage it to the hilt, and then gradually seek ways to get their returns, which can mean selling off divisions. It can mean doing an IPO [initial public offering] for a certain portion of the shares -- and then, once part of the company is traded publicly, to continue to exert this control over management, to call the shots in a fashion manner that benefits the private-equity company. And this is not anything illegal. It's often spelled right out in those IPO documents as a risk: "We still will retain as major shareholders XYZ Private-Equity Company, and we owe them through all these side arrangements, related-party transactions." I have a set of antennae that just shoot up when I hear that a company which is controlled by private equity is going to offer some shares to the public.
Now, that doesn't mean that it can't benefit both the public and the private holders. But you have to do your homework in cases like this.
Sciple: Exactly. Michaels, as you mentioned, it is no different. They disclosed in their 10-K that Bain Capital and Blackstone owned approximately 46% of the stock outstanding, and: "They will be able to strongly influence or effectively control our decisions, and their interests may conflict with yours, the individual shareholder, and that of the company."
We talked earlier about the heavy debt burden of Michaels, and about its free cash flow. Given its high debt burden, we had discussed before the show that if I were managing capital for this business -- a lot of concern and pressure on the valuation that is hurting their net income has been the cost it takes to service this debt, to pay that interest over time. So, it would seem to be prudent to take some of that free cash flow and pump it into paying down debt.
However, when you look at the capital allocation decisions of the company, in recent years, they have been buying back $200 million to $300 million in stock over that time. As we've mentioned, the stock has declined markedly over that period of time, noting that those buybacks maybe weren't the best investment. When you see the company pushing funds toward buybacks, when we think maybe it'd be more prudent to use that toward debt service, does that contribute to those little feelings, with antennas being up about, maybe the private-equity folks are helping push the company to buy shares back from them?
Sharma: Yeah, a little bit. Obviously, reduced float out in the marketplace theoretically will, at some point in time, increase the value of those shares as they get scarce. But, for that to happen, there's got to be demand. But on the flip side of the coin, so many companies buy back their shares in the hope that it helps prop the share price up. You'll see various corporations get into a rut of allocating a lot of cash because their stock keeps declining year after year. And they watch successful companies buy back shares, and it becomes this self-fulfilling prophecy: You're using precious capital that maybe should be invested back into the company to buy back shares. It's not helping the stock price, and then poor financial results because of lack of investment cause the stock to depreciate further, so you feel more inclined to try to pump the share price up by buying back shares. I'm positive it could potentially equally be a missed cue by management. But, sure, there's the suspicion that the private-equity hands are directing the company to reduce that float because, again, that theoretically increases their percentage of ownership over time.
There have been companies that have cycled both public and private. Dell is a great example of a company that's gone through public, private, public iterations. I'm not ascribing any motive to either of these companies, if they want to again take this private. However, you have to wonder at the logic of a struggling company which is not using every last penny to try to reinvest in the business. We'll talk about that as we discuss whether this is a value trap or not.
Sciple: On the topic of debt, another pink flag -- in the most recent quarter, Michaels rolled some of its debt. It had some notes coming due, I believe it was this year, and they rolled that debt out to 2027. When you talk about their leverage, when they rolled that debt, I think the interest rate on that debt had been 3% or 5%. When they rolled that debt, they now have a rate of around 8.5%, maybe higher than that, for these new notes. Given that high interest rate, does that concern you? In today's environment, getting that high of an interest rate, particularly with free cash flow as strong as it appears to be with this company: What are the bankers seeing that we're not seeing in this case, Asit?
Sharma: Bankers tend to evaluate companies in a few different ways. They do what's called spreading the financials. All that means is, they throw the numbers up on an Excel spreadsheet. They pay attention to how the numbers look on a strictly GAAP [generally accepted accounting principles] earnings basis. They compare that, ultimately, to cash flows. The cash flows look OK, as we've discussed. But when you flip over to this look from GAAP, it doesn't look as great. The interest coverage -- like, how many times does this cash flow cover interest expense? As I noted before, it's meager. That scares the bankers. It's a less creditworthy profile that Michaels is presenting on a GAAP basis to the lending public.
That's why these notes -- a blend of what you're talking about and this latest refinancing, but let's just round here -- they had $500 million in senior notes that were at a previous interest rate just under 6%, so already a high interest rate; that was refinanced at 8%. That's going to cost them an additional $10.6 million in interest a year. Without getting into too fine of numbers here, roughly about 25% of operating income is being swallowed up by interest expense every quarter. That's something that, when the bank turns its ratios and decides how much risk it can take, it just doesn't look so great.
Now, that's not to say that the lending public doesn't believe in Michaels. It has an asset-based lending facility on its inventory and accounts receivable that will allow it to borrow $600 million to $700 million when it needs to, and it periodically taps into that and pays that back during the year, oftentimes before the holiday season, when it's ramping up inventory. It does have sources, access to capital. But, it has to concern shareholders a little bit. How come this debt is staying on the books? Again, we're talking about decades. Wouldn't it be a good idea to try to pay some of this down, rather than buying back stock?
