Description
I am recommending a short position in Teavana (TEA), a recent IPO that trades at a growth multiple, but is in reality a structurally challenged retailer. Bulls believe this is a secular growth story of increased penetration of tea drinking coupled with a runway for new store expansion. While headline same-store-sales have been healthy, a deep dive into their reported metrics illustrates a flawed business model with long-term headwinds to growth. TEA currently trades at $18.78 a share, or 40x FY 2011E EPS and 31x FY 2012E EPS. Although the stock is down 22% from its recent October highs, I still see downside of 50% or greater from its current valuation. Upcoming catalysts include the expiration of the lock-up on January 23rd and earnings that show continued deterioration of fundamentals.
Business Overview:
TEA is a mall-based retailer of loose tea and tea accessories (e.g. tea kettles and pots). While the Company also sells ready-to-drink beverages at its stores for $4-5 a cup, TEA has deemphasized the product to focus more on higher margin loose leaf tea sales. Beverages accounts for 4% of sales while tea and merchandise account for 56% and 40% of sales, respectively. As of September 30th, TEA owns and operates 196 stores across 39 states as well as 18 franchised stores primarily in Mexico. The Company generates approximately 7% of its sales through e-commerce. The business is very seasonal as TEA generates around 70% of its earnings in the 4th quarter since its products are often purchased as holiday gifts, adding an element of earnings volatility.
New Store Expansion and Productivity Deteriorating:
A key cog of this growth story is their runway of new stores openings. The Company plans to more than double its existing store count to500 intotal by 2015. While this may seem like a reasonable strategy for growth, recent performance suggests this concept is saturated and new store economics will be materially worse going forward.
A handful of sell-side analysts do a simplistic calculation of new store productivity. They calculate it as the total sales growth less same-store-sales growth divided by growth in stores (1). The table shows the new store productivity over the last several quarters.
| TEA New Store Productivity Analysis |
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1Q10 |
2Q10 |
3Q10 |
4Q10 |
2010 |
1Q11 |
2Q11 |
3Q11 |
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| Total Sales Growth |
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43.3% |
33.1% |
32.4% |
41.0% |
38.2% |
35.6% |
36.3% |
35.1% |
| Less: Comp Store Sales |
15.7% |
6.9% |
5.9% |
7.5% |
8.7% |
6.0% |
6.9% |
6.0% |
| Growth from New Stores |
27.6% |
26.2% |
26.5% |
33.5% |
29.5% |
29.6% |
29.4% |
29.1% |
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| Average Store Growth |
26.3% |
27.5% |
29.3% |
33.5% |
30.3% |
35.8% |
38.2% |
39.4% |
| New Store Productivity |
105.0% |
95.6% |
90.3% |
100.0% |
97.3% |
82.5% |
76.8% |
73.8% |
This simplistic approach overstates productivity though because it includes e-commerce sales in new-store sales. An offset though is there is a discontinued business line (2) that is weighing on productivity in 2011. Net-net, when making these adjustments, I believe 1Q11 through 3Q11 productivity should be 82.7%, 76.5% and 71.2%.
What’s evident is that new store productivity is declining at a significant pace. The reason for this decline is TEA’s saturation in Class-A malls and lack of suitable new locations. TEA sells a premium product (average ticket is $46) targeting an upper-income demographic. There are only so many retail outlets that will have that ideal demographic. It’s becoming clear that it will be challenging for TEA to scale its concept as it moves into lower-end Class-A malls as well as Class-B malls.
Same-Store-Sales Growth Not As Good As It Seems:
Taking a look at the performance of their existing stores, it initially appears as though same-store-sales are healthy. TEA has been reporting 6-7% comps over the last few quarters. However, a breakdown of their comps raises red flags. Looking at same-store-sales excluding beverage sales (3) and e-commerce, here is a breakdown of the comps over the last two quarters (4).
| Comps Ex Beverage & E-Commerce |
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2Q11 |
3Q11 |
| Avg. Ticket |
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9.3% |
8.8% |
| Transaction |
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(1.8%) |
(2.5%) |
| Total Comp |
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7.5% |
6.3% |
All of TEA’s same-store-sales growth is from increasing average ticket while they actually show negative transaction growth. The growth in average ticket is driven by the Company’s aggressive salespeople who try to up-sell customers on higher priced teas. It’s easy to Google countless horror stories of overly aggressive sales people that ended up alienating the customers and deterring business. To add insult to injury, many of these online posts encourage people to avoid Teavana altogether.
