Description
Jo-Ann Stores, a 1000 store nationwide specialty retailer
of crafts and fabrics, is one of my current turn-a-round favorites.
JAS.A traded as high as $32 in 1998 but has tumbled to around
$4 a share. The primary reason being the rocky implementation
of their new SAP Retail system.
My observation of Jo-Anns's chief competitor, Michaels Stores,
is that their improved inventory system -- put in operations in 1997,
has substantially improved operating margins. They also stumbled
with implementing the system, although briefly. -- 1996 = 1.8%
1997 = 7.9%; 1998 = 8.9% and 2000 = 9.5%.
Before Jo-Ann subscribed to the SAP Retail system, it
supported comparible operating margins to Michaels Stores
(1996 and 1997 both 8.1%).
Also, a newly completed Visailia, California distribution
center (630,000 sq. ft.)has been costly -- apr.$50 million plus the extra
cost of carrying 3 centers (the Los Angeles center will be
closed soon). The SG&A expenses should come down considerably
by the end of this fiscal year (end January 2002) when JAS.A
returns to 2 distribution centers.
Between the SAP Retail system and the new distribution
center, Jo-Ann Stores has had capital expenditures of $67.4m
in calendar year 1999 and $75.1m in 2000. Capital expenditures
this year and next will return to a normalized $30m or less.
The increase in FCFE (free cash flow to equity) will be used
to pay down debt which has increased in the past 2 years -- a
new $325m credit facility has been signed in April 2001 for a
term of 4 years (Libor + 1 3/4% - 2 1/4%).
Jo-Anns is in the process (fiscal 2Q and 3Q) of reducing
unprofitable inventory through their SKU inventory plan which
calls for the elimination of some 10,000 items. Jo-Anns currently
carries 90,000 items of which 90% of sales come from 25,000 items.
By the end of the 4Q of fiscal 2002, JAS.A's gross margins and
operating margins should improve.
By the 2Q FY 2003, (in about 1 year) Jo-Ann's with their
loyal customer base (my mother-in-law is one of them), and the SAP Retail
system and the distribution centers fully operational and improvements
in shrink rates, I am estimating sales to be in the $1.65b range --
11% increase this year and flat next year. With gross margins
returning to a modest 45.4% and SG&A expenses at 38.3% -- EBITDA
as % of sales would be 7.1% or $117 million.
At the current $4 share, with approx. 19m shares ($76m market
cap) and $240 of total debt minus the $23m in cash, leaves JAS.A's EV
at$293m. Debt may increase at bit but should stabilize with the
balance sheet in mid calendar 2002.
An EBITDA of 4X is not unreasonable (compared to Michaels Stores
near 6X) with valuations in the early and mid 1990's of 4X+. $117m
EBITDA times 4 = $468m. Subtract the $240m debt and this leaves
$228m for equity. Divide $228m by the 19m outstanding shares and
a value of $12 is assigned.
Finally, there are 2 additionl positives (not including the macro
stimulus of monetary and fiscal policy). A potential bonus -- maybe
2 years out -- is the likely increase of significant improvements in
inventory turnover. A turn from a current paltry 1.8 to 2.0 would
bring smart gains to the bottom line. The other plus is a $22.5m
NOL tax carry-over. EPS will look extra good for a while.
And of course, a couple of concerns. First, JAS.A's stock
option pro-forma for fiscal 2001 was an aprox. 15% drag on earnings.
Long term investors should consider this. Also, shrink rates
deteriorated 50 basis points last accounting period. This issue
is currently being adressed by management, but it is worth keeping
an eye on.
Catalyst
The successful implementation of Jo-Ann's new SAP Retail
system, along with the new West Coast distribution center
becoming fully operational, should lead to significant improvements
in gross and operating margins. A return to historical margin norms
would bring an approx. $12 value to the stock in less than 18 mo. Also,
a potential additional increase in share price over a longer term as
inventory turnover increases.