Description

Tuesday Morning has been written up twice on VIC in the past five years, both times as a short.  Initially by Handley in December of 2013 when the stock was $13.50 and again in June of 2014 by Scott265 when the stock was $19.  Both were great calls.  I recommend you read those write-ups in conjunction with this one as there is useful context.  At $2.85, I think the risk reward is dramatically skewed the other way.  I am recommending TUES as a long with a $5-6 near term price target and $11 long term price target.

Overview

Tuesday Morning is a close-out, treasure hunt style retailer based in Dallas, TX that operates 724 stores nationwide.  LTM sales were $979 million so it is not a small company; yet, TUES is a tiny stock with an only a $124 million Market Cap (45.9 million shares x $2.70) and an adjusted enterprise value of only $93 million ($148 million before real estate value) is attractive here for both value and growth investors.  I see the stock hitting $5-6 this year and $11 three to four years years out.

Investment Points:

1)    Sales Growth is about to accelerate as

a.     Store closures abate

b.     Store relocations continue aggressively

c.     Sales disruption from the DC fiasco last year is lapped, and

d.     Comparisons become easier

2)    Stabilization of the distribution center issues (now complete) will result in improved comp store sales and expanding gross margins beginning with the current March 2018 quarter.

3)    Operating leverage is beginning to appear as high exceptional corporate costs become a thing of the past and as growing store square footage (for the first time in 5 years) throws off more contribution margin.

4)    Gross Margins could eventually improve by 200-300 basis points ($20 to $30MM of EBITDA) by replacing the existing Dallas DC with a new facility (most likely in the Southeast).

5)    Tuesday Morning owns significant unencumbered real estate assets (Corp headquarters and Dallas DC).  A third party appraisal we commissioned from a nationally recognized commercial real estate valuation consultant valued the buildings at between $50-$60 million.  These assets provide meaningful downside protection for a company with an unadjusted $175MM enterprise value.

6)    The market expects very little from Tuesday Morning as evidenced by its valuation.  The price to Book is 0.58.  TUES’ Adjusted EV to Sales of 11.5% is one of the lowest in retail, even when compared to distressed names.  Given that the market is largely not focused/aware of the value of the real estate, the Unadjusted EV to Sales of 17% is still a fraction of other troubled names.  TUES is trading at around an Adjusted EV of 3.7x my estimate of 2019 Adjusted EBITDA of $30.5MM[1] which could double to $60MM if the Distribution Center cost savings are achieved.

7)    Strong environment for Tuesday Morning’s business model.  Buying and reselling close-out merchandise is a tailwind right now with all the store closures, bankruptcies, etc.  Furthermore, the Treasure Hunt/Off-Price retail model is proving more resilient to on-line pressures than traditional retail.

8)    Conducive environment for Tuesday Morning’s store relocation strategy.  Basically, it’s a buyer’s market for retail real estate which helps Tuesday Morning get better locations at better prices for the 40-60 stores they are relocating annually.

9)    Strong Technical Setup with 12.2 million shares sold short, which as nearly as I can tell is a largely a legacy of the S&P 600 and Russell 2000 index drops from spring 2017.   The short interest constitutes 26.6% of the shares outstanding and around 30% of the float.  Current shorts are paying 5-6% and new must likely pay high single digits to low double digits.  The short exposure represents over 50x the average daily trading volume.

10) Potential Index addition could be a significant catalyst.  A simple extrapolation of the Russell 2000 cut off from 2017 based on IWM appreciation from 6/23/2017 would suggest that TUES needs to be about $3.30 to be added back to the Russell.  It traded at $3.30 briefly in September and again in January and would likely trade there consistly if the upcoming March quarter is strong and/or there is a short squeeze.   An index addition would create buying demand in the range of 6 to 8 million shares by the machines.

11) Insiders have purchased large amounts of stock.

12) Activist involvement potentially sets the stage for strategic options if the turnaround does not bear fruit sooner rather than later.  James Corcoran of Purple Mountain Capital Partners was offered a board seat in October in response to a threatened proxy contest.  My understanding that even before the activist involvement, the board’s leash on management is short.

In summary, Tuesday Morning trades like it is going out of business or at best a dead man walking.  However, the company has grown sales five years running despite closing 12% of its stores over this period and shrinking overall square footage by 2%.  Average sales per store have grown from $950K in 2012 to over $1.3 million today.  Sales per square foot have grown from $95 in 2012 to $115 in FY 2017 (ending June) and are likely now trending close to $120.

