KIRKLAND'S INC KIRK
August 09, 2011 - 4:33am EST by
rhg
2011 2012
Price: 8.79 EPS $1.00 $0.00
Shares Out. (in M): 20 P/E 8.7x 0.0x
Market Cap (in $M): 175 P/FCF 0.0x 0.0x
Net Debt (in $M): -90 EBIT 0 0
TEV ($): 85 TEV/EBIT 0.0x 0.0x

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Description

Summary

Kirkland's (NASDAQ:KIRK) is a leading specialty retailer of home décor that has a fortress balance sheet and is super cheap today on every possible metric. For the patient investor that has a 5 year horizon, I believe that the risk/reward offered by Mr. Market is very compelling - very conservatively it's a ~2x upside by 2015 or an IRR of 14% and a near zero chance of permanently losing capital.

$m except per share data

 

Current Price

$8.79

(x) Shares Outstanding

19.92

(=) Market Capitalization

175.10

(-) Cash & Short Term Investments

90.25

(+) Total Debt

0

(+) Pref. Equity

0

(+) Total Minority Interest

0

(=) Total Enterprise Value

84.84

 

 

2008A

2009A

2010A

2011E

Revenue

391,277

396,701

446,828

440,000

Growth %

NA

1.4%

12.6%

 

Gross Profit

133,991

168,506

170,536

 

Margin %

34.2%

42.5%

38.2%

 

EBITDA (Net Tenant Allow.)

28,410

61,443

54,791

 

Margin %

7.3%

15.5%

12.3%

 

EBIT

9,669

46,938

41,974

30,800

Margin %

2.5%

11.8%

9.4%

7%

NI

9,305

34,570

26,431

20,020

Margin %

2.4%

8.7%

5.9%

4.6%

Diluted EPS

0.47

1.71

1.28

1.00

Diluted Shares Out.

19,691

20,249

20,578

20,578

OCF

29,562

49,972

36,700

 

FCF

30,552

39,726

14,104

 

Net New Stores

-36

-20

+21

+20

Cash & Cash Equivalents

36,445

76,412

91,222

 

Inventories

38,686

39,355

44,452

 

ROA

7.5%

23.7%

14.7%

 

ROE

19.6%

49.1%

25.6%

 

EV/EBITDA

   

1.5x

 

EV/EBIT

   

2.0x

 

EV/OCF

   

2.3x

 

EV/FCF (incl. growth capex)

   

6.0x

 

P/E

   

6.8x

9.0x

P/E less cash

   

3.4x

4.5x

Background

KIRK sells items such as framed art, mirrors, candles, lamps, pictures frames, accent rugs, garden accessories and artificial floral products. Its customers are mostly 25-55 female from the "sun-belt" region who are looking for home décor items priced in the "value" range. KIRK appeals to its customer base by sticking to traditional styled items that are based on widespread trends, rather than by being a fashion leader. Their merchandising strategy is to house limited SKUs that are carefully selected rather than carry a full range within each category. This helps the business have a high inventory turnover, leading to a constant flow of new products thereby creating a treasure-hunt type environment, and a sticky customer that keeps coming back.

The company operated successfully for years until it went IPO in 2002. With the new money raised, management went crazy and started opening locations outside their "core" markets. What worked well in the "Middle America" didn't resonate well with the fashion conscious crowds of Los Angeles. Their problems compounded further as management experimented using a fashion forward theme-based strategy. This didn't appeal to their new customers of Los Angeles. and it alienated their loyal customers of Louisiana. Management realized that something was fundamentally broken, so they fired the responsible merchandisers, closed locations outside their core markets, and went back to their proven merchandising strategy. The numbers for 2008-2010 speaks for an honest management team that owned up to its mistakes and turned around the company. I encourage you to read previous VIC write-ups by banjo1055 (Sept 08) and edward965 (Mar 09) to get a flavor for the turnaround.

