Tuesday, August 21, 2012

A Good Stock to Buy for Housing Market Exposure?

Investors looking for signs of a housing market recovery were cheered when Pier 1 Imports Inc (NYSE: PIR) recently gave a good set of results. In summary, I’m not convinced that this is clear evidence of a recovery.

Larger companies like Home Depot (NYSE: HD) and Lowe's Companies (NYSE: LOW) have both said that they are not really seeing any sign of a housing-related pickup in their sales. Indeed, the commentary around results from Pier 1 was pretty neutral. Consumers don’t appear to be accelerating spending on home furnishings just yet, and in any case, I’m not sure that Pier 1 is the best way to play this theme.

The company has certainly achieved an incredible amount in the last few years. Having been on the verge of bankruptcy in 2009, the turnaround has been little short of sensational. Since then, gross margins have seen a sterling improvement from 27% to nearly 40% currently. It is a textbook story of generating operational efficiency and it isn’t over yet. Store relocations and remodeling are an integral part of the ongoing strategy and management is clearly delivering. Moreover, the stock sits on a lowly rating. There are a lot of things to like about Pier 1 ... but there are also challenges.

E-Commerce and Shipping?

The company will undergo a soft launch of its new e-commerce enabled website at the end of July and frankly, this is a necessity rather than an optional add-on. Pier 1 tends to sell a large volume of low-ticket home furnishings and gifts. In other words, it’s exactly the sort of product that is increasingly sold online via the likes of Amazon. In addition, firms like TJX Companies (NYSE: TJX) are expanding their offerings in home ware. Competition is coming and Pier 1 needs to react to it. The question is, how can they expand an online presence without cannibalizing their own store sales or even, de-facto, encouraging people not to go and experience the sensory pleasure of shopping at one of the stores?

The management's expectation is to increase online sales so that they will be at least 10% of sales within five years, but I think this could be a conservative estimate. The trend toward e-commerce is an inexorable one and low ticket items are attractive to purchasers because they can try and save on shipping costs. The problem is that these costs then get passed onto the retailer. Pier 1’s current plan is to offer the customer the option of picking up the goods in-store or paying to have them delivered.

In contrast to a high-end retailer like Nordstrom Inc (NYSE: JWN), Pier 1 regards free shipping as being effectively a ‘markdown’ and won’t be offering it. This may be laudable but consider that it offers a large amount of small ticket items whilst the average Nordstrom customer spend will be higher. Similarly, its costs could be relatively higher because more of its goods are bulky and fragile.

In addition, the idea of internally crediting the stores with the sales that come from the trade areas in the region is a good way to ensure that employees get internal recognition. However, workers require remuneration for their efforts. So would it be sensible to reward staff for sales that are actually coming from another channel?

Moreover, since the plan isn’t to hold the online inventory at the stores, it’s not hard to see the possibility for a dilemma arising over this issue in future. It is particularly concerning because the stores are intended to have pricing parity with the online offering. In other words, if online competition is forcing online sales to be cut then they will have to be reduced in-store as well.

What Next for Pier 1?

A stronger housing market will help sales and I think it is set for a cyclical tailwind to support it. Thinking more long term, I think there maybe better ways to play this theme. Pier 1 is certainly a cheap option but it faces a combination of execution risk in its own internet-based strategy as well increasing competition elsewhere. Investors need to keep an eye out for how the online offering is developing and whether this will have an effect on in-store sales and gross margins. All of which paints a mixed picture but no one said investing as easy!

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