Description

hhgregg is a compelling long side investment at $6.34.  The stock trades at 2.5x EV/EBITDA, has $1.55/share in cash, generates positive FCF, is buying back stock, and should begin to see improvements in both of its major product categories over the next 12 months.

Why does the opportunity exist?  A few reasons. 

1) TVs—they sell them.  Since the flat screen upgrade cycle and housing market peaked in 2007 ASPs have fallen by approximately 45% and Amazon has taken a significant amount of unit share.  As discussed below both of these trends look like they are about to start mitigating.

2) Best Buy—most investors believe HGG is the exact same, it isn’t.  While they have the TV business in common the reason to own HGG is it’s appliance exposure which generates 50% of EBIT.  In addition, BBY gets roughly 12% of its sales from knickknacks like DVDs and video games that are literally going away, this isn’t the case with HGG.

3) Management—they are C+ at best.  Including the most recent pre-announcement that sent the stock down to today’s levels they have missed 5 of the last 7 quarters.  Execution hasn’t been atrocious but they tend to be overly optimistic.

Business Description

hhgregg operates 208 big box consumer electronic stores mostly in the mid Atlantic and south Eastern states.  All stores are leased and typically 33k square feet.  Over the past five years unit growth has averaged around 25%, it will ratchet down to 7-8% in the years to come.

Sales mix is as follows:

Video                                                                                                                      43%

Appliances                                                                                                              37%

Computing/Mobile                                                                                                   9%

Other (audio, furniture, mattresses)                                                                       11%

Investment Thesis

The thesis from these levels revolves around two tenets that will be discussed below 1)  appliance retail is a great business, HGG is a share taker, and it will benefit from a housing recovery  2)  the TV cycle seems like it’s about to turn for physical retailers.  Once the stock gets credit for an improving tone (likely only after a few decent quarters) it should trade at 10x FY2014 EPS of $1.14, or $11, a 73% return from these levels.

Appliances

• 37% of sales, 50% of EBIT (as per mgmt). 
• It is a product category that AMZN will never carry due to its physical characteristics (weight) and need for professional installation. 
• HGG has been a share gainer in the category (their comps outperformed AHAM shipments by 1630bps in FYQ3 and 530bps in Q4), partially due to an increased focus on the segment and partially due to Sears decision to begin closing stores.
• Most importantly, it is tightly tied to the housing market, specifically existing home sales.  There isn’t much point of diving into a housing analysis as it has been well vetted on VIC but we are bullish from here.

Video

• 43% of sales, undisclosed EBIT contribution (clearly Video, Computer, and Other segments carry much lower margins)
• As mentioned above, TV ASPs have sank by 45% over the last five years or so, this combined with share theft from online retailers forced Circuit City into bankruptcy and put the remaining bricks and mortar retailers a world of pain.  It looks like the skies will start to get a little brighter for the following reasons (keep in mind it is expected that these catalysts will take a few quarters to play out):
  • On a tear down basis OEMs are barely breaking even on the gross profit line (see Citi’s BBY upgrade on June 14^th).  To combat this LG, Samsung, Sony, and Sharp have started a unilateral pricing program (UPP), mostly on larger screen TVs.  So far it seems to be working, in June pricing at AMZN/BBY/HGG was at parity on UPP applicable products (Stifel/Citi surveys).  This should help stem both price bleeding and share loss to AMZN.
  • Amazon only pays tax in 6 states, they should begin collecting in California later this year, with state budgets starving it should only be a matter of time before the majority follow.  This should further tighten the price arbitrage.
  • Currently HGG doesn’t carry Apple products, however they just began an Apple requested test of iPads, iPods, etc.  While nothing is known about the iTv including whether or not it will exist) this would a huge positive for HGG as it not only removes the risk that they simply don’t get the product, but it could spur a real innovation cycle.
  • As screen sizes get larger TVs get heavier and the value of installation becomes greater.
  • Comps are very easy, for FY 2010/2011/2012 they came in at (12.1%)/(5.1%)/(8.7%), so not a whole lot needs to happen to get back into the black.
  • Similar to the appliance business TV sales will get a boost from increased existing home sales.

Earnings Estimates, Capital Structure, and Valuation

Cash:                     $59M

Debt:                     $71M (deferred rent)

Cap :                      $240M

EV:                         $252M

Note:  HGG bought back $47.5M worth of stock in FY12, roughly 3.7M shares, and authorized another $50M program, at these prices they could buy back 7.8M shares (20% of s/o).  The estimates above could be conservative if the full plan is executed.

HGG should be valued as a hybrid of HD/LOW (appliances), BBY (TVs), and maybe CONN (although it gets a premium I would argue its consumer lending business makes it much sketchier).  Wrapping all those together 10x forward earnings sounds reasonable for an $11 target.  Although if they string a few decent quarters together it wouldn’t be shocking to see it regain its 20x handle similar to LL (another name deemed to be structurally challenged boosted by cyclical tailwinds).

Risks:

• UPP doesn’t gain traction, ASPs continue to fall
• The housing market falls off yet again
• Management fails to execute against incredibly low expectations

Catalyst

• Further awareness/acceptance of UPP's viability
• Apple iTv announcement
• Positive July commentary on next week's earnings call
• Mgmt meeting FY Q1/Q2 estimates