We review the four recommended companies that reported earnings this week, including GameStop (GME), Macy’s (M), Signet Jewelers (SIG) and Thor Industries (THO). All retain our Buy rating with no changes to their price targets.
GameStop (GME) - Revenues fell 34% from a year ago. In late March and April, all of its U.S. stores and 90% of its global stores were closed, with some offering curbside pickup. All Australian stores were fully open in the quarter. The company provided comparable sales data (-17% excluding stores that were closed, -30% including all stores, and +35% in Australia) but this data is of limited usefulness in parsing underlying demand trends from the Covid impact. Some datapoints indicate that the company remains relevant: online (e-commerce) sales surged over 500% in the quarter, with an even stronger showing in May (after quarter-end).
Adjusted EBITDA fell to a $(76) million loss compared to a $43 million profit a year ago.
GameStop is squeezing cash from the business, as receivables and inventory fell sharply compared to the prior quarter and the year-ago quarter, partly offset by lower payables. Its overall cash position of $570 million provides stability despite being nearly fully-offset by debt.
The company has $471 million in debt due in March - it is asking debt-holders to exchange these notes for new notes due in 2023. This is a bit of a risky move as it not only subjects the company to the chance that inadequate numbers of holders accept the swap (forcing the company to find new lenders) but the new notes pay a 10% interest rate (vs 6.75% rate for the old notes) and it is secured by the company’s assets leaving little additional collateral. GameStop continues to have access to its seasonal line of credit.
At its annual shareholder meeting today, GameStop announced that the two activist-nominated candidates were elected to the company’s board of directors. We believe this is a meaningful positive, as it continues what has been valuable pressure on the company to cut its costs, boost its performance and improve its disclosures. Two indicators: the company recently cut its senior executive compensation by 30-50% and sold its corporate jet.
The biggest catalysts for GameStop are the console upgrade cycle by Sony and Microsoft, followed by any new initiatives to meaningfully boost GameStop’s relevance to gamers. Strategically, GameStop is standing in the shallow waters of the surging gaming river - it wants to wade deep into those waters to ride its full current.
Management is taking steps to control and reverse its cash burn - critical as these steps better-position the company to refinance its debt and to benefit from the upcoming console cycle upgrade (Sony is already starting to provide early views of its new PS5). The company closed 181 stores net of openings, with another 280 or so more stores to be closed by year-end. GameStop is fortunate to have roughly half its stores having remaining lease terms under a year.
We remain positive on GameStop, acknowledging its high turnaround risks.
Macy’s (M) - Preliminary fiscal first quarter results were sharply weaker than a year ago, as the company’s stores were closed for about half of the quarter (February-April). Revenues of $3.0 billion were 45% below a year ago. Operating income fell to a $(969) million loss, compared to a $203 million profit a year ago. Adjusted EBITDA, a measure of cash operating profits, was a loss of $(723) million compared to a $446 million profit in Fiscal 1Q2019.The company cut SG&A expenses by 24%, as its in-store labor was minimal during the closures, but this was not nearly enough to offset the $2.5 billion decline in revenues. For second quarter, Macy’s expects its EBITDA loss to be about the same as the first quarter, then improve as its stores reflect full-openings.
Clearly the company is struggling. The company has sold a lot of inventory, helping boost its cash flow - and expects to be in a clean inventory position by the end of July. On-line sales have surged (not nearly enough to offset in-store) but indicate that customers value the Macy’s venue.It will be closing 100 mall stores, with the remaining 400 stores located in high-quality malls. Macy’s has raised $4.5 billion in cash and liquidity, and held $1.5 billion in cash on May 2 (not reflecting all of the cash raised). This will likely be the limit on cash they can raise, except for the Herald Square (NY) store which remain unencumbered.
Macy’s is taking a very aggressive approach to right-size the company to match its now-diminished revenue outlook. Its recent capital raises leave it with plenty of liquidity, likely to last at least through early-mid 2021.