Nick, this is something that you and I both agree on -- the company has some methods by which it can reduce this debt burden. I'm going to go ahead and spell out one of them: Why not close some underperforming stores? We've seen over the past few years so many chains which are in deep trouble -- let's say, J.C. Penney, Sears [Holdings]; I mentioned Forever 21, which actually didn't quite make it -- the practice is to start closing underperforming stores when you're in serious trouble. Now, Michaels is not in serious trouble. They're pretty stable. They run a profit every year. But they just need to reduce this leverage somewhat. I think it would be a good trimming exercise for the company to do this.
I'll give you one example of a company that successfully went through this. This is Dine Brands Global, which owns both IHOP and the Applebee's franchise. A couple years ago, Dine Brands decided enough was enough, and they closed a good portion -- in the high-teens percentage -- of that company store base. That had the effect of improving cash flow; it improved comparable sales, because the bad-performing stores were taken out of that comparable-sales space. I think this would be a great exercise to free up cash flow, to remove some of the drag on that income from underperforming stores. The reason the company probably hasn't done it is because it's not in enough trouble, and it's always hard to make that move until the very last minute.
Nick, what about you? Do you see that this is possibly a big hurdle for someone who sees the company as a value play, this whole debt burden?
Sciple: It's tough. Given the free cash flow yield and what it looks like from a value perspective, buying back stock doesn't look manifestly like a bad strategy; however, the market has not rewarded that behavior over time. If I were management, and I was in this position, I would want to try a different approach.
As you had mentioned, it's been a significant drag on their net income, their debt service. This is debt they've been carrying for a large number of years. The fact that they're generating what appear to be stable results is not being rewarded by their lenders. They're having to pay higher rates. At this point in time, the prudent move from my perspective would be to adopt a different strategy, try to pay down that debt load. Clearly, what appears to be the concern of the market at this time is that they have such a high debt load burdening the company. To take some of those concerns away from the market would seem to be the appropriate approach.
However, management hasn't done that to date. They have noted that there is a new interim CEO in place. Perhaps that's the step to make.
Again, to your point on closing stores, it's not urgent to do that this time. But the strategy that you've been trying so far clearly has not been rewarded by the market. What could it hurt at this point? That's my perspective on it.
Another place where you have to wait until things are really bad before you have some leverage is lease rates. Management is expecting about a 2% inflation in lease rates going forward. There have been some short-sellers that are critical of Michaels that have said: "Why are their lease rates going up 2% a year?" Some other retailers -- Best Buy is an example that's been called out -- have been able to negotiate their lease rates down. Looking at that, any high-level thoughts on that? Why are their lease rates going up when it seems to be that, for a lot of major retailers, they have some leverage to push on their landlords to get those lease rates down?
Sharma: One thing that investors should zero in on here is, they are a victim of their own success. Success is relative. In this retail industry, where Amazon and a bunch of other companies who've dived into e-commerce have disrupted what it means to go shopping physically in a store -- in this kind of landscape, it's really difficult to break even or show some slow growth. That's what Michaels has done.
Renegotiation of lease rates is always a dance between a tenant and a landlord. Most of the time, these triple net type leases, where the tenant is paying most of the operating expenses of the lease -- paying for insurance, taxes, maintenance of common areas -- those get renegotiated sometimes at five and 10-year tranches. But they have built in annual clauses. So, when a landlord is able to make the argument that, "You're doing all right. You're making enough money to pay me 2% a year," it's more difficult for the retailer to have negotiating power.
The thing about Best Buy or some of these other companies that we've talked about is, at one time or another, they've been in serious trouble. I tell you, when you can look the landlord in the eye and say, "If you don't help me out on this lease rate, I might not be here next year to pay you on a monthly basis," you have some leverage there that a company which is even marginally successful doesn't have. It's an accepted practice in the commercial real estate industry to have a lease rate bump up 1% to 2% a year.
In my opinion, I hear what the short-sellers are saying, but they're comparing apples and oranges. Michaels is a victim of its relative success on this front.
Sciple: One last criticism that short-sellers have leveled against the company we'll talk about, before we reach our final conclusions, is on framing. Michaels is one of the largest framers in the U.S. I'm talking about picture frames, those sorts of things, custom framing. They're the owner of Aaron Brothers. They've recently closed most of the Aaron Brothers stores and have brought those inside Michaels stores as a store-within-a-store concept. It's about 16% of their revenue, but it's significantly higher-margin than their core craft-supplies business. There have been some concerns that online disruptors -- Framebridge is one example -- are going to be able to chip away at some of Michaels' market share in that space. If that takes place, some of their high-margin business in this framing area may be chipped away, and that is a major driver of their free cash flow.
How do you handicap this risk for the company, Asit? It's really hard to tell. What are your thoughts there?
Sharma: It's a risk, but we also have to look at some of the benefits the company gets by moving its framing in-house. A very important metric in the retail industry is sales per square foot of a particular location. What the company is doing is reducing the overhead that it's got in the separately positioned framing stores. Getting rid of all that operating expense, lease expense, bringing it in-house. That does two things. It reduces the economic drag. It also increases the profitability, productivity of each store that receives an in-house framing unit.
