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Are Michaels' Strong Results a COVID-19 Mirage?

By Lawrence Rothman, CFA - Oct 23, 2020 at 8:00AM

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The arts and crafts retailer turned in better results in the quarter that ended Aug. 1, but the issues that held it back haven't gone anywhere.

Michaels Companies' ( MIK ) results rebounded nicely in its most recent quarter. After the pandemic forced the arts and crafts retailer to close its stores earlier in the year, customers who had been largely stuck at home came back and made purchases when those stores reopened.

But before this surge, Michaels had been going through tough times that led to the stock losing more than half its value over the last three years. Can the company maintain this newfound performance and reward shareholders?

A girl looking at a laptop while folding a piece of paper.

Image source: Getty Images.

A strong quarter

The recent quarter notwithstanding, Michaels has had its share of troubles over the last several years. These include relying on its physical stores at the expense of an online strategy. Now confronting competition from the likes of Amazon and Walmart, its sales were stagnant and its operating profitability weakened, particularly in 2019. Excluding foreign exchange translations, same-store sales fell by 1.8% due to lower customer traffic, and operating profit tumbled from $563.6 million to $515 million.

Its fiscal second quarter, which ended on Aug. 1, was a different story. Michaels experienced a 12% same-store sales increase, driven by people spending more, and its adjusted operating income grew by better than 40% to $105.8 million.

Ashley Buchanan, Michaels' CEO, said on its earnings call that "as our stores reopened during the quarter, we saw an immediate and sustained recovery in demand that largely kept pace with what we had initially seen in May."

While the recent results are encouraging, Michaels will face major headwinds in trying to build off of its recent sales growth.

Rejuvenation?

Management has been focusing on improving its e-commerce efforts and building an omnichannel experience by offering more goods online and giving customers the option to pick up the merchandise in the stores. It is also focusing on the stores by working on product placement and layout. However, these aren't really unique, and customers aren't likely to flock to its stores or order online based on these factors.

The company has also been working on its store footprint, closing all its Aaron Brothers and Pat Catan's stores --  numbering more than 130 combined -- a couple of years ago. Michaels has also been relocating and closing stores. Over a longer period, it feels it can increase its 1,275 stores to between 1,400 and 1,500 in the U.S. and Canada.

It is also looking to deepen customer relationships. With the pandemic, the focus was on online classes. With its stores reopening and in-person classes taking place, this has the potential to increase traffic. However, with other businesses reopening and customers finding more things to do, Michaels will face a greater challenge attracting people. After all, while some localities have stricter rules on socializing, other people are not stuck at home with little to do. Busy people may not continue to work on family crafts projects.

Michaels' stock has been doing well lately. However, with only one solid quarter during the pandemic, this has the making of a value trap rather than a value stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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