Michaels Companies Made Lots of Mistakes in the Third Quarter

Arts and crafts retailer Michaels Companies (MIK) reported earnings Thursday morning for the third quarter of fiscal year 2019. The windup period in front of this year's holiday shopping season wasn't terribly inspiring. Michaels' results fell short of Wall Street's third-quarter targets, followed by weak fourth-quarter guidance.

Michaels Companies' third-quarter results by the numbers

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

Management's guidance for the third quarter suggested adjusted earnings near $0.49 per share and flattish to slightly higher comparable-store sales. Wall Street's analyst consensus pointed to earnings near $0.48 per share on sales in the neighborhood of $1.26 billion. Michaels fell short of every target.

Looking ahead, Michaels management sees comps falling by roughly 2.5% in the fourth quarter. Adjusted earnings for that period should land near $1.24 per share, 14% below the earnings collected in the holiday quarter of 2018. Your average analyst had been looking for fourth-quarter earnings closer to $1.42 per share.

This guy might not be a member of Michaels' coveted Makers group. Smashers, maybe. Image source: Getty Images.

What's going wrong?

On the earnings call, CEO Mark Cosby admitted that the third quarter was disappointing. Starting with weak comps, the entire income statement came in below expectations. The soft comps resulted from a mixture of events within and outside the company's control.

From a company-specific point of view, Michaels didn't handle the many seasonal shifts in the third quarter -- back to school, autumn, Halloween -- as quickly and crisply as it could have. Store decorations, marketing messages, and inventories all came up a penny short and five minutes late for pretty much every thematic shift. Cosby noted that the Black Friday event broke that negative streak, and he expected the following "cyber week" to continue the improving trends.

Part of the secret behind Black Friday's improved performance came from a detailed companywide action plan and clearly defined daily scripts that outlined what was expected from each store on a day-to-day basis. These components were new to Michaels, and Cosby wants to continue using them for the long term, given the tighter operating performance they appear to have triggered.

Beyond that, macroeconomic worries and the American retail market's secular shift toward e-commerce alternatives continued to weigh on Michaels' results in the third quarter. The long-term plan for tackling these issues includes leaning away from the price-sensitive mass market and toward crafting enthusiasts under the Makers banner.

"Our core Makers are searching for more than just price," said CFO Denise Paulonis. "They are searching for a great assortment, a great experience, a great linkage to community, which doesn't mean that we don't have to offer a great value, but doesn't necessarily mean that price is her first choice."

What's next for Michaels and its shareholders?

The company is facing many challenges at the moment, from Chinese tariffs and flagging foot traffic in stores to the integration of recently acquired store-chain A.C. Moore. None of this will be easy, even with better tools such as the new action plans and data-driven daily scripts.

I do like Michaels' strong focus on a clearly defined target demographic, even if that strategy shift implies lower revenue in the long run. Wider profit margins should balance out that downside, allowing the company to get back to bottom-line growth once the Makers strategy starts to pay off.

The stock is trading 64% below its 52-week high today, at the bargain-bin valuation of 3.3 times trailing earnings. Market makers are treating Michaels like a lost cause -- one of the retail dinosaurs that won't survive the e-commerce sea change. If you believe, as I do, that this company actually has a fighting chance to redefine its business in a smaller but more profitable niche market, you might want to pick up some shares at these unbelievably low prices.

Don't bet the farm on this company, mind you. I could be wrong, and Michaels might fail to bottle the lightning it found on Black Friday. Consider this ticker as a small, speculative bet on a brighter future, but not a huge slice of your investment portfolio.