 

 

Q1 11

Q4 10

Q3 10

Q2 10

Q1 10

Q4 09

Q3 09

Q2 09

Q1 09

Q4 08

Revenue

94,403

139,606

92,725

89,504

93,465

142,797

92,389

87,688

83,320

133,638

SSS Growth %

-8.4%

-7.9%

-2.4%

1.0%

12.6%

10.2%

11.3%

6.1%

5.2%

5.3%

Gross Profit

38,088

59,085

35,993

34,822

40,636

64,621

38,142

33,569

32,174

51,647

Margin %

40.3%

42.3%

38.8%

38.9%

43.5%

45.3%

41.3%

38.3%

38.6%

38.6%

EBIT

5,166

22,191

3,766

5,064

10,953

30,491

7,643

4,776

4,028

15,751

Margin %

5.5%

15.9%

4.1%

5.7%

11.7%

21.4%

8.3%

5.4%

4.8%

11.8%

NI

3,170

14,382

2,279

3,252

6,518

22,078

5,570

3,444

3,478

15,022

Margin %

3.4%

10.3%

2.5%

3.6%

7.0%

15.5%

6.0%

3.9%

4.2%

11.2%

Diluted EPS

0.15

0.70

0.11

0.16

0.32

1.09

0.27

0.17

0.17

0.76

Diluted Shares Out.

20,660

20,548

20,552

20,636

20,607

20,453

20,333

20,204

20,008

19,901

Why Cheap?

KIRK is not a turnaround today and operating within its core competencies. So, why has Mr. Market thrown this baby with the bath water?

Negative SSS

7% of the 8.4% decline in SSS last quarter was due to lower transactions, and the rest was due to slightly lower ticket. The lower transactions were mostly because of lower conversion and only slightly due to traffic. Management commented that these trends indicate that current merchandize may not be resonating well with the customers.

This is not alarming, in my opinion, and in fact quite expected on occasions given their strategy of housing only limited SKUs. Not having a full range of items, KIRK has to execute each time a customer shows up at stores (unlike a Bed Bath & Beyond where merchandize does not change that much). Current merchandize not resonating well does not trouble me much because KIRK's strategy also allows them to stay nimble and quickly get out of "unwanted" SKUs without much risk of inventory (relatively speaking). The real upside to this strategy is that KIRK has much high inventory turns than many of its peers. 

 

KIRK

PIR

BBBY

CPWM

TJX

ROST

Inv. Turnover (TTM)

5.99

2.75

2.67

3.43

5.76

5.58

The other reason for lower conversion could be due to consumers' lower discretionary spending in light of macro concerns. Remember the last two quarters were in the backdrop of pretty high oil prices. The pendulum has now turned and oil prices are coming down, but now concerns have turned to a double dip. Not to be flippant about these issues, but I think KIRK has gone through a pretty stressed environment in 2008-2009. The last global recession was considered as one of the worst since the great depression, and in my opinion, KIRK did fine in that environment.

Margin Compression

Gross margins have compressed by 313 bps in Q1 11 compared to prior year quarter. A 175 bps reduction was due to higher promotional activity and discounting (for reasons explained above), a 69 bps reduction was due to store occupancy costs caused by deleverage and fewer rent negotiations, and the rest of the reduction was due to freight costs. Operating margin compression in Q1 11 was primarily due to deleverage caused by negative SSS. I have no ability to predict what margins will look like if US goes into a double dip, and my guess is as good as yours. But I'll take a shot anyways - I think depressed EBIT margin is closer to 6% and peak margin is closer to 11% and 2011E is pretty close to depressed margins. 

Reduction in Net New Store Growth Forecast

In Q1 11, KIRK moderated its net new store growth forecast from 40 stores to 20. Management commented that they are finding it increasingly difficult to close on deals as landlords are holding out for better rates. Management is focused on finding the right locations rather than focusing on growing for the sake of growth. Shows they learnt their lesson well from their prior life fiascos on locations. In this business, location can make or break you. The street obviously did not take the renewed guidance very well. If U.S. does indeed goes into a double dip, I think management will slow down net new growth and release much of growth capex, hopefully, for shareholder friendly uses.

Valuation

Comparing KIRK to its peers, it's clearly evident that KIRK is much cheaper than the rest. The possibility that a major revenue decline due to a double dip can cause major deleverage is always there (although these were the same consumers that showed up at KIRK's footsteps during the worst recession since the depression), but at today's price, I think even this outcome is baked in. Besides KIRK has the balance sheet to live through this scenario. 

