Handley posted Tuesday Morning (TUES) as a short in early December 2013.  While the stock is up 40%, not much has changed in the prospects for the turnaround.  I would like to look at the risk/reward and financials slightly differently and pose a different reason for the change in the business.

785mm EV with 40mm of cash (though that is seasonal peak and will fall to closer to 10mm into the holdays).  Trailing adj EBIT (backing out any company claimed one time turnaround and inventory charges) of -5mm and sales of 850mm.  

Just as background, TUES is a closeout retailer of home goods (sheets, towels, kitchen items, decorative items) with 811 stores.   Stores vary widely in size from 5-10k sq ft all the way up to 30k sq feet and they tend to locate in irregular low quality (very cheap rent as a result) locations with very flexible lease terms. Average store is around 10k/sq ft.    It’s a glorified garage sale for women who love to shop for stuff around the home.

For years, they were a cash machine that grew store count with low capital investment and good returns.  (382 stores in 1999, 577 in 2003, 795 in 2005, peaking at 860 in 2011 to todays 811).   Until 2005, it was tried and true, grow stores, gain scale, EBIT improves (I’ll use EBIT throughout since D+A and capex are both running $10-$15mm ish and not much room to shrink capex below $10mm for 810 stores of 10k plus sq ft plus a HQ and DC’s).   

Then EBIT peaks and begins to fall off.  Read VIC write up in 2006 and thread if you want to see the debate at the time. Was it the housewares industry and the start of a housing implosion or was it the internet taking away shoppers?  Expansion of Ross Stores or Homegoods by TJX?

Business continues to fall each year with declining revenue/store.  In 2012, Becker Drapkin files a 13d and takes over chairmainship months later, buys nearly 4mm shares in the $4 to 6 range.  They fire the long time CEO, Kathleen Mason, bring in some interims and settle on Michael Rouleau who is 75 and credited with turning around Michael’s craft store in the late 90’s.  

Stock enters “turnaround” phase.  Rouleau shuts the tiny ecommerce site down, runs with the more SKU’s and less deep retail plan (doesn’t every turnaround either go more deep on the buys for better profit or less deep for more selection), exits womens apparel and takes a sizable inventory charge.  He also says he is going lower initial mark ups and more aggressively use clearance to improve turns and profitablity.  Makes scant reference to a better store experience (lighting, more cashiers at xmas)  At this point, Rouleau says they are almost done with the “turnaround”. His final phase has been taking a small number of stores and improving the locations.  In some calls he cites varying numbers of store rev pickups (40-50%) from these relocations without noting how much size improved.  I’ll note it is small sample size (16 out of 800), probably the prime ones to change over and they never quanitfy the rent increase (either in nominal rent or the increased risk of longer leases with less kickout clauses which are key to the model.)  If there is a final piece to the bull case, it would have to be real estate as the head of real estate says he sees an opportunity to relocate possibly half the chain.  This whole thing sounds a bit crazy (see DXLG for how this strategy works) and would materially change the economics with higher rents with longer and less flexible leases exactly when the chain is in flux.  If business does not improve I don’t think the markets will stand for the radical overhaul of half the stores.  If they start to really quantify the results with specific rents/op prof store and sales/sq feet and do far more than the 16 lay-ups, maybe this is something that could be worth watching.

Comps have improved mid single digits over last year but bottom line results have not because of the lower intial mark up.  The business is surprisingly easily to analyze since gross margins are merch margin plus any distribution costs.  Rent is in SGA.  Revenue/store has fallen from 1.2-1.3mm down to about 900k.  Gross margin has fallen from 38% to 35% as they cut IMU to keep revenue from not falling more.  SGA/store rises slightly every year (rent and labor inflation).  Simplistically the business in mid 2000’s was doing 120k store op prof to zero today as revenue and merch margin fell.

This “turnaround” is now about building sales back as merch margins are where he wants.  So how will he do that and what are the odds and why did they fall off in the first place.

So let’s review theories out there as to why the business has fallen off:

1. internet theories -  This is now multi-fold.  Originally (2005)  it was about EBAY and overstock and their ability to conduct its own garage sale online.  The counter argument was women love a treasure hunt and the internet does not replace that.  I would say that as of today it is clear online shopping in general is taking share and women peruse malls and phsyical retail outlets less.  Tuesday has no internet presence so it’s a complete loss to them if that trend continues which almost everyone agrees it will.  My feeling on this is that clearly many women love a treasure hunt and always will.  But it seems quite reasonable to also say that of 100 women some percentage (10-20%?) through a combination of less mall/retail visits will hit a TUES store.  

