Did Bon-Ton Stores (NASDAQ:BONT) bite off more than it could chew by buying a chunk of stores nearly twice its size? The market doesn't seem to think so lately; the stock is up almost 40% year to date. Yesterday's results covered Bon-Ton's first quarter as a combined company, and shares jumped more than 8% to close at $26.42. Was this justified?
Back in October, Bon-Ton announced the purchase of 142 stores from Saks' (NYSE:SKS) Northern Department Store Group, or NDSG, for approximately $1.1 billion. The deal, motivated by Saks' decision to focus on its namesake stores, closed in March. Bon-Ton's 271 department stores now include Bergner's, Boston Store, Carson Pirie Scott, Elder-Beerman, Herberger's, and Younkers. Combined, they span the upper Midwest and Northeast regions of the U.S.
Results for the quarter were skewed by the NDSG transaction, causing sales to jump 114%. However, Bon-Ton's same-store sales fell 2.9%; they have been weak for the past couple of years. NDSG sales were a bit stronger, up 1.7% since their acquisition March 5. Due to integration charges, earnings for the quarter were negative, but full-year earnings guidance stands at $2.15-$2.35 per share. That's higher than initially forecast, which may explain the recent pop in the stock. The market clearly liked recent guidance, but it will take at least this year for Bon-Ton to work on integrating its sizeable acquisition. As a result, don't expect much improvement in same-store sales growth for the company as a whole.
The most frightening development from the NDSG transaction is the significant amount of debt Bon-Ton took on to fund the purchase. Its net debt-to-total capital ratio now exceeds 80%. I tend to avoid companies with a debt-to-capital ratio higher than 60%, because any operational difficulties could complicate their ability to pay interest expense related to indebtedness. Serious difficulties can even lead a company into bankruptcy.
Bullish investors expect the recent NDSG purchase to result in cost-reduction synergies, but the new entity will still face anemic sales growth, since both the original Bon-Ton and NDSG department-store brands have been struggling for quite some time to boost their top lines. Combining two organizations with mediocre sales just leads to one bigger, uninspired entity, and cost-cutting measures can only go so far.
The stock is unquestionably cheap, with a trailing P/E of about 16 and forward P/E of 11-12, based on recent guidance. But again, it's useful for potential investors to consider the opportunity cost here -- the simple risk of missing out on better investments. Overall, investors stand a better chance of outperformance in the newer breed of mass-merchandisers, such as Target (NYSE:TGT), Wal-Mart (NYSE:WMT), and Kohl's (NYSE:KSS). As a comparison, Target currently trades slightly below 18 times trailing earnings, while Kohl's trades at 21 and Wal-Mart at 18 -- higher multiples, but worth paying for.
In my opinion, an investor is risking less by going with retailers with significantly less debt and more compelling growth outlooks, both in the near term and over the next decade or so. Things may work out well for Bon-Ton and its recent NDSG purchases, but faster-growing competitors with better business models and track records may prove to be the safer and more profitable bet.
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Fool contributor Ryan Fuhrmann has no financial interest in any shares mentioned. Feel free to email him with feedback or to discuss the company further.