Data from Cap IQ

KIRK

PIR

BBBY

CPWM

TJX

ROST

EV/EBITDA

1.5

5

6.7

6.5

7.4

7.2

TTM P/E

6.8

9.9

15

15

16

14

2013E P/E

7

9.5

11.7

7

11.5

11.5

 

2015E

Worst

Base

Best

Revenue

     

Avg. net new stores / yr

0

15

20

(x) revenue / store

1.5

1.5

1.5

(=) 5yr x Total new store revenue/yr

0

112.5

150

2011E sales

440

440

440

(x) Growth in revenue

0%

0.5%

1%

(=) Growth in current store base revenue

440

451.1

462.4

Total Revenue

440

564

612

     Implied Revenue CAGR

0%

5%

6.8%

(x) EBIT Margin

8%

9%

10%

(=) EBIT

35

51

61

(x) (1-Tax Rate)

62%

62%

62%

(=) Net Income

22

31

38

Implied Net Margin

5.0%

5.6%

6.2%

Shares Out (5M reduced from 2011E)

15

15

15

EPS

1.45

2.10

2.53

Implied P/E (at $8.79)

6.0

4.2

3.5

Target P/E

6

8

10

Value

8.73

16.77

25.31

Upside

-0.7%

90.8%

188.0%

IRR

-0.1%

13.8%

23.6%

The risk/reward profile for KIRK is very compelling. We are assuming that management uses only half of the 90M cash for buybacks over the next 5 years. This is quite drastic in my opinion, given that the cash needs of this business are quite limited and not all OCF generated from here out will be used for capex. Net of landlord allowances, fixed costs to start a store is about 125K and inventory costs are 100K. So, costs to start up 15-20 stores are 3.5M to 4.5M. Maintenance capex is another 5M and working capital needs are 8-10M at most. All in all, capital to run the business is 20M. Management is wrapping up with IT capex, so it's all set in this area for the next few years and supply chain logistics are already where they need to be for up to twice current store count. Just using my imagination here, but I wouldn't be surprised if KIRK accrues 10M per year on its balance sheet after its capex needs. 

Lastly, if the environment were to return to normalcy faster than what Mr. Market is projecting today, KIRK could accelerate its growth to net of 40 stores a year. It's store base is quite underpenetrated relative to peers, so you are essentially getting a free option on growth. (KIRK is 293 stores, PIR is ~1200) 

Risks

Dependence on US overleveraged consumer

Major recession that lasts longer than we all can imagine

 


 

Catalyst

Net positive growth and stabilizing of SSS
Share buybacks / dividends using excess cash
    sort by    

    Description

    Summary

    Kirkland's (NASDAQ:KIRK) is a leading specialty retailer of home décor that has a fortress balance sheet and is super cheap today on every possible metric. For the patient investor that has a 5 year horizon, I believe that the risk/reward offered by Mr. Market is very compelling - very conservatively it's a ~2x upside by 2015 or an IRR of 14% and a near zero chance of permanently losing capital.

    $m except per share data

     

    Current Price

    $8.79

    (x) Shares Outstanding

    19.92

    (=) Market Capitalization

    175.10

    (-) Cash & Short Term Investments

    90.25

    (+) Total Debt

    0

    (+) Pref. Equity

    0

    (+) Total Minority Interest

    0

    (=) Total Enterprise Value

    84.84

     

     

    2008A

    2009A

    2010A

    2011E

    Revenue

    391,277

    396,701

    446,828

    440,000

    Growth %

    NA

    1.4%

    12.6%

     

    Gross Profit

    133,991

    168,506

    170,536

     

    Margin %

    34.2%

    42.5%

    38.2%

     

    EBITDA (Net Tenant Allow.)

    28,410

    61,443

    54,791

     

    Margin %

    7.3%

    15.5%

    12.3%

     

    EBIT

    9,669

    46,938

    41,974

    30,800

    Margin %

    2.5%

    11.8%

    9.4%

    7%

    NI

    9,305

    34,570

    26,431

    20,020

    Margin %

    2.4%

    8.7%

    5.9%

    4.6%

    Diluted EPS

    0.47

    1.71

    1.28

    1.00

    Diluted Shares Out.

    19,691

    20,249

    20,578

    20,578

    OCF

    29,562

    49,972

    36,700

     

    FCF

    30,552

    39,726

    14,104

     

    Net New Stores

    -36

    -20

    +21

    +20

    Cash & Cash Equivalents

    36,445

    76,412

    91,222

     

    Inventories

    38,686

    39,355

    44,452

     

    ROA

    7.5%

    23.7%

    14.7%

     

    ROE

    19.6%

    49.1%

    25.6%

     

    EV/EBITDA

       

    1.5x

     

    EV/EBIT

       

    2.0x

     

    EV/OCF

       

    2.3x

     

    EV/FCF (incl. growth capex)

       

    6.0x

     

    P/E

       

    6.8x

    9.0x

    P/E less cash

       

    3.4x

    4.5x

    Background

    KIRK sells items such as framed art, mirrors, candles, lamps, pictures frames, accent rugs, garden accessories and artificial floral products. Its customers are mostly 25-55 female from the "sun-belt" region who are looking for home décor items priced in the "value" range. KIRK appeals to its customer base by sticking to traditional styled items that are based on widespread trends, rather than by being a fashion leader. Their merchandising strategy is to house limited SKUs that are carefully selected rather than carry a full range within each category. This helps the business have a high inventory turnover, leading to a constant flow of new products thereby creating a treasure-hunt type environment, and a sticky customer that keeps coming back.

