Summary:

The market has given full credit to Steve Becker’s ability to turn around Tuesday Morning given his prior success with Hot Topic, but he has already sold more than half of his shares over the last 3 months and the margins are still solidly negative.  I think the stock is worth $8 or less.

Business Overview (from the 10-k)

We are a leading closeout retailer of upscale decorative home accessories, housewares, seasonal goods and famous-maker gifts in the United States. We opened our first store in 1974 and operated 828 stores in 43 states as of June 30, 2013. Our stores have periodic advertised events that occur in each month.

        We sell first quality, upscale home furnishings, housewares, gifts and other related items. We do not sell seconds, irregulars, refurbished or factory rejects. Our merchandise primarily consists of lamps, rugs, furniture, kitchen accessories, small electronics, gourmet housewares, linens, luggage, bedroom and bathroom accessories, toys, pet products, stationary and silk plants as well as crystal, collectibles, silver serving pieces, children's apparel and accessories. We specialize in well-recognized, first quality, brand name merchandise, which has included Viking and Calphalon cookware, Breville, KitchenAid and Cuisinart appliances, Peacock Alley and Sferra linens, Michael Kors bath towels, Travel Pro luggage, Reed and Barton flatware, Lenox and Denby tabletop, Waterford and Riedel crystal, Steinbach and Hummel collectibles, Madame Alexander dolls, Royal Doulton and Wedgwood china and giftware, Couristan rugs and many others.

        We believe that our well recognized, first quality brand name merchandise and value-based pricing have enabled us to establish and maintain strong customer loyalty. We differ from other discount retailers in that we do not stock continuing lines of merchandise. Because we offer a continuity of merchandise categories with ever-changing individual product offerings, we provide our customers a higher proportion of new merchandise items than general merchandisers. We are continually looking to add new complementary merchandise categories that appeal to our customers. Our customers, who are predominantly women from middle to upper-income households, are brand savvy, value-conscious customers seeking quality products at discount pricing. While we offer our customers consistent merchandise categories, each monthly event features limited quantities of new and appealing products within these categories, creating a "treasure hunt" atmosphere in our stores.

Basically, the company sells items that are more want than need based in a treasure hunt / estate sale atmosphere to women who enjoy the thrill of getting a good deal.  Unfortunately for Tuesday Morning, the number of locations to get a good deal have grown dramatically over the last 7 years – Gilt Group, Groupon, Overstock, Big Lots, etc. In addition, there are now more choices for retailers who want to liquidate excess goods so it has become more difficult for them to get the same quality of merchandise.  This can be seen in their results:

In case that is difficult to read, the important take aways are

1)      Between 1998 and 2005 Tuesday had EBIT margins between 10.4% and 13.4% and generally decent same store sales growth. 

2)      Starting in 2006 EBIT margins declined and then troughed in a range between 0.3% and 2.8% setting aside the -6.7% in the last year. They also had negative same store sales comps.  (Note: Tuesday shifted its year end from Dec 31 to June 30 in 2007)

Background

Steve Becker filed a 13-D in TUES on June 6, 2012.  He got appointed to the board on July 2, 2012 and became chairman on Sept 19, 2012.  They have turned over most of the management team at least once since then including the COO on Oct 22, 2012, 2 CMOs one on Nov 13, 2012 and one on April 3, 2013, two CEOs by March 2013 and the CAO and CFO positions by Sept 2013.

Steve did a great job turning around and selling Hot Topic but Tuesday Morning appears to be recalcitrant.  Here are the results since Steve joined the board last Sept:

They have been able to get their same stores sales up, but only at the expense of gross margins and ultimately operating margins.

During this time the stock has run from 5 to 14.  Steve has responded by selling more than half of his shares since August – not exactly a sign that the most knowledgeable insider (and the one that the market is counting on) thinks this is going to be an easy turnaround that will lead to a sale a la Hot Topic.

Valuation

The company has negative EBITDA.

In a best case scenario, I think over the next 3 years they can grow their same store sales by 30% and get their operating margins back up to 8%.  We are in a much more competitive world for treasure seekers than we were 8 years ago and I’m doubtful they can even manage to get margins back up to 8%.  That would lead to 1,104 mm in sales and $1.25 in earnings (assuming a 35% tax rate).  If the stock traded at Big Lot’s earnings multiple (13.5x) that would imply a $17 stock price in 2016.

In a more realistic successful turnaround scenario, I think they can get same store sales up 10% and have operating margins improve to 5%.  That would lead to $0.61 in earnings which at Big Lot’s earnings multiple would imply an $8.27 stock price.

If the turnaround is only able to get their margins back to where they’ve been over the past 5 years, the stock could revert back to the $4 level.  $850 mm in sales at 3% EBIT margins implies $0.29 in earnings which could lead to the $4 downside case.