The top line successes from changes in store location, store size, fixtures, and merchandising have been overshadowed (and partially reversed) by the Phoenix Distribution Center fiasco for which the planning and delay from 2015 to 2016 drove significant SG&A costs and from 2016 to 2017 caused management distraction, massive cost overruns, and inventory misallocations resulting in lost sales and increased costs of goods sold.

With the DC crisis resolved (but not all DC efficiency issues resolved yet) we believed Tuesday morning can return to growth and profitability.

Phoenix Distribution Center Fiasco

As mentioned above, Tuesday Morning is recovering from a colossal screw up in launching its second distribution center in Phoenix, Arizona.  The DC went live in late 2016 and froze up during the 2016 holiday season.  The company incurred probably $20-30 million in expenses to fix the problem and to keep the merchandise moving which in many cases required merchandise at Phoenix to be sent to Dallas (and then maybe back to Phoenix) and then to a store. 

Sales were impacted in the FY2017 Q2 (December 2016 holiday season) and significantly impacted in the FY 2017 Q3 (March 2017 quarter).  Gross margins were affected from the FY2017 Q2 to FY2018 Q1 with some residual impact possibly in the just reported FY2018 Q2 December 2017 holiday season. 

Initially, the market did not understand the extent of the problem (i.e. on the Q2 2017 earnings call in February 2017) and it was not until May 2017 when Tuesday reported the March FYQ3 quarter and people saw a negative comp and the impact on the balance sheet that the stock dropped below $3.  The stock was further knocked below $2 when TUES was dropped from the S&P 600 Small Cap and Russell 2000 indices in May and June of 2017. 

The Distribution Center in Phoenix is running well now and is servicing 182 stores and targeted to service 243 (a third of the chain) by the end of the 2018 fiscal year (June 2018).  However, management says there is some residual impact on sales from last year’s events as current store inventories are planned based on prior year’s levels adjusted for performance.  Needless to say the algorithms spit garbage out when the data input is tainted.  So, there is an echo to the problem that apparently gets smaller as time passes.  I view this as an opportunity as it should be a tailwind to comparisons going forward.

Sales Growth is about to accelerate

I believe sales growth at Tuesday Morning is about to accelerate.

Store Closings about to abate

Tuesday Morning has been closing stores.  At the end of FY2009 (June 2009), Tuesday Morning had 852 stores.  Today Tuesday Morning has 724 Stores, a net closure of 128 stores comprised of 296 store closures and 163 store openings.  From June of 2012 through June of 2016 total square footage at the chain declined 326,000 square feet (or the equivalent of 28 11.5K square foot stores).  FY 2017 was the first year in five that the square footage at the chain increased (181,000 square feet or 2%).  Management is guiding to 7 store openings and 5 store closures over the next two quarters after which new store openings and store closures will become more rare as they focus on relocations.  Given that relocations are about 30-40% larger than the stores they replace, total Tuesday Morning square footage should grow steadily from here.  This should remove a headwind and add a tailwind to sales growth going forward especially as new stores appear to be opening at around $140 of sales per square foot versus the chain at around $120 and the stores being replaced at around $105.      

Store Relocations to Continue

Tuesday Mornings store relocation program has been a success despite the criticism of the shorts.  Tuesday Morning is moving stores with little or no contribution margin to better, and sometimes larger locations.  The relocated stores are typically 10-12K square feet, require an investment of approximately $400,000, generate $1.6 million in first year sales, have a contribution margin of 15% and a payback period of 2 years.  As of June 2018, 45% of TM’s stores will be relocated/refreshed.  They believe the opportunity to be another 200 to 300 stores.  Even if the low hanging fruit have been picked, and the incremental contribution margin is only 10%, on 200 Stores the incremental contribution margin should be $32 million of EBITDA on a $80 million investment (or a 2.5 year payback) over 5 years.

Sales Disruption from Last Year’s DC fiasco about to be lapped.

The March 2017 quarter was a -2.7 comp, the first negative comp since 2012.  There is no doubt that inventory in the stores was low and management was distracted.  Now that the Phoenix DC is operating properly, the flow to the stores restored, the chain should all else equal should perform better.  Critics are saying that this should have appeared in the just reporting December 2017 quarter as Phoenix DC froze in the December 2016 quarter.  However, the December 2017 quarter was subdued due to significant reductions in inventory achieved year over year, poor weather, and a short of the promotional cadence from the December quarter to the September Quarter.  It is hard to drive sales when you are taking 12% of your inventory out of the channel.  March should provide a cleaner comparison

Comparisons become easier

The December 2017 quarter compared against a 3.8% comp from the prior year and a 12.1% 2 year stacked comp while the upcoming March quarter compares against a -2.7% comp and a 10.7% two year stacked comp.  The two year comps get easier from there at 7.8%, 8.7%, and 5.4%

Stabilization of the DC issues (now complete) will result in improved comp store sales and expanding gross margins beginning with the current March 2018 quarter.