Most of its stores are now open, with the majority in full-access format, with sales beginning to respond accordingly.
Macy’s will release full results and hold an earnings call on July 1.
Signet Jewelers (SIG) - While the Covid pandemic has hurt Signet like all retailers, the company is pressing ahead by accelerating its impressive turnaround which we believe is producing a more valuable company. Signet’s product category remains healthy - its turnaround is focused on improving its merchandise mix, reducing its exposure to fading retail malls, and boosting its relevance in the digital marketplace. All of these initiative are making good progress.
Revenues of $852 million fell 41%, with comparable store sales falling 39%, with the Covid-related store closures driving the declines. E-commerce revenues grew 7% but were hindered by the shutdown of the James Allen distribution center in New York. Prior to the store closures, same store sales were increasing in the low single digits range (perhaps 1-2%). Per-item gross margins were unchanged, but overall gross margins declined due to the effect of fixed costs. Operating profits excluding write-downs fell to a $(143) million loss from a $24 million profit a year ago.
Signet is accelerating its program to become a digital-first retailer, part of which now includes not re-opening 150 North American and 80 U.K. stores, as well as committing to closing another 150 stores by fiscal year-end. The company has closed most of its “D” mall stores and regional store brands, and is moving to decrease its fleet of stores in “C” and “B” malls. In addition, it is re-investing much of its $185 million in net cost-cuts into its digital platform, which appears to be producing solid results.
The company had negative free cash flow of $(15) million in the quarter, helped by a reduction in working capital. Its cash balance of $1.1 billion was bolstered by new borrowings and looks more than adequate to support the company during the economic re-opening. Debt (net of cash) of cash was $291 million, only $54 million higher than in February.
Signet addressed a potentially large risk - the possibility of its non-prime credit providers pulling their financing. As a reminder, Signet outsourced its former in-house credit operations due to excessive losses. The credit providers, CarVal and Castlelake, will continue to provide credit to existing customers, but Signet will retain the receivables from new sub-prime customers, representing about 2.5% of sales. We are more confident in the current management’s ability to oversee this credit but are a bit wary.
So far, the re-openings have apparently gone well, providing further support for the turnaround. We continue to believe Signet’s turnaround will produce a much stronger, more valuable company.
Thor Industries (THO) - Fiscal 3Q 2020 revenues of $1.68 billion fell 33% from a year ago while operating profits fell 33%. Much of the decline was due to the Covid-19 pandemic and the related stay-at-home orders and closures of many independent RV dealers. However, the company said that demand is gaining strength with the re-opening of the economy in both the U.S. and Europe, with dealers seeing growth in first-time buyers. Thor said that it is seeing an evolution from “work-from-home” into “work-from-anywhere”, which could improve the secular demand for RVs. While we believe this trend is clearly positive, its duration is unknowable. Overall, the company described its North American outlook as “increasingly positive”. Its European outlook remains more unclear.
The company generated $232 million in cash flow from operations, although more than half of this was due to reductions in working capital, which we expect to grow in the fourth quarter as production ramps up. Still, Thor’s flexible operating model is producing considerable cash flow. In the quarter, Thor reduced a variety of costs, including reducing its CEO salary to zero, other top executive salaries by 40% and board of directors compensation by 40%. While these latter reductions may not represent large sums, they provide a valuable signal to the employees that the senior leadership is sharing their pain.
Thor’s order backlog in the U.S. is roughly flat/up modestly, but increased by about 17% in Europe, partly due to higher demand and partly due to the company’s reduced ability to fulfill that demand as it had to close/curtail production on Covid-related safety concerns.
The company’s financial position is improving. It fully repaid its temporary $250 million in borrowings that provided Covid-related liquidity, and also paid an additional $45 million of debt related to the EHG acquisition last year. Thor has $655 million in cash on its balance sheet.
We are reviewing our $98 target as the shares now trade at $101.
Disclosure Note: One or more employees of the Publisher own shares of all Turnaround Letter recommended stocks, including the stocks mentioned in this note.