Back the truck up Mavis. Electronics retailers are cheap.
Dirt cheap. Historically cheap. Do my eyes deceive me cheap. Wal-Mart rollback cheap. Groupon cheap (the deals, not the IPO). You get the picture.
I’ve written about how Best Buy (NYSE: BBY) is a shareholder-friendly value stock, and about how Radioshack (NYSE: RSH) represents a remarkable value opportunity. I’ve gone on at length about how these companies have long track records of earning exceptionally strong returns and free cash flows. I’ve shouted from the rooftops about their conservative capital structures and how they are buying back shares. Don’t even get me started on GameStop Corp (NYSE: GME) otherwise we’d be here all day. Despite the shareholder nirvana that is electronics retailers, Mr. Market is unimpressed. He quietly hums “That Don’t Impress Me Much” while tossing these in the trash heap. “Better to focus on companies like Netflix (NASDAQ: NFLX) or Green Mountain Coffee Roasters (NASDASQ: GMCR) (The Highest Valuation in America).
Here’s why: Mr. Market favours growth. NFLX and GMCR have grown rapidly quite recently, and it is easy to extrapolate this growth off into the distant future, and then salivate over the expected value. BBY, RSH and GME likely aren’t going to see future growth like this. They are relatively big companies and (to varying degrees) have snagged all the low-hanging fruit of North American growth. Future growth will occur abroad, and so far it isn’t clear whether they’ll be able to accomplish this while maintaining their historical performance.
Enter hhgregg, Inc (NYSE: HGG), a relatively tiny competitor based in the southeastern United States with just 173 stores. The company’s small size means that it has a wide open map in which to expand before saturation becomes a concern. The company has been the beneficiary of rapid growth over the last few years. Let’s look at the company’s growth:
The company has tripled its store count since 2005, and grown nearly 60% since 2009 – the depth of the recession. BBY and RSH will never see growth like this again – by virtue of their size, only small brick&mortar retailers can achieve this.
Some may look at the above chart and be concerned by the fact that revenue per store has declined. I wouldn’t be too concerned. New stores take a few years to build local awareness and reach mature sales levels. Given the company’s rapid growth, a huge number of its locations are relatively new and are unlikely to be operating at their mature levels. Also, there’s been a pesky recession obscuring things so rather than worry, we’ll keep an eye on this metric over time.
You may also be wondering “Why is Frank stuck on store growth? Isn’t it a common mistake to focus on store growth rather than free cash flows and returns on equity (the things that really drive investment returns)?” Good question – let’s turn to these metrics.
Admittedly, this chart is somewhat less useful than others I’ve created. First, the timeline is short because the company went public only in 2007 and prior historical data is somewhat difficult to come by. Second, the company had extremely little equity in 2007, as it was largely debt financed (a risky proposition!), so the ROE figure is literally off the chart. At the very least, we can see that the company has historically (albeit, for a short history) earned double-digit returns.
Let’s look at Free Cash Flows:
As expected for a young company enjoying rapid growth, the company has had high capital demands as it builds out new locations. This accounts for the difference between Cash Flows from Operations (green bars) and Free Cash Flows (blue bars). The negative quarterly data reflects the company’s inventory builds, and they largely line up with the expansion in the number of stores (compare to the top chart).
Speaking of inventory, readers of Financial Shenanigans will know to check the components of the company’s cash conversion cycle to identify problems early.
This is pretty impressive. Despite the company’s growth, they have done a remarkable job of keeping inventory levels in line (note the holiday season build-up), and maintained a very healthy cash conversion cycle.
Here’s something else that is impressive – the recent changes to the company’s capital structure:
Keep your eye on the blue bar (total debt). Suddenly, Poof! No debt this quarter. The company still has a revolving credit facility available to them, but they repaid the last ~87 million of term debt outstanding. The company still has $73 million in cash on hand, which it will use for future growth (they plan to open 35 – 40 stores this year). I love companies that have no debt. They have the aura of a cross-country road trip. Complete freedom and flexibility. Masters of their own domain. Landlords (for the operating leases) are much easier to negotiate with (especially as a larger tenant, which HGG would qualify as with more than 30,000 square feet for the average store) than creditors, and companies can tactically negotiate with individual landlords in different locations, rather than negotiating with one creditor for the whole shebang.
Before we get to valuation, let’s take a cruise by the company’s margins, in order to identify whether the company is discounting in order to prop up sales.
I don’t see any obvious discounting here, and I am impressed with the consistency of the company’s margins, despite the recession.
Ok, on to valuation.
At the current price ($11.90 as of 7/19) I believe the company is undervalued. Moreover, the company has 12.35M shares sold short, which represents nearly 1/3 of the shares outstanding, a short interest ratio (shares short / average volume) of 23. This is a precarious position for the shorts to be in, given the company’s rapid and profitable growth, and conservative capitalization. Also, given the fact that the company’s shares are at their lowest price since early 2009 (they’ve lost a stunning 45% of their value so far this year), I am left wondering what more the upside the shorts expect. It will be very difficult to cover that number of positions without the pricing rising significantly.
Oh, one more thing: the company has a new share repurchase program (emphasis added).
Based upon the Company’s strong liquidity position and its commitment to drive long-term stockholder value, the Company’s Board of Directors authorized a $50 million share repurchase program. Under the program, purchases may be made from time to time in the open market or in privately negotiated transactions in accordance with applicable laws and regulations. The repurchase program will expire on May 19, 2012, unless extended or shortened by the Company’s Board of Directors.
What do you think of hhgregg? Long or Short, and why?
Author Disclosure: Long HGG, BBY, GME, RSH