Description

TUEM represents a rare opportunity to invest in a turnaround situation led by an all-star team executing a playbook they know well.  TUEM struggled for many years driven by poor operational decisions and lack of off-price acumen – we believe new A+ management is in place that solves these issues.  We also have a unique CEO agreement that strongly aligns his interest with shareholder value creation. 

For background, Tuesday Morning is an off-price retailer that got started in 1974.  The founder purchased leftover inventory from big name manufacturers and basically held a garage sale every Tuesday morning in a Dallas warehouse.  Through time the company morphed into just another 800-unit brick and mortar discount retailer before it entered into a Covid-inspired bankruptcy in May 2020, which, to the benefit of new investors like ourselves, allowed the company to meaningfully restructure its cost structure (more on this below).

Various issues kept us on the sidelines for many years until recently.  We initially took notice when Paul Metcalf joined TUEM in April 2019 (1).  Paul was a big win, and was the first real hire from the traditional off-price world.  His official title is Acting Chief Merchant, and serves TUEM in a similar capacity as his time at Burlington.  Paul helped lay the groundwork that produced BURL’s improved merchandising execution after the company went public in 2013.  He was well respected by the industry as well as Wall Street, as this old BURL research note attests:

 For an off-price model to be effective the retailer has to offer good value that the customer wants, and continue to add freshness to the inventory.  When the customer is on the treasure hunt, she will more likely purchase in the moment if she knows the inventory will not be there during her next shopping visit.  That’s been an issue for Tuesday Morning – their inventory turns were 2.7x per year vs best in class off-price retailers of 4-5x (2), and TUEM’s sales per square foot were $115 vs > $350 for other off-price models.  If you get the inventory right it’ll move faster with less discounting, and the customer will increase frequency therefore driving higher sales.  A high velocity turning inventory assortment comes down to your merchandising team (although your supply chain and ops are also important elements to execution).  Getting the right merchandising team is what Paul has been working on for the last few years.

When Paul joined TUEM he immediately got to work changing the merchandising team, which at the time lacked deep off-price experience.  According to our diligence, Paul replaced a significant portion of the merchandising team in 2019 and 2020.  Of the approximately 55 current Tuesday Morning buyers and related roles that we’ve identified on Linked-In, over thirty were hired after Paul’s arrival.  Many of them have deep experience at other off-price retailers (eg, here, here, here, here, here, here, here, here, here, here, here).  We were hard pressed to find buyers with legacy off-price experience when perusing EX-Tuesday Morning buyers who left the company in the last 3-4 years.  Paul’s arrival resulted in an internal talent shift towards off-price merchants within TUES, and the benefits are starting to bear fruit through better/different vendor relationships and brands.  As evidence, in the last call the company claimed to have added 300 new vendor partnerships in late 2020/early 2021.

We believe these merchant changes will manifest themselves into stronger top-line growth starting in 2021.  Lapping Covid periods obviously complicates matters, but the most recent reported period showed encouraging signs: comparable store sales increased 17.9% for the quarter ending 3/31/21 (3). Some of this increase was due to the temporary closure of all stores which started on March 25, 2020 due to Covid; but even after adjusting for the last week analysts are able to pencil out a hsd to ldd increase in SSS.  This was an even bigger achievement considering inventory levels on a comparable store basis were 36% below the prior year (also suggesting inventory turns are improving). 

After Paul changes the merchant DNA internally he is encouraged with what he sees.  In fact, he made a large personal investment in Tuesday Morning common stock sometime in late 2019/early 2020.  The timing is unfortunate as Covid hit a few months later and the company is forced to file bankruptcy when it temporary closed all 700 stores.  I’ll speak more about the benefits that came out of the bankruptcy process in a bit, but through it all the company was able to restructure its cost base and exit bankruptcy in January 2021.  Paul then calls his buddy, Fred Hand – then COO at $20bn market cap BURL -- and walks Fred through the opportunity (4).  On May 6th of this year, TUEM announces that Fred Hand is hired as CEO.  This entailed career and personal risk - at the time he was receiving an annuity-like $2-3mm annual economic benefit from BURL, and Fred left this to join a $300mm market cap company.  We surmise he would not have made this move if he had any doubts in the potential of TUEM.

Two weeks later, TUEM announces ANOTHER star hire.  This time it’s Marc Katz, a well-respected off-price executive who was previously BURL’s CFO from 2008 through 2019.  For the first time, TUEM’s leadership is dominated with deep off-price experience.  The C-suite pedigree punches above its weight for such a small company: 

Going back to the bankruptcy...TUEM was forced into Chapter 11 on May 27, 2020 when the store closures and operating losses triggered a default in the revolving line of credit, which the company was using to help fund operations during Covid.  Unlike many bankruptcy reorgs, legacy shareholders were able to retain equity, albeit on a diluted basis after a $40mm rights offering was backstopped by Osmium Partners and Tensile Capital (“Backstop Parties”).  The Backstop Parties now own 30.2mm shares, or 37% of the company, and have three members on the 10-person board.  Note that the 30mm shares are in an SPV.