As mentioned above, stabilization of the Phoenix DC should allow management to improve sales performance versus the prior year given greater focus, and easier comparisons.  Even more significantly, the March and June quarters approaching should see a 200 bp to 300 bp gross margin benefit versus the prior year which contained capitalized logistics costs from the DC issues.  I believe the actual result should come in closer to the high end of that range.

Operating leverage is beginning to appear as high exceptional costs are in the past and as growing store square footage (for the first time in 5 years) throws off more contribution margin.

Tuesday has had a couple years of extraordinary center costs associated with the new DC, management severance, proxy fight, etc.  These should be lower going forward.  More importantly the continued roll out of the store relocation program should result in operating leverage as square footage growth and higher contribution margins help TM leverage its center costs.

Dallas Distribution Center Opportunity

The Dallas distribution center (consisting of five non-contiguous buildings) is described by management as inefficient, cumbersome and expensive.  Management believes that 200-300 basis points of COGS can be removed by moving to a new modern distribution facility in a new location.  Management announced in February 2018 that they have begun the process but I do not expect the launch of a new facility until mid CY2019.  200-300 bps off of approximately $1 billion of revenues would be $20 to $30 million of incremental EBITDA.  Given what happened with the Phoenix DC, the prospect of doing this again is a bit frightening but the logistics/supply chain team is not the same and there should be lessons learned as well.  The cost of a new facility, equipment, etc should be around $15 million which would be financed through the sale of the Dallas facility which is worth about $40 million.

Significant Unencumbered Real Estate

If Tuesday Morning does go ahead with a new DC they should be able to monetize their land and buildings associated with their Dallas DC upon closing.  I have had the land and buildings of  Dallas DC appraised by a well know national commercial real estate appraisal firm with the value estimated to be approximately $40MM to $50 MM pre-tax. 

Furthermore, Tuesday Morning owns its Corporate Headquarters, Also in Dallas.  This building has been appraised at approximately $10 million pre-tax.

Any taxable gains can be sheltered by $48 million of NOLs.

In my adjusted EV calculations I assume all the real estate is sold for $55 million and leased back at an 8% cap rate, i.e. $4.4 million per year of rent.

Low Valuation

I estimate the enterprise value to be $148 million

$124MM Market Cap + $30MM of debt (seasonal, none right now) - $9MM of cash.  (I assume $30 million of debt as the average debt over the past year).

I estimate the adjusted enterprise value to be $93 million

$148MM EV - $55MM of unencumbered real estate

The adjusted EV to Sales is around 9%.  For context, JC Penny trades at an EV to Sales of 43%, Bed, Bath and Beyond trades at an EV to Sales of 35%

My projection for CY2018 EBITDA is $29.4 million. My Adjusted EBITBA (assuming a sale lease back of the real estate is $25 MM.  My adjusted EV to adjusted EBITDA is 3.7x ($93MM/$25MM).  (for context the one analyst covering the company (B. Riley analyst) is projecting $23MM for CY 2018 EBITDA).

Summary and Target Valuation

My estimate of 2018 EBITDA of $29MM + $25 MM logistics savings from implementation of Second DC (in 2019) + $32MM in increased profitability from 200 store relocations (@ 10% contribution margin over 4 years).  My target of $11 is based on $86MM of target EBITDA x 6 = $516MM EV - $80MM of store cap ex - $15MM new DC cost + $40MM proceeds from sale of Dallas DC -$24MM of net debt / 45.9 million shares.   Near term target of $5-6 as March quarter surprises with a strong comp and strong gross margins and TUES is readded to the Russell 2000. 

Large and Consistent Insider Purchases from the CEO and Lead Director

Notably, in the Past 18 months Steve Becker (CEO) has bought stock at $4.49, $3.66, $1.82, and $1.73 investing about $1.25 million in addition to the $550,000 of stock he purchased at $5.37 when he became CEO. Terry Burman and Stacie Shirley have also made multiple purchases of meaninful amounts.  

Catalyst

Improving Comp Store Sales post DC issues and with continued store relocations

Improving Gross Margins post DC issues and with a 2nd new DC implemented

Improving Contribution margins from new stores

Add back to Russell 2000 in June 2018