Description

Overview

HH Gregg is a specialty retailer of appliances (49% of LTM sales), consumer electronics (37%), computers and appliances (9%), and home products (5%).  The Company leases and operates 228 stores averaging 32k square feet in the South (58% of stores), Midwest (32%) and Northeast (10%).

HGG stock has been decimated over the last 1.5 years, shedding ~60% of its value, as sustained negative comps in consumer electronics have been accompanied by deteriorating same store sales in computers and tablets (which have gone from -7.2% a year ago to -33.7% in the latest quarter) and appliances (once a bastion of strength, comps in this segment have gone from 2.6% to -5.8%). Reduced guidance and operational missteps have exacerbated an already stressed situation.

Valuation

HGG now trades for 0.07x sales (using avg. net cash from last 4 quarters) vs. 0.27x for Best Buy and 0.15x for SHOS (though, admittedly, neither are great comps from a product mix / business model standpoint), and less than tangible book value.  Short interest is elevated at ~1/3 of float and the sell-side has abandoned the stock (13 holds / 2 sells / 0 buys).  The Company has no debt and sits on a mountain of liquidity with $400mn of unused capacity and borrowing availability of $186mn as of Sept 2014, way more than sufficient to meet seasonal working capital needs.  To paraphrase from a conversation we had w/ the new CFO, the Company's liquidity profile is "more attractive than anything I've seen in the last 10 years". 

Potential Opportunity

On Sept 11, the Company announced the hiring of a new CFO, Robert Riesbeck, who served as CFO at Sun Capital Partners, a private equity group with a distressed/turnaround focus.  He purchased 100k shares at $4.86 on November 4, unprompted by mandatory ownership requirements.  We've had a few conversations with Robert in the brief time he's been at HGG, and while it's early days, we're encouraged:  

(1) For years following its IPO, unit growth was aggressive and that's been costly for shareholders.  It's clear that prior ambitions of 600 nationwide stores have been tabled indefinitely.  

(2) Working capital management has not historically been a strong focus for HGG, with turns (rev basis) slowing dramatically over the years, from 8x-9x/year to less than 6x, while BBY's turns are higher and have improved over the last year. Robert's spent the last decade+ on working capital management and sees this as an area of improvement

(3) HGG spends too much on advertising relative to its revenue (~6%) compared to BBY (~< 2%) and CONN (~5%).  Even a 1% save could translate into an incremental ~$20mn in pre-tax profits.

There are other strategic initiatives that seem generally sensible to me:

(1) Continue placing greater emphasis on appliances, including high-end, higher margin "Fine Lines" segment.  The Company touts its high-touch service as a differentiating competitive advantage....they can do broad, complex installations ("we're going to cut your countertops, we're going to do cabinet work, we're going to install a water line, gas hook up"), and they want to emphasize product categories that cater to that orientation.  

According to management, appliances are generally a less volatile category as 65% of purchases in a given year are duress-driven (vs. 20-30% for TVs); another 10-15% remodeling and the remainder comes from housing turnover.  New house builds are less relevant as the largest homebuilders source directly from manufacturers.  But, make no mistake, this is still a cyclical category as evidenced by the 15%-20% segment comp declines from 2008/2009.

I'm somewhat concerned about the increasingly promotional tenor of this category.  A few quarters ago, management commented that promotional activity in appliances was relegated to increased ad/marketing dollars, but the Company has now started offering free instant delivery on appliances (vs. mail-in rebates prior), and that negatively impacted gross margins by 50bps in the most recent q.  SHOS is seeing free delivery on top of pricing pressure.

(2) Increase the number of furniture brands and price points therein.  Prior to the summer, the Company offered a single brand.  The newer brands carry higher ASPs and gross margins, and the category itself is materially higher gross margin than the co's overall (a few quarters ago, the Company commented that it would be 13%/14% of gross profit at 10% of revenue).  Furniture will be around 6% of sales this fiscal year, growing to 10% by next.

(3) Expand third-party credit offerings.  All non-recourse, so not a future balance sheet risk.  The % of sales funded w/ 3rd party credit has expanded from 29% to 37% over the last 3 years, though the Company admits that progress here has been slower than they'd like (which makes CONN's 30%+ receivables growth from a year ago all the more incredulous).  The Company's primary credit offering is through GE, while newer secondary and tertiary offerings to lower income consumers that have been rejected by GE, are underwritten by Tidewater and Progressive.  They also rolled out lease-to-own through RAC in FY13.  An hhgregg card holder is 4x more likely to make a purchase and generally guy higher ticket items w/ warranties attached.     

(4) New technology/productivity investments like in-store price comparison tools, POS rollout, new delivery tracking system, e-commerce (only ~5% of biz but growing 50%-60% / yr).

The Company has guided towards flat EBITDA for the fiscal year ended March 2015 (vs. LTM EBITDA of $11mn).  Historically, the Company averaged ~5.5% EBITDA margins.  Am I being unreasonable by setting my sights on $100mn in EBITDA (~4.5% margin on LTM revenue)? That seems really far away but it's not outside the historical range.  Dare I say 6x on $100mn? ~$22+ stock (w/ no credit for cash build in the interim)?  Crazier things have happened.

Also, while I don't want to hold myself to a near-term call on holiday sales, management commented that it started to see comp improvement w/ post-Labor Day sales down msd, vs. -11.4% for the quarter as a whole as comps turned positive in appliances, stayed positive in home products and got less negative in consumer electronics and computing.  It also sounds like during the last holiday season, the Company has some major missteps (they were not competitive during holiday hours and didn't maximize the e-commerce channel) that should set up for an easier comp.

History 

In July 2007, the Company went public in a PE-backed IPO (3.75mn primary shares / 5.63mn secondary) at $13/share w/ visions of 15%-18% unit growth and a long-term opportunity for 400 stores.  

Two years after the IPO, the Company executed another equity offering (3.5mn shares offered at $16.50, all primary) to fuel accelerated store growth following the Circuit City bankruptcy.  In the two years from IPO to secondary, the Company grew from 79 stores to 113 and with the proceeds from the secondary, announced its intent to open 20-22 stores in FY10 (ending March) and 40-45 stores in FY11, while concurrently bumping up the long-term potential to more than 600 units, a target they maintained as recently as two years ago. 

Store productivity has steadily declined over the last decade - from $14.5mn-$15mn / unit to < $10mn today.

FS ownership

Freeman Spogli (a middle market private equity firm and current 47% owner of HGG) obtained its position in Feb 2005, when it acquired most of “Gregg Appliances”, predecessor to hhgregg, as part of a recap to cash out family members.  It looks like they sold 4.6mn shares into the IPO at $13 but purchased 1mn shares in the July 2009 secondary offering at $16.50, bringing their total ownership to around 13.5mn shares, where it stands today.  So, they've been involved for nearly a decade and have had plenty of opportunity to unload at higher prices, though wee haven't spoken to anyone at Freeman Spogli and can't speak to their current intentions. 

Risks

This is a mediocre company (trading at a bombed out valuation) in a tough sector facing secular challenges.  Size accordingly.

I would give management a C-rating, though there's been a fair amount of turnover over the last year, and this grade could change w/ Robert coming on board.

Catalyst

No hard catalyst.