Description

Link for Charts & Graphs : Link

Gordmans is a small Midwestern retailer. Hearing that, I know some of you already have discarded the idea, I can't blame you, but that reaction could help create opportunity. Secondly, there are no signs of tangible improvement with the business. However, there have been recent developments which could be the start of stabilization and eventual improvement at GMAN. These developments include multiple management changes, the introduction of a supplementary strategy, and insider buying. We have kept this position small given the uncertainty and potential for large loss.

Business Description-

Gordmans is a Midwestern everyday low price retailer. As of Q3, the company operates 98 stores, with the goal to operate 97 by year-end 2014. The company sells apparel (60% of YTD sale), home fashions (25%), and accessories (15%). The stores average 56,000 square feet. The stores feel like a TJX, but they have more fixed fixtures, which can help make the store more aesthetically pleasing, but limits layout flexibility. Sun Capital continues to own a majority of the stock. GMAN v. peers can be seen at the link above. Please note the chart is from YE 2013 (GMAN’s EBITDAR margin has since declined to approximately 10.5%).

Old Management-

Jeffrey Gordman stepped down from the CEO position in March of 2014. Gordman was the great-grandson of the founder, who opened the first predecessor to Gordmans in 1915. Jeff had been CEO since 1996, after an investment banking stint at Lehman. In 2008 he sold the business to Sun Capital, which subsequently IPO’d the stock in 2010.

Speaking with current management and store personnel, a lack of leadership resulted in poor morale. Jeff Gordman was overbearing on top executives and often made decisions based on instinct rather than data. Sure, some retailers succeed based on instinct driven management, but once comps turn decidedly negative, this should send a signal that instincts are misplaced. One example of Jeff’s decision process is advertising. The company focused advertising on building the Gordmans brand rather than highlight deals/name brands that could help drive traffic. There was also no attempt to measure ROI for this expense, even though current advertising runs at close to $1.00 per share on a pre-tax basis.

Meeting with Jeff did not evoke strong feelings of confidence.

There were a couple of bad decisions made during Jeff’s tenure. The first being the special dividend. In August 2013 the company levered up ($45 million second lien term loan) to pay out a $70 million dividend ($3.60). This decision, which in all likelihood was driven by Sun Capital, created a large burden that has continued to become more onerous. The second poor decision is the new distribution facility, which can be assigned to Jeff. This distribution facility DOUBLED capacity and cost over $20 million. Lastly, the third poor decision was the new HQ. This leased office required substantial capex. The building looks more appropriate for Microsoft, Twitter, or Google than a struggling, unprofitable, retailer. It is clear that shareholders capital was squandered by Jeff.

New Management-

Andy Hall was announced as the new CEO in August 2014. Andy had previously been with Stage Stores from 2006 through 2012. In 2012 Stage generated $1.6 billion in sales (v. GMAN’s $640mil) and operated 864 stores (v. GMAN’s 98). Prior to Stage, Andy worked at May and Arthur Anderson. Andy has experience with all functions of retail including: merchandising, planning and allocation, corporate finance, and real estate. The new CEO is a big improvement from Jeff Gordman in my opinion. Andy isn’t afraid to make decisions and take full responsibility. This mentality can be seen in the Q2 2014 conference call, where Andy had only been in place for a week, yet he led the call and answered all questions. The pre-existing management team welcomed the change, as they had all been growing frustrated with the prior CEO.

Andy’s new strategy will entail more data driven decisions throughout the business and more square footage dedicated to off-priced buys (which I will detail below).

Other recent hires include Amy Myers as Chief Marketing Office (Things Remembered background) and Lisa Evans as Chief Merchandising Officer. Lisa was EVP and Brand Leader at Carter’s and a SVP and GMM at Macy’s, Andy has worked with her in the past.

Move to Off-Price Oriented Strategy-

One of the most meaningful changes Andy will attempt is a move to incorporate more off-priced product in the mix. Although GMAN has previously stated it was an off-price player, they were extremely particular in what off-price product they were buying. Historically, off-priced product represented less than 3% of total sales, while the opportunity is to take that to 30%.

