Pier 1 Imports (NYSE:PIR), a 40-year-old success story with great consistent growth and a superb brand, seems to have lost its way for the better part of two years. Pier 1's stock price has consistently stayed around $18 since August of this year, helped by an aggressive buyback of 2.4 million shares at an average price of $17.93 and Berkshire Hathaway's (NYSE:BRKa) purchase of 8 million shares. It unfortunately doesn't reflect the inability of its management to revive and boost same-store sales, which have been sagging for the second year in a row.
Comparable-store sales had declined 2.2% for the year ended February 2004, after having grown 4.7% and 4.5% in fiscal 2003 and 2002, respectively. Besieged with weak merchandise and the lack of a clear-cut marketing strategy, same-store sales dropped 3.7% in the first nine months of fiscal year 2005. Comps, which fell 3.4% in the first two quarters, slid further by 6.1% in the third quarter, aided primarily by a dismal 9.1% decline in November 2004.
Net margins dropped to 2.5% from 4.5% in the first half of the year, due to poor merchandise, fewer footfalls, heavy promotions, and discounting. Earnings per share for fiscal year 2005, estimated by the company at the start of the year to be in the $1.20-$1.30 range, should claw their way to about $1.00.
The brand weakens
Struggling to sell merchandise and then, eventually, resorting to heavy promotions or discounts suggests several things:
a) The brand has not been strong enough to convince customers to buy knick-knacks without any discernable value.
b) Pier 1 has not been reading its customers right. Some 70% of the merchandise is new and the company is pushing to take that to 75%. That's way above historic levels of 40% in the 1980s and 1990s, and higher than the 60% to 65% level over the past five years. Pier 1 is simply not getting the right products on the shelves.
c) The switch to the new spokesman Thom Filicia from Kirstie Alley has not generated the buzz management would have liked. In October 2004, Pier 1 switched advertising agencies, too, hoping to recover lost ground.
d) Competitors like Bed Bath & Beyond (NASDAQ:BBBY) and Williams-Sonoma (NYSE:WSM) are doing a better job. I wouldn't be surprised to see more competition from places like IKEA too. IKEA offers a much larger shopping experience, and that could eliminate or reduce the need to visit Pier 1. One could argue that while IKEA is much cheaper and appeals to a different demographic, it does have substitute products, and that often eliminates the need for a walk-in to drive across town.
e) Pier 1 might have penetrated its band of loyal supporters to the fullest and is now having a tough time converting the swing shopper. My guess is that there are a precious few, if any, who shop exclusively at Pier 1. I would also guess that most new homeowners in the past two years have been at lower income levels -- aided by lower interest rates and taxes -- and are more likely to shop at Bed Bath & Beyond and IKEA than Pier 1.
Uncertain growth strategy
What other strategy could Pier 1 adopt? Going down-market to counter mall-based competitors is not a good idea since its merchandise consists largely of handcrafted imports targeted at the higher end of the market. Doing more incisive research and offering better merchandise could be a more productive option. Steady average ticket prices and fewer footfalls indicate that the loyal shoppers are still going there but are disappointed with the merchandise.
Pier1 wants to reach about 1,500 stores in the next three years from the existing 1,189 (as of February 2004) and, as mentioned above, plans to increase new merchandise to 75% of items (on a yearly basis) to lure back customers. The strategy to continue opening 110 stores (around 10% of total space) in a struggling comps scenario every year could boomerang on Pier 1, besides dragging margins into the gutter. Management confidently stated in last year's annual report that it has strong research to back this move. However, to execute this it will have to do a lot better on merchandise, marketing, and positioning.
Strong competition
Bed Bath & Beyond, while conceptually different (it's about three times the average store size of Pier 1, is situated in malls, appeals to a wider demographic, stocks more mass items, and obviously does not provide the same aesthetics), could be a bigger threat due to its lower penetration levels (around 600 stores), and because it successfully erodes Pier 1's brand advantage in lower-value decorations, knick-knacks, and essentials.
Williams-Sonoma, on the other hand, is conceptually closer to Pier 1, and like Pier 1, has warned of slowing growth in the last quarter. Still, it has remained on top of its game as far as execution of merchandising and marketing strategy are concerned. Like Pier 1, Williams-Sonoma also stocks 64% imported items, but has a much stronger catalog segment and has grown same-store sales at 4.5% this year.
Still not a bargain
Not surprisingly, Pier 1 is the cheapest of the lot, trading at 19.5 times estimated fiscal year 2005 earnings of $1.00 per share. Bed Bath & Beyond and Williams-Sonoma -- both with stronger margins and higher growth -- are available with comparable valuations: Bed Bath & Beyond at around 21 times estimated forward earnings of $1.88 per share, and Williams-Sonoma at around 22.8 times estimated forward earnings of $1.60.
Pier's past-three-year sales and income growth of 10% and 7%, respectively, lag the 23% and 32% of Bed Bath & Beyond, and 14.5% and 40% of Williams-Sonoma. Operationally, for the past three years, Pier 1 has been earning 6.4 cents on each dollar of sales, better than 4.9 cents for Williams-Sonoma, but lower than the 8.2 cents earned by Bed Bath & Beyond.
Investing in Pier 1 at $19 is iffy. Even with the struggles it has had over the past two years, the company is as rock-solid as ever. It has huge cash reserves, a great brand, and generates more than $100 million in free cash every year. The promise of a buyback of at least another million shares will ensure that the stock price remains at these levels. But if competitors like Williams-Sonoma, Bed Bath & Beyond, and IKEA keep eroding its market and Pier 1 is too slow to respond, then I would wait for more positive signs than a share buyback. The big question is not the weak comps themselves; it's why is it taking the firm two years to fix them?
Fool contributor Bobby Shethia doesn't own any shares of Pier 1 Imports or any of the other companies mentioned here. His wife doesn't trust him to shop for furniture. The Motley Fool has a disclosure policy.
