Friday, November 2, 2012

Pier 1 Imports Analysis

Pier 1 Imports $PIR provided the latest bit of positive evidence towards the idea that housing is a mini sweet spot within an otherwise slow growing US economy. It’s an investment theme that has been working this year and I think investors should not shy away from pursuing it further. There is more to go here.

With regards to Pier 1, there is also the ongoing story of a remarkable turnaround that has been engineered over the last few years. The company was on the verge of bankruptcy in 2009, but since then it has undergone a textbook restructuring that involved aggressive store relocations and remodeling. An example of its operational improvement can be seen in its gross margin improvement from 27% then to around 41% now. Impressive stuff.

Pier 1 Earnings Results

A quick summary of the Q2 results

  • Q2 Revenue of $367.6 million vs. estimates of $367.2 million
  • Q2 non-GAAP EPS of 19c vs. estimates of 19c
  • Full year non-GAAP EPS guidance of $1.10-$1.16 vs. previous guidance of $1.08-1.14 and analyst estimates of $1.16

The results were pretty much in line but the full year guidance raise was good news. In addition there may be more to come. Management forecasted comparable same store sales growth for the full year to be in the mid-single digit range. However this number came in at 6.7% in Q2 so they may be a bit cautious here. The economy is improving gradually and housing is making a slow –if tentative- recovery. Indeed, Pier 1 confirmed that footfall and average ticket item spend was up too. Both are good signs.

Investors might have expected this following recent results from Home Depot $HD. The leading home improvement retailer seemed to mark a turning point in housing by arguing that its growth going forward would no longer be necessarily tied to GDP growth. It’s been a long time coming but housing seems to have turned a corner. Another key takeaway from Home Depot's recent results was that the discretionary elements (kitchens, baths, flooring) were outperforming and the commentary on Florida and California 'stabilizing' was good news for Home Depot shareholders. I think it is a good play on housing.

It’s rival Lowe’s Companies $LOW did not report such positive results, but by its own confession the company needs to improve its level of execution. Lowe’s believes that underlying demand will remain ‘soft’ but was encouraged by ‘improving housing metrics’. Companies usually look to blame the macro environment when they are not performing well, but in this case Lowe's was noticeably more willing to admit that there are some internal issues. This is an indication that it sees the macro environment improving. Lowe's is going to have to prove that it can defend market share before it becomes an attractive play on housing.

Pier 1 Long Term Picture

I like Pier 1 and think that the near to mid-term outlook is positive. My concern here would be more over where the business will be in five years time. Pier 1 typically sells a large volume of low ticket items. In other words, it’s exactly the sort of product that is increasingly sold online via the likes of Amazon and other online retailers. Management obviously knows this because it has just launched (in July) an e-commerce enabled website.

The plan is to generate 10% of sales from e-commerce within 5 years. This would be impressive but I think its approach seems a bit piecemeal and incomplete. Pier 1 wants to give online customers the option to pay for delivery or to pick up the items in store. The former will invite negative comparison with competitors who do offer free shipping and the latter will involve a certain amount of logistical challenges. In addition it could de-motivate staff by having them deliver the online items which could have been bought in store. No salesman likes to see his sales cannibalized by his own company.

Moreover, if store pricing is supposed to be matching online pricing, there will be downward pressure on pricing if Pier 1’s online competitors start competing aggressively on price. In a sense Pier 1 has to have an e-commerce offering but there are a lot of uncertainties going forward. The good news is that these issues aren’t likely to appear anytime soon so the outlook remains positive for the time being.

Competition

Aside from growing online competition, Pier 1 may find itself increasingly competing with discount retailers like TJX Companies $TJX or Ross Stores $ROST. While both companies are better known for clothing they also have expanding home ware operations. More importantly, they are both expanding their store roll outs in response to customer demand. The result will be more competitive floor space selling the kind of home ware products and knick knacks that Pier 1 does.

For example, TJX sees home goods as having the potential to expand to about 750 stores and is reporting strong store performance in stores opened last year. The combination of off-price clothing and home ware sales is working and I expect this to affect Pier 1 in future. As for Ross Stores, it is opening 80 new stores this year.

Where Next for Pier 1?

I think it will probably drift higher as the market chases housing related stocks. I like the theme but am not sure of longer term prospects for Pier 1.  Nevertheless for investors looking for exposure to housing, Pier 1 is a good near term option and there is nothing wrong in buying a stock that you think is going up. Worse things can happen to an investor.