Is it an electronics retailer? Is it an ethanol play? No one's quite sure anymore. What we do know is that REX Stores (NYSE:RSC) is reporting Q1 2006 earnings tomorrow morning. And here's what else we know.
What analysts say:
- Buy, sell, or waffle? Exactly one analyst follows REX, and he doesn't seem enthusiastic to be doing so, only rating the stock a hold.
- Revenues. He expects sales to decline 5% to $85 million in tomorrow's news.
- Earnings. And for profits to crash, down 71% to $0.14 per share. Let's find out why.
What management says:
When REX talks, investors need to listen in stereo. Because for all intents and purposes, what started out as a chain of specialty electronics retailers has now become two companies: (1) the aforementioned retailer, and (2) a strategic investor in alternative energy -- investing in alternatives to oil, then cashing out its investments for impressive gains. To illustrate, in the March earnings report for fiscal 2005, REX reported earning $7.7 million (before taxes) from selling electronics -- and an additional $30.5 million (before taxes) "from synthetic fuel limited partnership investments." This was up from $6.2 million and $18.6 million, respectively, in fiscal 2004.
In other words, not only did the company earn four times as much from its synthetic fuel investments last year as it did from electronics, but these "synfuel" (it doesn't mean what it sounds like) profits also grew more than twice as fast (64% vs. 24%). Similarly, though less impressively, fourth-quarter 2005 results showed an 11% decline in operating profits from electronics, while synfuel profits increased 18% before taxes.
Despite the lagging electronics results, CEO Stuart Rose pronounced himself pleased with the fact that Q4 2005 marked REX's second consecutive quarter of same-store sales gains -- even if actual electronics profits declined.
What management does:
Thanks to synfuel, REX has posted strong margins growth in recent quarters. Although rolling gross margins from its electronics stores don't seem particularly impressive, falling 50 basis points over the last 18 months, operating profitability is up 240 basis points (selling its interests in the synfuel plants being the major contributor here). The bad news? REX is paying increasingly higher taxes as tax credits on its synfuel investments begin to fade away, with the result that rolling net margins finally fell back below rolling operating margins last quarter.
|
Margins % |
10/04 |
1/05 |
4/05 |
7/05 |
10/05 |
1/06 |
|---|---|---|---|---|---|---|
|
Gross |
28.1 |
28.1 |
27.5 |
27.7 |
27.9 |
27.6 |
|
Op. |
7.2 |
6.6 |
6.5 |
8.2 |
9.4 |
9.6 |
|
Net |
7.2 |
7.3 |
7.5 |
8.9 |
9.6 |
7.1 |
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.
One Fool says:
There's more bad news to relate, but it's a ways down the road. According to the company's latest 10-K, investments in the original ethanol partnerships have been sold and payments on those investments will only keep rolling in through 2007. That means that unless REX finds new places to invest, and makes similarly strong profits on its new investments, operating margins could begin crumbling some time next year.
To prevent that from happening, REX is indeed seeking out new alternative energy investments. For example, on March 17, REX hitched its fortunes to the ethanol wagon, buying a note from (i.e., lending money to) a company that needed $14 million in cash to build an ethanol plant. Presumably, REX will collect interest on this loan, but more importantly, the note gives REX the right to buy into the ethanol company at a later date -- assuming this whole ethanol fad doesn't go boom before then. This investment follows several similar investments, including one made just two months before, when REX made an equity investment in another ethanol plant.
When you consider how much more profitable REX's alternative energy business has become than its electronics business, this seems the smart thing to do. While for many companies, ethanol is just the latest craze, REX has been in the synfuel business for seven years already -- and profitably for the last five. As a matter of fact, this Fool is starting to wonder when REX will just quit hawking A/V equipment altogether and focus on what it's good at: investing.
Competitors:
- Best Buy (NYSE:BBY)
- Circuit City (NYSE:CC)
- RadioShack (NYSE:RSH)
- Sears (NASDAQ:SHLD)
- Wal-Mart (NYSE:WMT)
What type of investor are you? Best Buy was recommended in Motley Fool Stock Advisor and Wal-Mart was an Inside Value pick. Talk stocks with other investors and our analysts when you give our newsletters a try.
Fool contributor Rich Smith does not own shares of any company named above.
