Is hhgregg a Worthwhile Big Box Gamble?
Tom is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It is not extremely easy to spark a degree of excitement into a stock that has reported a prolonged string of worrisome operating results over the past several years. Consumer electronics, appliance, and furniture retailer hhgregg (NYSE: HGG), following in close tandem to its recently sold-off competitor Best Buy (NYSE: BBY), trades slightly down this morning following the release of its year-end results.
The corporation’s annual revenue posting of $2.5 billion represents a meaningful 20% increase as compared to year-end March 2011 results, and were a slight $30 million short of average analyst estimates for the period. Despite the strong top line growth, however – and as the market’s reaction to the news release implies – there is still relatively little to get excited about when it comes to hhgregg’s mid-term outlook.
Similar to the market’s sentiments surrounding the significantly larger Best Buy, players within the big box consumer electronics sector are still being hit by huge industry headwinds:
- “Showrooming” Effect: A meaningful amount of buzz has been placed on online retailers’ ability to use brick-and-mortar competitors as physical showrooms for their products. hhgregg, despite its much smaller footprint as compared to Best Buy, is not immune to the phenomenon. It is not only the pure play online counterparts like Amazon.com (NASDAQ: AMZN) that will continue to hit hhgregg’s comparable store sales, but also the other traditional brick-and-mortar counterparts with a meaningful online presence – i.e. Wal-Mart (NYSE: WMT) and Staples (NASDAQ: SPLS). If anything, hhgregg’s relatively small physical footprint and its reliance on local advertising (as opposed to a general awareness of its brand on a nationwide basis) gives the corporation a much more intense downside as compared to Best Buy.
- Unproductive Assets: It is generally understood, among both investors and managers working within the industry, that the big box retailing concept is a dying breed. With pick-and-choose purchase options now available and preferred among consumers (such as an Amazon.com-like set-up), the large showroom full of assorted consumer products is no longer a value-adding strategy. Consumers generally place little value on commissioned salespeople, especially with the ability to research a full product line at home on the computer, and the (hopeful) one-stop-shop set-up does not exploit consumers’ willingness to pay because most of the items are of low frequency, large ticket purchase decisions. Additional square footage used to tie all of these strategies together is therefore not an optimal use of shareholder assets.
- Unfavorable Product Lines: hhgregg and its other big box retailing counterparts place a meaningful emphasis on big ticket consumer electronics, especially in the TV/video category. Significant headwinds driven by wildly unprofitable product manufacturers, an oversupply of the product in the market, relatively weak consumer demand, and advances in product technology (reduced product costs in showroom) has led to a very unattractive, sustainable competitive advantage-less product category for retailers. The category has historically comprised between 40-50% of hhgregg’s sales.
An investment in hhgregg or other brick-and-mortar competitors including Best Buy is therefore a hopeful bet that the corporations can swiftly and effectively evolve. Unfortunately for all players, there is relatively little that can be done to quickly catalyze an effective turnaround. Will any of the company’s attempts make a meaningful difference?
Shift in Product Emphasis
hhgregg management, for instance, is placing a larger emphasis on appliance sales to supplement the ailing TV segment and to minimize its vulnerability to consumer showrooming habits – online retailers like Amazon do sell home appliances, but such larger products will, for the foreseeable future, be largely purchased in physical showrooms.
Such a shift, as management guides, will at best slow the company’s perpetually falling gross margins, however. Pricing in the TV/video segment is not expected to improve anytime soon (although in a hopeful scenario it will stabilize), and it will take a significant amount of time to supplement the company’s core product category with higher margin appliance product sales. With the 140+ basis point drop in gross margins in 2011, hhgregg forewent more than $35 million in top line growth that could have flowed toward the bottom of the income statement.
Even if the retailer can fully supplement its top line with new growth from such product categories, is it the best route for future growth? The appliance industry is no less fragmented than consumer electronics, and the lack of a full and foreseeable turnaround in the housing market implies that appliance sales will continue to stagnate. In today’s conference call company management did explain that sales in the appliance industry fell 9% in the most recent quarter, and although the corporation did enjoy a 9% comparable jump in appliance sales in the period (and therefore gained market share), future market share gains are likely to be made at the expense of pricing power. hhgregg controls no sustainable advantage in appliance sales (does anyone?), and due to the corporation’s relative lack of logistics efficiency as compared to larger players like Best Buy and Wal-Mart, the smaller retailer is unlikely to win the inevitable price war. Likewise, the corporation’s infinitesimal size compared to larger players also implies that it will need to significantly boost advertising expenditures (per unit sale) to attract attention to its offerings.
Smaller Store Size
Company management, especially with comparable store sales being largely negative over the past 16 consecutive quarters, seems to understand that its big box retailing concept is adding little value. To infuse its operations with more efficient square footage, hhgregg has showcased a new 25,000 – 30,000 square foot prototype store that is smaller than its traditional 32,000+ square foot outlets. The effect of this shift, however, will take a considerable amount of time to infuse into the corporation’s operating results due to the slower growth hhgregg management has projected for the near future.
New store growth estimates of 20-22 new outlets for the year ending March 2013 represents slightly more than a 10% footprint expansion, which is less than half of the previous five year store growth rate of more than 22%. Even if the new, smaller store format is more efficient than hhgregg’s traditional big boxes, therefore, it will take at least several more years for the results to become apparent in its financial reports. Top line growth, as mentioned, has been largely fueled by new store growth since the corporation’s 2007 IPO, and sales per square foot have fallen by 8% over the same time period. Similar to the company’s gradual shift into new product categories, the change in store formats does not represent a meaningful catalyst, with a known timeframe, toward better operating results.
Worth the Price?
Having fallen 25% in price over the past three months, it has been argued that hhgregg has now reached potential value investing territory. Although the stock now sells for around 9.1x the most recent year’s earnings, and is significantly less expensive than its five year P/E (ttm) average of 15.7x, investors must question whether the market is willing to once again ante up for a given level of hhgregg’s earnings. The corporation’s top line, which has been growing at a near 20% CAGR over the past six years, is likely to experience a much more subdued growth potential going forward due to the plan for a reduced level of new store openings and the stagnant comparable store sales for existing outlets. At the same time, the gradual shift to a smaller store format and a higher margin product emphasis will, per company guidance, not show a large boost to gross margins over the mid-term.
Price appreciation is therefore more likely to come from the company’s recently announced $50 million share buyback program than it is to come from valuation multiple expansion. Guidance for $1.12 - $1.27 in earnings per share for the upcoming year ending March 2013 could turn into a heightened earnings power if the corporation can lock in share purchases at today’s reduced prices. hhgregg management did utilize the majority of the prior year’s $50 million share repurchase program, and with significantly reduced capex for the upcoming year (projected $50-$55 million versus $83 million in 2011) the corporation will undoubtedly have funds on hand to reduce the current share count to a meaningful degree. Potential hhgregg investors should determine whether such a short-term, anti-dilutive initiative is worth the gamble of the other operational difficulties that have continued to plague the corporation.
gibbstom13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Best Buy, and Staples. Motley Fool newsletter services recommend Amazon.com, hhgregg, and Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.