Monday, June 12, 2006

Tuesday Morning will be Difficult for Tuesday Morning- Are You Activists Out There?

Tuesday Morning (TUES) is a closeout retailer of upscale home furnishings and gifts operating over 700 stores. The stock is down some  45% over the last 52 weeks and 22% YTD. The home furnishings area has been tough (looked at Pier One [PIR] lately?) The May-Federated consolidation has resulted in heavy discounting in home furnishings and the general economic environment have made life difficult in this sector.

The situation continues. Earlier this evening, the company announced that same store sales for the quarter were comping down 8.0-9.5%. The company expects earnings for the second quarter to come in at 7-10 cents per share versus consensus expectations of 21 cents.

Tuesday Morning sells first quality brand name merchandise at closeout prices 50-80% below those charged by department stores, not factory rejects or irregulars. Its merchandise can include Hummel figurines, Royal Doulton and Wedgwood, as well as Martex bath towels, and Kitchenaid or Cuisinart applicances. Great stuff, great deals, but highly discretionary purchases.

The store base has grown by about 10% a year for the last five years. Costs are kept low by renting almost anything that is available cheaply for its space.

The treasure hunt atmosphere that prevails at its sales events attracts predominantly women from middle and upper income households, not the mortgage interest and gasoline marginalized customers of Wal-Mart. Median annual income for TUES' customers is believed to exceed $60,000. The weakness that concerns many WMT bears (and we are not bearish on WMT) seems to be reaching higher economic strata.

Retail stock problems are often evident in the gross margin and the working capital accounts. From this perspective, TUES did provide some clues of its difficulties during the first quarter. The cash conersion cycle had moved out to 143.4 days versus the comparable quarter's 113.3 days. Days of inventory outstanding had moved up to 209.2 days versus last year's 141.6 days. Gross margins did not show, at least during the first quarter, any signs of deterioration hanging in at 41.3% versus the prior period's 41.0%

In June of 2005, the company paid its first ever cash dividend of $0.65 per share. Long term debt as of year end 2005 was zero.

This has been a stellar performer with respect to ROIC:

In mid-May, the CFO resigned unexpectedly to accept a position at a privately held aerospace company. The company's problems do NOT relate to any accounting or financial issues that I can ascertain, it appears to be simply a competitive environment that has proven difficult for TUES' merchandise. There may be issues with sourcing as manufacturers have improved their own inventory management or operate their own closeout stores.

On a valuation basis, this is about as good as it gets...EV/EBIT is 7.2 times. The company delivers ROIC is above what one would expect for this price, but the story should not end there.

Looking at CFFO adds to the mystery and to my reluctance to use this name . Here is CFFO:
2000...$  2.4

Madison Dearborn owns 27.5% of the stock, so the company has strong support. Of interest, in the last quarterly conference call, management was peppered with questions regarding the declining profitability by Robert Chapman, a noted activist at Chap-Cap Activists. I suspect that successful activists of Mr. Chapman's ability could utilize tomorrow's weakness to add to positions.

But, until I have a better handle on what's happening with working capital management and hence, cash flow from operations, I really can't own this one just yet. Restained by my discipline...but I am intrigued by price, by long term value, and by the potential for activist interest.

Disclaimer: Neither I, my family, or clients have a current position in Tuesday Morning.


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