    The company operated successfully for years until it went IPO in 2002. With the new money raised, management went crazy and started opening locations outside their "core" markets. What worked well in the "Middle America" didn't resonate well with the fashion conscious crowds of Los Angeles. Their problems compounded further as management experimented using a fashion forward theme-based strategy. This didn't appeal to their new customers of Los Angeles. and it alienated their loyal customers of Louisiana. Management realized that something was fundamentally broken, so they fired the responsible merchandisers, closed locations outside their core markets, and went back to their proven merchandising strategy. The numbers for 2008-2010 speaks for an honest management team that owned up to its mistakes and turned around the company. I encourage you to read previous VIC write-ups by banjo1055 (Sept 08) and edward965 (Mar 09) to get a flavor for the turnaround.

     

     

    Q1 11

    Q4 10

    Q3 10

    Q2 10

    Q1 10

    Q4 09

    Q3 09

    Q2 09

    Q1 09

    Q4 08

    Revenue

    94,403

    139,606

    92,725

    89,504

    93,465

    142,797

    92,389

    87,688

    83,320

    133,638

    SSS Growth %

    -8.4%

    -7.9%

    -2.4%

    1.0%

    12.6%

    10.2%

    11.3%

    6.1%

    5.2%

    5.3%

    Gross Profit

    38,088

    59,085

    35,993

    34,822

    40,636

    64,621

    38,142

    33,569

    32,174

    51,647

    Margin %

    40.3%

    42.3%

    38.8%

    38.9%

    43.5%

    45.3%

    41.3%

    38.3%

    38.6%

    38.6%

    EBIT

    5,166

    22,191

    3,766

    5,064

    10,953

    30,491

    7,643

    4,776

    4,028

    15,751

    Margin %

    5.5%

    15.9%

    4.1%

    5.7%

    11.7%

    21.4%

    8.3%

    5.4%

    4.8%

    11.8%

    NI

    3,170

    14,382

    2,279

    3,252

    6,518

    22,078

    5,570

    3,444

    3,478

    15,022

    Margin %

    3.4%

    10.3%

    2.5%

    3.6%

    7.0%

    15.5%

    6.0%

    3.9%

    4.2%

    11.2%

    Diluted EPS

    0.15

    0.70

    0.11

    0.16

    0.32

    1.09

    0.27

    0.17

    0.17

    0.76

    Diluted Shares Out.

    20,660

    20,548

    20,552

    20,636

    20,607

    20,453

    20,333

    20,204

    20,008

    19,901

    Why Cheap?

    KIRK is not a turnaround today and operating within its core competencies. So, why has Mr. Market thrown this baby with the bath water?

    Negative SSS

    7% of the 8.4% decline in SSS last quarter was due to lower transactions, and the rest was due to slightly lower ticket. The lower transactions were mostly because of lower conversion and only slightly due to traffic. Management commented that these trends indicate that current merchandize may not be resonating well with the customers.

    This is not alarming, in my opinion, and in fact quite expected on occasions given their strategy of housing only limited SKUs. Not having a full range of items, KIRK has to execute each time a customer shows up at stores (unlike a Bed Bath & Beyond where merchandize does not change that much). Current merchandize not resonating well does not trouble me much because KIRK's strategy also allows them to stay nimble and quickly get out of "unwanted" SKUs without much risk of inventory (relatively speaking). The real upside to this strategy is that KIRK has much high inventory turns than many of its peers. 

     

    KIRK

    PIR

    BBBY

    CPWM

    TJX

    ROST

    Inv. Turnover (TTM)

    5.99

    2.75

    2.67

    3.43

    5.76

    5.58

    The other reason for lower conversion could be due to consumers' lower discretionary spending in light of macro concerns. Remember the last two quarters were in the backdrop of pretty high oil prices. The pendulum has now turned and oil prices are coming down, but now concerns have turned to a double dip. Not to be flippant about these issues, but I think KIRK has gone through a pretty stressed environment in 2008-2009. The last global recession was considered as one of the worst since the great depression, and in my opinion, KIRK did fine in that environment.