What else does that unit do? It brings in additional traffic within Michaels locations. Sometimes those are two separate customers. We tend to think of a customer who's going to an isolated framing unit and a customer who's going to a Michaels as the same person, because those results and financials get rolled up into one bucket. However, someone who just goes with the framing needs to a separately identified store may not be a loyal Michaels customer. Now, if they have to go through the Michaels store -- past the end caps, past the maker's spaces, which the company is really trying to ramp up, making the stores more experiential -- it has a chance to upsell while that customer's there for a framing need. It also has a chance to make this new customer into a longer-term customer.
So I think that there's some real benefit here. Again, the short-sellers have correctly identified a risk, but maybe haven't looked at some of the benefit that's coming. I'm not, frankly, as worried about that. I'll note that competitors like Jo-Ann Fabric do pretty well by having some framing facility, although much smaller, located in a strategically placed area of the store, which brings people in. It's like the IKEA concept, you have to wind your way through to the framing area. And by that time, you've inevitably picked up a couple of small items.
Sciple: Yeah, it's like putting the milk in the back of the store, right? You're going to get that thing, you have to walk by all the other items to get there.
Asit, we've walked through the whole story of Michaels. When you look at their free cash flow and some of their operating metrics, there appears to be a decent amount to like there relative to its current valuation. However, when you look at its high private-equity holdings, when you look at its debt, its amount of leverage, which is partially due to that high private-equity relationship, there are some risks there. When you take a look at all that together, do you think this company is a value stock or a value trap?
Sharma: I'm intrigued by this company. I believe it's a value play. I believe it's a value stock, but one that you maybe want to take some baby steps into, or put on a watch list. I'll tell you why.
Value, to me, is finding a quantitatively cheap asset that the market recognizes as fairly valued. In other words, the market sees a low stock price associated with certain companies and says: "That's fair because this company ain't going nowhere. It's got X number of problems." But you, the investor, see that as quantitatively cheap. You're like: "Look, this is a profitable company. It should be valued more than it is. It's cheap, and I'm going to buy it." Now, I will say, having tried this route before, of investing in value stocks, your idea of what's value is inversely proportional to the pain you'll experience the longer it takes for the market to recognize what you see.
However, there are some things here that Michaels, fairly or unfairly, is also being pelted by. One of those is, it's in a tough industry right now. The reason it's got that very low forward P/E ratio that Nick mentioned at the beginning of the show is because it's part of a group of stocks which has been decimated by online shopping. Michaels presents the customer with a reason to come in-store. It's more specialized, it has a specialized product, it has loyal customers. So, it's a little bit better insulated than a generic company like a Kmart, or parent company Sears, or J.C. Penney. Again, all examples of companies that could not cross that bridge. It's got a discount that the market is applying, even though it's profitable. It has the high debt load, and it does have the private-equity ownership.
But on the other hand, it's got a pretty savvy interim CEO. If you're listening, Michael's management, I think you should make Mr. Cosby the permanent CEO. What he's doing is trying to get rid of customers like me and Nick. The strategic thrust of the company is to not worry about the one-or-two-timers-every-year, but embrace that core customer and have experiences in the store, partner with companies that make the scrapbooks, and have mini-demonstrations in-store. Kind of like what you see in a Home Depot or Lowe's, this idea of classes, which bring a sense of community. It's got some very intriguing positives about it.
If the company could reduce its debt load -- again, not offering direct advice to management -- why not consider getting rid of some of the underperforming stores? Boost that cash flow, boost net income, pay down some debt. I see that this stock could rise once the market recognizes that it deserves a higher multiple. It's worth more than most people are willing to pay. I am going to err on the side of, this is a value play.
I am immensely curious, Nick, what are your thoughts? Is this a trap? Or is this a value stock, in your opinion?
Sciple: From my perspective, I tend to see this as a value stock as well. I think qualitatively, as you mentioned, it's one of these retailers that, you can tell a story of why they should still exist despite the onset of e-commerce. When you go to buy a craft good, seeing that thing in front of you -- seeing what color that paint is, or what texture that canvas is, that sort of thing -- is something that can't be replicated online. There's a reason to come into the store. Their performance, as we mentioned, their free cash flow is strong. And because of those qualitative characteristics I just described, I expect that should be able to be maintained over time.
However, the leverage is a concern to me, and the private-equity interest does raise a little bit of a concern. There could be a conflict between the major holders and an individual shareholder. To your point, I would be reticent to buy the stock until they have a permanent management team in place, so that I can know that the strategy that they're taking today is something that is going to carry through over the next several years.
For my stance, today: I think it's a stock that you put on your watch list, you follow whatever the final management team's strategy is, and check off that they are able to see some traction from those sorts of things. And then, I think it's a stock you have to just buy and hold and wait for the market to realize that value. When you're buying value stocks, you have to be comfortable to look a little dumb for a while when you buy these things. This stock is no different.
Asit, thanks as always for coming on the podcast. I will look forward to having you on again soon.
Sharma: It was a pleasure. I look forward to it next time.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass. For Asit Sharma, I'm Nick Sciple. Thanks for listening and Fool on!
