Street Watchdog Starts Pier 1 Imports at Sell

Price Target $5.60

  January 17, 2017

Pier 1 Imports, Inc. (NYSE:PIR) has been on a magical carpet ride since early November of this past year, rising within  
this 3-month period  over  100%  from  an  intraday  low   of
$4.12 on November 1st to an $8.14 - $9.68 trading range within the last 3 weeks.  The shares hit a 52-week high of $9.68 prior to Christmas before pulling back into the $8s shortly thereafter.  What’s causing this dramatic gain, and most importantly, is it sustainable?  We think not.

Background Information :  Pier 1 Imports is a global retailer of decorative home furnishings and gifts.  It is North America’s largest specialty retailer in the space and has a current store count in excess of 1,000 in the United States, Canada, and Mexico.  Founded some 50 years ago, the company specializes in direct importing of home furnishing items from their native countries, oftentimes purchased directly from villages.  The company offers a quirky and eclectic assortment of goods similar to a bazaar: from fragrant candles to dinnerware to furniture.  These home furnishings consist of a staple of over 6,000 items offered throughout the year, with individual items changing frequently to meet customers’ changing demands and preferences.
According to the company’s website, “Our authentic and distinctive merchandise reflects the diverse cultures of the many countries we explore. We offer a broad assortment of items and styles, with something for everyone–useful, decorative and the purely whimsical. We help our customers reflect their personal style.”  Yet, while it is a treat to browse a Pier 1 store, fierce competition is deteriorating its unique advantage.

Current Year YTD Results :  Pier 1’s earnings and margins have been steadily declining in this tough retail environment.  Net sales declined 3.2% for the first quarter of this fiscal year versus the comparable period last year, and they declined 5.6% for the second quarter.  For the third quarter, net sales only decreased by only 0.4%, and the market went absolutely wild, thinking the company was in turnaround mode.  Not so fast.  According to then CEO Alex Smith, sales rebounded in the second half of November following the election (what we shall refer to as a “Trump Bump”), which helped the company deliver third quarter results “well ahead” of its forecast.
We’re not seeing a turnaround based on one single quarter that saw a bit of election optimism.  Keep in mind, net income has been steadily declining since 2012.  Consider these numbers:  Net income was $169M in FY 2012; $129M in 2013; $108M in 2014; $75M in 2015; and $40M in 2016.  For the first three quarters of the current 2017 fiscal year, we have a grand total net profit of $3M.  Q3 was simply a glitch in an otherwise bleak picture of another failing brick and mortars retailer.

Competition:  While some retailers are struggling, TJX Companies, owner of T.J. Maxx, Marshalls, and HomeGoods, plans to boldly grow its number of stores by over 50%.  Sporting strong sales growth last year, CEO Ernie Herrman said the company will have 5,600 stores when it’s finished expanding, up from a current total of about 3,700.  In 2015, the company opened over 200 new stores, and last year it added some 200 more, representing a 5% growth. 
The company is considering even more store openings beyond the 5,600 target as it contemplates the potential to expand into additional countries or open new chains in existing markets by snapping up bargains for buildings that other retailers have closed.  Brick and mortar closures are a growing trend as shoppers turn to more online options such as Amazon.  In mid-2015, Pier 1 announced it would be closing 100 stores over the next three years, to eventually operate with just under 1,000.  Other retailers such as Wal-Mart, Sears, Kmart, Kohls, Target, Macy’s, and Gap have all announced store closures.
HomeGoods provides stiff competition to Pier 1 with its discounted pricing.  Other strong brick and mortar retailers such as Burlington Stores have been adding more emphasis to their home assortment, and Amazon dominates in the online space.  Last year, J.C. Penney announced that it would be boosting its home collection in partnership with furniture company Ashley Furniture.  The company aims to become a destination for home design and decorating to weather-proof its business during seasonal periods of the year.

Valuation:  Given all of the challenges facing Pier 1, we are wondering why the company is trading at a premium to its peers.  Based on Friday’s closing price of $8.15, Pier 1 is trading at a trailing PE in excess of 29.  Havertys and Kirkland’s trades at a trailing PE of 20, Ethan Allen trades at 16, At Home Group and Williams-Sonoma trade at 14, and Bed Bath & Beyond trades near 9.  We would most closely associate Pier 1 with At Home Group and Williams-Sonoma at 14.  This would imply a share value of $3.92 based on a four-quarter trailing PE.

Will the Activist Investor Help Matters:  Probably not.  Last year, Alden Global Capital announced a 9.5% stake in Pier 1.  Instead of demonstrating some willingness to listen to the investor’s ideas to revamp the company, in September Pier 1 adopted a poison pill (shareholder Rights Protection Agreement) to protect itself from any single entity acquiring a 10% or more stake in the company. 
According to the company, “In general terms, the Rights restrict any person or group from acquiring beneficial ownership of 10% or more of the Company’s outstanding common stock (including, for these purposes, certain derivative securities) after the date of this announcement. The Rights will not prevent a takeover of the Company, but may cause substantial dilution to anyone acquiring 10% or more of the Company’s common stock, which may block or render more difficult a merger, tender offer or other business combination involving the Company that is not supported by the Board of Directors.”  The agreement attaches to every share of common stock the right to buy a fraction of junior preferred stock at the price of $17.50.  The preferred shares would carry similar voting rights to the company’s common stock, watering down the influence of any shareholder with a sizable position.
Alden shouldn’t feel too bad though.  If it’s average basis for its Pier1 stake is in the upper $3s or lower $4s, and the company is now trading three months later above $8, they’ve realized a 100%+ return in a very short period of time.  Bravo.
Concerns For the Future of Pier 1:  Besides the dividend, which provides a 3.44% yield, there is probably no good reason to hold Pier 1.  While the company may be taking a better approach to merchandising margin growth and inventory management, going forward we believe that increasing marketing expenditures will further pressure SG&A levels.  And in light of brutal competition, we see little in the way of significant sustained sales growth.  For the upcoming 2018 fiscal year, we are looking for earnings per share of $0.40.  At a forward PE of 14, we derive a fair price of $5.60 for Pier 1 Imports.