Up 18% and Just Getting Started

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Not many companies are able to fall significantly behind their competition when it comes to technology and still compete. In fact, most investors look for companies that are using technology to its fullest to stay ahead of their peers. With that being said, there is one retailer that seems clearly behind the times, and yet the stock could be a great value for investors. If you are looking to capitalize on the continued recovery in the domestic housing market, Pier 1 Imports (NYSE: PIR) could be the perfect stock to ride this recovery.

A Little Perspective
For those who don’t follow Pier 1, let me set the stage. This is a retailer that sells an eclectic mix of housing goods primarily through its stores. In an age where millions of purchases are made online, Pier 1 stands apart as an old school retailer. The reason the company is able to thrive in this environment is the housing market is beginning to recover, the employment picture is improving, and customers feel better about making purchases for their homes than they did just a few years ago.

What’s ironic is that Pier 1’s story above could have been cut from the pages of one of Peter Lynch’s books from more than 20 years ago. Contrary to popular belief, the housing market didn’t always go straight up prior to the Great Recession. Lynch lamented years ago that homebuilders’ stocks had already been discovered as housing recovered, and he looked at Pier 1 as an indirect play on the coming recovery, sound familiar? Pier 1’s stock is up about 18% since the beginning of the year, but this move up is just getting started.

3 Numbers Tell a Growth Story
Any company that can post positive sales momentum in a world where Amazon.com (NASDAQ: AMZN) seems to want to take over everything, is a company to watch. Though Pier 1 faces competition from not only Amazon, but also Bed Bath & Beyond (NASDAQ: BBBY) and Williams-Sonoma (NYSE: WSM), the company is doing quite well.

In their last quarter, Pier 1 posted a comparable store sales increase of 5.9%, which drove top-line sales growth of 9.3%. This might not sound that great, until you consider the company was able to turn 9.3% sales growth into 19% earnings growth. What’s more, analysts expect similar growth going forward.

At present, most analysts see Pier 1 posting better than 16% EPS growth over the next five years. Of their peer group, only Amazon is expected to see better EPS growth at 37%. By comparison, Bed Bath & Beyond and Williams-Sonoma are both expected to grow earnings by more than 12%.

In a similar way, Pier 1 finishes second only to Amazon when it comes to cash flow growth. Earnings growth is important, but cash flow growth is more important to some investors. Amazon posted better than 58% operating cash flow growth last quarter, whereas Pier 1 reported core operating cash flow (net income + depreciation) of nearly 17%. In case investors assume this is standard growth, for established companies, consider that Williams-Sonoma posted core operating cash flow growth of 7.22% and Bed Bath & Beyond reported growth of 5.38%.

A third reason investors should watch Pier 1’s performance going forward is that the company has the best gross margin of their peer group. Pier 1’s gross margin of over 42% has a lot to do with the type of merchandise the company carries. Pier 1 focuses on unique merchandise, which helps the company avoid competing on price with Amazon and other retailers. The only company that comes close to Pier 1’s gross margin is Bed Bath & Beyond at 39.55%, but Williams-Sonoma and Amazon’s margins don’t even come close at 30.46% and 26.56% respectively.

2 Ways Pier 1 Gets Better
While Pier 1 is doing well, there is always room for improvement. What’s exciting for investors is that the company can improve its sales with one change, and its margin and earnings with another.

The first change Pier 1 can make is in the area of selling, general and administrative expenses. To be blunt, the company needs to get more efficient. In the last quarter, Pier 1 spent 31.8% on SG&A. By comparison, only Williams-Sonoma came close at 30.46%. If Pier 1 wants to model better expense management in this area, they might want to look at Bed Bath & Beyond’s SG&A of 27.18% or Amazon’s percentage of 25.44%. Improving their SG&A spending would push more money to the bottom-line as earnings and cash flow.

A second way that Pier 1 can improve in the future is by implementing a more connected store and e-commerce business model. The company is already on track with a new point-of-sale system, and by allowing customers to seamlessly shop online or in-store, Pier 1 should be able to deliver on their expected growth rate.

With Pier 1 reporting strong sales and earnings growth, the company is already in position to be a great investment. If management can cut expenses, and improve on their online and in-person sales model, this could be one of the best ways to play the housing turnaround.

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Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Bed Bath & Beyond, and Williams-Sonoma. The Motley Fool owns shares of Amazon.com. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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