If you are one of the many who have the remarkable ability to create pieces of art from a jumbled bundle of thread, you get a big high five from me. I am about as a capable with a needle and thread as I am in swinging to a handstand on gymnast still rings -- which is to say, it's not happening. While quilting enthusiasts will recognize the term stitch in the ditch as a technique for joining two sections of fabric, because I have zero sewing skills, I'll unabashedly use the term liberally. Linens 'n Things (NYSE:LIN) has stitched together a nice fourth quarter, but this Fool believes the stock may be in a ditch because of its valuation.
Let's take a look at the good news first. From comparable store growth of 2.7%, the company produced quarterly sales of $857.7 million and earnings of $45 million, exceeding analyst expectations. Its revenues increased 11.1%, but because of a newly applied accounting procedure (EITF 02-16), its net income for the quarter was a million dollars shy compared with the same period a year ago. (The accounting rule changes how companies that resell products account for payments vendors made to them for promotional consideration.)
EITF 02-16 had an even more pronounced impact on the company's earnings for fiscal 2004. For the year, Linens 'n Things' net income was $63.1 million -- significantly below the $74.8 million from 2003. However, it's important to note that if you remove EITF 02-16 from the picture, the earnings actually increased year over year, so on a strictly operational basis, the firm did well.
Looking ahead, the company expects its 2005 earnings to be $1.80 to $1.86 per share -- 33% higher than the $1.38 offered in 2004. Yet it does project a slight decrease in its sales growth rate, with an estimated 8% to 10% growth compared with 11% last year. With the company's price-to-earnings ratio at 19.5, its stock appears to have already factored in 2005's blended earnings and sales growth rate of 20%. Because it's difficult to make a case that Linens 'n Things is selling at a discount, we need to find other reasons to buy its fully valued shares.
The company has positive cash flow, which is no small feat in an industry with razor-thin operating margins. Its free cash flow has allowed it to carry a manageable balance sheet with $204 million in cash and $127.6 million in long-term debt. However, it takes more to whet the appetite of Foolish investors than 4% to 5% operating margins and marginally decelerating sales. And it's difficult to see its margins and resulting cash flows significantly improving when considering the competition includes some tough players such as Jo-Ann Stores (NYSE:JAS), Michaels (NYSE:MIK), Bed Bath & Beyond (NASDAQ:BBBY), and general retailers Target (NYSE:TGT) and behemoth Wal-Mart (NYSE:WMT).
Linens 'n Things sewed together a fine fourth quarter, but its threads appear to be a bit too pricey with a stock trading at a forward P/E of 15. This may be a good time to exercise patience and perhaps even pick up sewing. You may even have time to practice the stitch in the ditch while waiting for an attractive buy-in price.
Fool contributor Jeremy MacNealy does not own shares in any of the companies mentioned.
