Shareholders in discount retailer Tuesday Morning (NASDAQ:TUES) have enjoyed a solid run over the past 12 months, with the company's stock price up more than 50%, thanks to better-than-expected top-line growth, including a solid increase in its comparable-store sales. In addition, the company has benefited from a higher gross margin, the result of its ongoing efforts to lower the amount of clearance merchandise in its inventory.
On the downside, though, Tuesday Morning is still finding profitability a hard goal to achieve, due in part to heavy competition from the large off-price retailers like TJX (NYSE:TJX) and Ross Stores (NASDAQ:ROST). So, is the company a good bet at current prices?
What's the value?
Tuesday Morning is a sizable player in the closeout segment of the discount retailing industry, operating a network of approximately 800 stores in 41 states that are focused on housewares and seasonal product categories. Unfortunately, that size has proved to be of little benefit to the company, anecdotally due to the larger size of many of its competitors that allow them to enjoy better economies of scale in their operations.
The net result for Tuesday Morning has been a need to increasingly engage in promotional activity, a trend that has led to a general shrinking of its operating margin over the past few years.
In its latest fiscal year, it was the same story for Tuesday Morning, evidenced by a sharp decline in its adjusted operating income. While the company enjoyed positive comparable store growth during the period, reversing two straight years of negative comps, the incremental sales were seemingly engineered through higher markdowns, negatively impacting Tuesday Morning's gross margin.
Not surprisingly, Tuesday Morning's lower profitability led to poor operating cash flow, hurting its ability to fund its growth initiatives, including an ongoing renovation of the company's store base.
Looking into the crystal ball
Of course, the question for investors is whether Tuesday Morning is on the right path for higher future profitability, a vital ingredient for future stock price appreciation. Based on its year-to-date results in FY 2014, the answer would seem to be no, judging by the company's double-digit decline in operating income during the period. Despite a positive customer traffic trend in FY 2014, Tuesday Morning has been unable to overcome lower average prices, as its new and existing customers continue to seem to be looking for better deals in their purchases.
A better way to go
While Tuesday Morning certainly has some potential, investors should probably avoid the urge to buy into the story at this juncture, instead opting for the discount retailers that continue to deliver solid results in the current selling environment, like TJX. The operator of off-price retail stores, mostly under its TJ Maxx and Marshalls brand names, continues to post solid financial results, reporting a 7.9% increase in operating income in its latest fiscal year.
More importantly, TJX continues to run a lean operation and pursue efficiencies, a trait that allowed it to generate an uptick in operating margin during the period. The net result for the company was solid operating cash flow, helping to fund a further expansion of its store base, including a larger presence for its HomeGoods unit, a major competitor to Tuesday Morning in the housewares category.
Likewise, Ross Stores continues to post solid financial results, reporting a 5.6% increase in operating income in its latest fiscal year. In much the same way as TJX, Ross Stores uses an efficient corporate overhead structure and no-frills stores to under price its competitors while generating a solid level of operating profitability, which remained at a double-digit level during the period. The ultimate benefit for the company, though, is strong operating cash flow and a rock-solid balance sheet, characteristics that allow it to thrive, even in challenging selling environments.
The bottom line
Tuesday Morning has been a big winner over the past year, likely due to expectations for higher profits in the near future. However, with improved profitability more of a hope than a reality, based on the company's recent results, investors would be wise to avoid the story until they see a little more proof in the pudding.