While up-selling may be an effective near-term driver of growth, long-term the negative transaction growth will be headwind as it suggests TEA has difficulties adding new customers. To exacerbate the issue, TEA does not have a CRM system in place to understand their customer purchasing behavior so management does not have a clear strategy on how to improve transaction growth.
To tie this back to the earlier point about new store productivity, it is shocking that management would pursue an aggressive growth strategy into a new demographic without customer level data to evaluate performance. How can they assess whether or not the strategy is working? This is akin to preparing for a car race, but your car doesn’t have a speedometer and you’re not timing the laps. At the very least, this has to raise questions about the quality of the management team and their operating ability.
Disintermediation / Competition Is A Long-Term Threat:
When boiling down the business, it doesn’t appear that TEA has any sort of long-term competitive advantage. What TEA excels at is employing aggressive salespeople to get people interested in drinking tea. After that, there’s no real reason for a customer to necessarily purchase tea from Teavana as there are other outlets to use such as Adagio, The Tea Spot, etc. A Google search of “loose leaf tea” will provide a bunch of retail venues and online outlets.
My favorite quote about Teavana from one of the online blogs is…(see link below)
http://www.teachat.com/viewtopic.php?f=41&t=12132
“had shopped there in the past, but no more. I have found all of their products from other suppliers and at a lesser price. Their sales tactics make my stomach curdle. "shivers" and.. I will tell everyone I know this too.”
TEA admits the market is competitive in their own S-1.
“The US tea market is highly fragmented. We compete directly with a large number of relatively small independently-owned tea retailers. Additionally, relatively low barriers to entry in the tea and beverage retail market may encourage other tea and beverage retailers who may have greater financial, marketing and operating resources than we do to enter the specialty tea retail market. As we continue to expand geographically, we expect to encounter additional regional and local competitors.”
But Teavana is convinced their competitive advantage is their “market-defining brand, the “Heaven of Tea” retail experience offered to customers in our stores” (from S-1). Yet TEA has negative transaction growth and numerous online reviews bash the “retail experience”. That just doesn’t make sense.
Valuation:
Share Price - $18.78
Shares Outstanding – 39.6
Market Cap - $743.7
Net Debt - $4.5
EnterpriseValue - $748.2
Based on Street Consensus Estimates (5)
2011 P/E – 40.0x
2012 P/E – 30.8x
2011 TEV / EBITDA – 20.3x
2012 TEV / EBITDA – 15.9x
Assuming the long-term comps of 3.0% that management guides and 70% new store productivity, I can see TEA hitting roughly $1.10 EPS in calendar 2015 when they have 500 stores open (giving them some credit for a few points of margin expansion). At that point in time, the Company will no longer have store growth to drive the top-line. Given their business is structurally challenged to grow, can’t imagine it trades north of 13.0x and at that point and probably trades closer to 10.0x.
So at 10.0x, the stock would trade at $11 and discounted back to today (3 years) at a 10% discount rate, TEA should be worth approximately $8.29 which represents over 50% downside from the current share price.
Summary:
TEA is touting itself as a high growth specialty retail story yet it exhibits
1) Saturated store footprint with declining new-store productivity
2) Negative transaction growth at its existing stores
3) No apparent competitive advantage selling a commodity product at premium prices
Risks:
TEA has a fairly high short interest. Given it is a recent IPO, there’s limited float and short interest represents roughly 60% of the float.
Notes:
(1) Analysts tend to look at this analysis on store basis rather than square footage given their stores are fairly uniform.
(2) TEA stopped selling SpecialTeas brand tea on January 30, 2011
(3) Beverage sales weighs down traffic comps given it is a larger contributor to transactions and it is being deemphasized by the Company. So I look at comps ex-beverage sales to give TEA credit for product mix shift.
(4) TEA only began providing a breakdown of its comps since it went public in the summer so only have recent quarterly data.
(5) TEA has January fiscal year end. 2011 represents fiscal year ended Jan 2012. 2012 represents fiscal year ended Jan 2013.
Catalyst
Lock-up expiration January 23rd
Quarterly earnings that illustrate deteriorating new-store productivity and negative transaction growth