2.  Flash sale sites -  Gilt, Rue la la, One Kings Lane, Zulilly - These sites sell closeout goods and do so in a treasure hunt atmosphere every day.  The goods do skew more high end than TUES but there is clear overlap in many categories.  I think they definitely change the economics of the business with more interest in closeout purchase and it is less clear how much they effect customer demand.  It is another form of competition at the minimum.

3.  Homegoods expansion - TJX’s homegoods business has grown from 50 stores in 2000 to 240 stores in 2005 to nearly 450 today.  These stores are 25k sq ft and very productive.  The company states in their 10-k that they think they can grow to 850 in the US and they discuss this being a main avenue of growth in their last investor day. They plan on growing sq ft 7% this year.   The business does $3B in sales up from $2.2B in 2012 and margins run 12.9%.  Anyone who has been in both stores would see significant overlap in goods but almost anyone will have a vastly different take on the shopping experience.  Homegoods spent real capex on their stores.  They are pleasant to shop in and very well run.  They have vast and deep selection.

Tuesday Morning claimed they were not being harmed by Homegoods but it seems comical to anyone who has been in both stores.  If you wanted to buy kitchen utensils, towels, pillows, random decorations, etc and cared little about specific brands they would be the place you would go.  

From 2011 investor conference:

NeelyTamminga - Piper Jaffray - Analyst

The question was about comparison to HomeGoods and positioning themselves relative to that.

Kathleen Mason - Tuesday Morning Corporation - Pres, CEO

We really don't comment on competitors. It's really a different concept than Tuesday Morning. We're both in the home furnishing business and home (inaudible) business but we've branched into other categories. So, it's really not apples to apples in terms of comparative. Our square footage is about 9,000 square feet and they're I under 30,000, 35,000 square feet. It's not really a

comparison. They're a really different model. I used to be President of HomeGoods, so I know it pretty well. Really different model.

Two things to note is they were only different in that they still offered women’s apparel and shoes until last year with the new CEO.   I would describe it now like it’s a totally different model in that Homegoods stores are bigger, cleaner, and better run and sell the same stuff at similar price points with better selection but we think women who really like to shop will come to us too.  

You can google to find discussion boards comparing the two and I don’t think you will find much variance in the opinions.

I will add anecdotally while Tuesday does not list stores by state, they have closed many of the stores in New England over the past few years and that is where Homegoods is fully penetrated because of their Massachusets HQ.

I think this is the bigger factor far and away in TUES’ fall off.  I think you see it even in the ‘turnaround’ actions...more selection, bigger stores.   

To figure out the risk/reward, you have to make a guess on where sales/store can get to. I think everyone is focused right now on the ‘turnaround’ is making it way too complicated.  They won’t grow a material amount of stores,  and with initial markups dropping you won’t likely see this about margin unless they get better than 2005 sales/store.  If they get back to 2005 levels of 1.25mm ish, this chain could do around 90mm of EBIT and trade at around 7.5x that number.  I think that is a dream.  Anyone can see the world has changed with Homegoods at a minimum.  I think the business continues to fall off as Homegoods and internet expands.  I think the turnaround has shown nothing but you can take a big inventory charge, cut initial prices and stabilize a business at losing a little bit of money.  

If you read the sell side bull cases, they basically say the CEO turned around Micheals and he can do it here.  They can open bigger stores that are more productive and the greater SKU selection will excite people.  Nothing has showed up and we are a year in (they have guided the June quarter to be weak again in the conference call).  

No one seems to care right now but this seems like one of the worst risk/rewards of a liquid, shortable stock out there.  If the business returns to 2005, I think it is fairly valued.  If I am right that the new competition and changed shopping patterns matter, you’ll make somewhere between nothing and 100%.  From a trading perspective, the market is giving them a nice breather as it loves a turnaround story and can’t find many positive comp stories out there.  It is hanging to this one.  I’m not sure why and would love someone to speculate.  If things don’t improve soon, people will lose faith and it could start trading like a non-turnaround distressed retailer which would prob look like a mid to low single digit stock.  If trends start to worsen which seems very possible based on any of the possible threats, I think this stock will be closer to inventory value which is a couple bucks and I don't think TUES inventory has much value in a fire sale store doing a fire sale. 

Just as a side note, the chairman has pretty much dumped all his shares starting in late 2013 at around $13 as recently as June 6th where he dumped another 250k shares leaving him with around 300k shares left.  If anyone has a view of risk/reward it would be a fund manager who is also the chairman.

There is always a risk in shorting turnarounds of price eupohira. Fortuantely this business trades at nearly 1x sales and is a well known and understood area so I think this mitigates the general shorting risk.