TUEM used the bankruptcy process to close 200 underperforming units, renegotiate leases for 80% of the remaining stores, closed a high-cost distribution center in Phoenix, and reduced corporate overhead costs.  The company claims that the remaining store base averaged 50% higher revenue then the stores that were closed.  These actions are nicely laid out in a “Confidential Information Presentation” that was subsequently filed publicly in an 8-K:

https://www.sec.gov/Archives/edgar/data/878726/000110465920125142/tm2035026d2_ex99-1.htm

The deck outlines total cost savings to the tune of $40mm per year, which is not insignificant given it represents about five points of revenues on the pro-forma store base, and is almost the entirety of their projection of $41.5mm for EBITDA in CY21 (see slide 21).  The company believes they can grow EBITDA to $50mm in year two.  We believe this can much higher in the out years assuming new management is successful in driving revenue $s per sq ft. 

The 1-2 year company projections are dependent on revenues getting to ~ $800mm, which seems reasonable as it implies $1.6mm per store annually, or $125 per square foot.  Pre-Covid TUEM was doing $115 in revs per sq ft, and this was before they culled off the lower performing 1/3 of the store base.  We believe this assumption is potentially conservative longer-term as the management team executes and narrows the $125 psf gap towards best in class off-price retailers such as Home Goods (>$300 psf).  For TUEM, $300 psf performance is likely unachievable given structural differences between their stores (lower unit count, less square feet per store, etc) and larger peers, but over time we think the stock can appreciate significantly from here if management is able to achieve even $130-150 psf.  In such a scenario TUEM can likely do $70mm of EBITDA (implying that the stock trades at 5.6x vs off-price average of mid to high teens EBITDA multiples). 

CEO Fred Hand is definitely incentivized to drive results.  The Backstop Parties basically gave Fred 30% of the carried interest within the SPV that holds their TUEM shares (5).  The package vests over 3.5 years.  We have not seen a more direct way to align a CEO with shareholders, and the unique aspect of this deal is that the company is not directly paying for it.  The Backstop Parties are willing to ‘give away’ a portion of their carried interest to Fred – a potential benefit that accrues to all shareholders assuming Fred is successful in his endeavors.  To our knowledge this is a first of its kind.

From a category perspective, the off-price channel should continue to benefit from a compelling value proposition (eg, selling prices on accessories and home décor merchandise are generally more than 40% below comparable items at both full-price brick-and-mortar and e-commerce competitors), a constantly changing assortment offering a “treasure hunt” appeal, ongoing challenges faced by full-priced department and specialty stores, strong appeal among younger demographics, and well-below-average vulnerability to e-commerce competition.  These factors are partly why best in class off-price retailers trade at mid to high-teens EBITDA.  We do not argue that TUEM should trade at such a high multiple, but the valuation discrepancy leaves plenty of room for multiple expansion as management delivers on their plan:

In summary, this is more of a conspiracy theory thesis predicated on an all-star management team running what was once a struggling concept.  Fred Hand, the CEO, did not leave BURL to waste his time at TUEM unless he saw a big turnaround opportunity. The three top executives were part of a successful business model in the past, and we believe the probability of success is high given the organizational changes mimick a prior playbook.

Footnotes:

(1)    Paul joined as a consultant in April 2019, initially to “advise and recommend to the merchandise team, things that would help them bring them back to the heritage of being a world-class off-price retailer.” (source: 2/5/20 conference call).  Paul transitioned to full-time in December 2019 as Acting Chief Merchant.

(2)    It’s speculated that TJX’s HomeGoods in-store inventory turnover is ~ 15x.  TJX consolidated turnover is mid-6x.  Regardless, TUEM has significant room for improvement on this front.

(3)    To put that in perspective, TUEM reported SSS of +lsd in FY 6/18 and 6/19, and down lsd for the six months ending 12/19

(4)    This is pure conjecture – I have no idea if Paul called Fred, but I sense some personal recruitment took place given that Paul and Fred overlapped at Burlington from 2013-15, both in executive positions, and were also colleagues at Filene’s/May Department store company in the mid-2000’s. 

(5)    See https://www.sec.gov/Archives/edgar/data/0000878726/000110465921062090/tm2115209d1_ex99-2.htm

DISCLAIMER:  DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK.  THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP.  THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.  

Catalyst

In the short-run the stock should work as management puts up better comp growth as merchnadising changes take hold; in the long-run we believe TUEM’s stock can double or triple as mgmt narrows the $ psf revenue gap with peers.