A lot of the buying team members have off-priced experience. At the time of my last conversation with management, the decision had not yet been made to either mix off-priced buys into the existing layout, or carve out a section of the store for off-priced goods only.

It is also important to note that Andy Hall launched Steele’s during his tenure at Stage. Steele’s is an off-price concept that Stage launched in the fall of 2011, grew to 35 units, and was subsequently sold off in March 2014.

The rationale for adding off-priced merchandise is it will help drive traffic to GMAN stores. Since GMAN is an everyday low price retailer, there has been little urgency to visit the stores. By flowing through fresh receipts of off-priced merchandise, Hall hopes to give GMAN customers a sense of urgency.

Inventory PSF Continues to Run Below Comps Gross Margins Finally Expanding-

Inventory per square foot was growing too fast, and as comps slowed management was taken off guard. To correct for this mistake, inventory has to be marked down to keep the product on the floor fresh. It is likely that inventories are at appropriate levels here. Management has commented that receipt reduction in recent quarters has likely left sales on the table.  See link above for graph.

Insider Buying-

There was some insider buying in late September, shortly after Andy took the reins. The most significant transactions were Scott King’s purchase of 50k shares on 9/15, and Andy’s purchase of 100k on the 17^th and 18^th. King was the interim CEO, and was previously a Senior Managing Director at the majority shareholder Sun Capital.

Weather/Gas Should Be A Tailwind in H1 2015-

Although I dislike incorporating weather in an investment case, in this instance, I think it is warranted. Approximately 70% of GMAN’s footprint is in the mid-west, which had an extremely harsh winter last year¹².

Gas prices may also benefit GMAN. According to the BLS, the gas budget for the average consumer unit amounted to just over $2,400 in 2013. The BLS also estimates the average consumer unit spent $51,100 in 2013. Assuming energy expenditures fall 30% Y/Y this could add 150 bps of growth to all categories (assuming categories shares stay flat (including savings), which they won’t). The negative implications of energy on GMAN will be its exposure to the Bakken. However, with only 5% of its footprint in N. and S. Dakota, this risk is manageable.

Another near-term benefit is that GMAN opened on Thanksgiving this year. This will likely be a 1% tailwind to comps in Q4. And although profitability may be negatively impacted, it is important to note that many of their “door busters” are planned buys specifically for that purpose.

Balance Sheet & Liquidity-

Gordmans capital structure is less than ideal for a retailer in their position. The company has an $80 million revolver which is subject to a borrowing base, of which $5.8 million was drawn at the end of the third quarter and $67 million was available. In addition to the revolver the company also has a second lien term loan for $45 million. Both the revolver and the term loan are due in August 2018.

Subsequent to Q3, the company prepaid $15 million under the second lien note using the revolver.

The company has hit covenants on the second lien note in the past, most recently in June 2014. As of today, the term loan contains a liquidity test ($20 to $30 million in liquidity depending on fixed charge coverage), a leverage ratio (that was significantly boosted in November³, GMAN will have more than 1 turn of breathing room in each of the next five quarters), and capital expenditure caps⁴. The revolver has a liquidity covenant.

Bottom line is the most recent amendment gave the company considerable breathing room.

Valuation-

If the company can stabilize sales (an interesting thing to note here is GMAN also has >3 million loyalty card members who represent 70% of sales) then subsequently grows sales, I would expect the EV/Sales multiple to move closer to peers (SSI/SMRT). Given the leverage on the business and the depressed multiple assigned to shares, the upside could be substantial.

The downside is likely significant as well, though I doubt $0 is in the cards for the next 12 months. I plan on giving the company 2-3Q’s, if there is no tangible evidence of improvement, I will be closing and moving on. 

Catalyst

• Earnings
• ICR, GMAN has pre-announced in the past.  ICR scheduled for the week of Jan 12th