It wasn't the sweetest music to hear, but did the earnings release by a leading music distributor sound a clarion call of opportunity, even for those of us with tin ears? With profits falling 33%, Handleman
No -- at least, not yet. Cheap stocks, while sometimes holding hidden potential, are often cheap for a good reason. Such is the case with Handleman. Although sales have been rising incrementally, profit margins continue to slide.
The music-distribution business is a competitive one and has been sickly of late; it was down 6.2% in the U.S. last year. In addition to straight-up competitors, all of which are privately held, Handleman also competes against divisions of the music companies as well as online retailers. The popularity of Apple's
To offset its dependence on music distribution, Handleman acquired Crave Entertainment Group last November, a privately held distributor of video game consoles, software, and accessories. With at least one estimate forecasting the console market to grow at a 90% rate through 2009, Handleman hopes to tap into that growth. Yet even there, the music maker expected more than what's apparently possible. It had thought Crave would become accretive by the second half of 2006, adding some $0.10 a share to earnings. But Handleman now says that those earnings will be "substantially lower," apparently because of Sony's
Handleman, it seems, will continue having a rough year ahead. The company hopes 2007 will be better for its new division, since it missed the Christmas season last year. The bulk of holiday sales had already shipped by the time the Crave deal closed at the end of November.
The other thing hurting Handleman was the loss of some 425 customers to other suppliers. Both Wal-Mart and Kmart, the latter now a part of Sears Holdings
So how cheap is Handleman, and how cheap might it get still? It currently trades at a price-to-earnings ratio of 8, with a minuscule price-to-sales ratio of 0.15 and price-to-book of 0.69. But its balance sheet has worsened since last year, when it was debt-free and had a ton of cash on hand. It took on $102 million in debt to acquire Crave, and cash dropped to just $8 million.
That has not stopped Handleman from continuing to buy back shares -- it bought some 500,000 in the past quarter, and it is committed to buying back more. Yet one wonders whether that is an appropriate use of its limited cash. The company continues to pay an $0.08 quarterly dividend, and while buying up cheap shares can increase shareholder value, management has not shown itself particularly adept at determining the fair value of its stock. The stock today stands nearly $4 a share cheaper than the average price the company paid for it during the quarter.
While Handleman is currently profitable, it refused to commit to any assurances it would stay profitable for the coming year. The outlook for music sales is just too murky, and Handleman expects operating results to fall substantially below last year's. That could easily translate into even lower share prices for investors.
The company would also not dismiss the prospect of ultimately taking Handleman private if its shares got cheap enough, but for me, that would not be reason enough to buy in. I would not foresee the premium offered, if any, being large enough to create a significant margin of safety to justify an investment.
Call me tone-deaf, but even at less than $10 a stub, Handleman still sounds off-key.
Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.