    Margin Compression

    Gross margins have compressed by 313 bps in Q1 11 compared to prior year quarter. A 175 bps reduction was due to higher promotional activity and discounting (for reasons explained above), a 69 bps reduction was due to store occupancy costs caused by deleverage and fewer rent negotiations, and the rest of the reduction was due to freight costs. Operating margin compression in Q1 11 was primarily due to deleverage caused by negative SSS. I have no ability to predict what margins will look like if US goes into a double dip, and my guess is as good as yours. But I'll take a shot anyways - I think depressed EBIT margin is closer to 6% and peak margin is closer to 11% and 2011E is pretty close to depressed margins. 

    Reduction in Net New Store Growth Forecast

    In Q1 11, KIRK moderated its net new store growth forecast from 40 stores to 20. Management commented that they are finding it increasingly difficult to close on deals as landlords are holding out for better rates. Management is focused on finding the right locations rather than focusing on growing for the sake of growth. Shows they learnt their lesson well from their prior life fiascos on locations. In this business, location can make or break you. The street obviously did not take the renewed guidance very well. If U.S. does indeed goes into a double dip, I think management will slow down net new growth and release much of growth capex, hopefully, for shareholder friendly uses.

    Valuation

    Comparing KIRK to its peers, it's clearly evident that KIRK is much cheaper than the rest. The possibility that a major revenue decline due to a double dip can cause major deleverage is always there (although these were the same consumers that showed up at KIRK's footsteps during the worst recession since the depression), but at today's price, I think even this outcome is baked in. Besides KIRK has the balance sheet to live through this scenario. 

    Data from Cap IQ

    KIRK

    PIR

    BBBY

    CPWM

    TJX

    ROST

    EV/EBITDA

    1.5

    5

    6.7

    6.5

    7.4

    7.2

    TTM P/E

    6.8

    9.9

    15

    15

    16

    14

    2013E P/E

    7

    9.5

    11.7

    7

    11.5

    11.5

     

    2015E

    Worst

    Base

    Best

    Revenue

         

    Avg. net new stores / yr

    0

    15

    20

    (x) revenue / store

    1.5

    1.5

    1.5

    (=) 5yr x Total new store revenue/yr

    0

    112.5

    150

    2011E sales

    440

    440

    440

    (x) Growth in revenue

    0%

    0.5%

    1%

    (=) Growth in current store base revenue

    440

    451.1

    462.4

    Total Revenue

    440

    564

    612

         Implied Revenue CAGR

    0%

    5%

    6.8%

    (x) EBIT Margin

    8%

    9%

    10%

    (=) EBIT

    35

    51

    61

    (x) (1-Tax Rate)

    62%

    62%

    62%

    (=) Net Income

    22

    31

    38

    Implied Net Margin

    5.0%

    5.6%

    6.2%

    Shares Out (5M reduced from 2011E)

    15

    15

    15

    EPS

    1.45

    2.10

    2.53

    Implied P/E (at $8.79)

    6.0

    4.2

    3.5

    Target P/E

    6

    8

    10

    Value

    8.73

    16.77

    25.31

    Upside

    -0.7%

    90.8%

    188.0%

    IRR

    -0.1%

    13.8%

    23.6%

    The risk/reward profile for KIRK is very compelling. We are assuming that management uses only half of the 90M cash for buybacks over the next 5 years. This is quite drastic in my opinion, given that the cash needs of this business are quite limited and not all OCF generated from here out will be used for capex. Net of landlord allowances, fixed costs to start a store is about 125K and inventory costs are 100K. So, costs to start up 15-20 stores are 3.5M to 4.5M. Maintenance capex is another 5M and working capital needs are 8-10M at most. All in all, capital to run the business is 20M. Management is wrapping up with IT capex, so it's all set in this area for the next few years and supply chain logistics are already where they need to be for up to twice current store count. Just using my imagination here, but I wouldn't be surprised if KIRK accrues 10M per year on its balance sheet after its capex needs. 

    Lastly, if the environment were to return to normalcy faster than what Mr. Market is projecting today, KIRK could accelerate its growth to net of 40 stores a year. It's store base is quite underpenetrated relative to peers, so you are essentially getting a free option on growth. (KIRK is 293 stores, PIR is ~1200) 

    Risks

    Dependence on US overleveraged consumer

    Major recession that lasts longer than we all can imagine

     


     

    Catalyst

    Net positive growth and stabilizing of SSS
    Share buybacks / dividends using excess cash
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