WHAT TO BUY WHEN COVID CASES DECLINE? PART TWO

What happens to the stock market once the initial phase of the COVID-19 pandemic subsides in the USA? I think there’s a good chance that happens as early as mid-September.

Could it be that the need for the incredible amount of stimulus infused into the economy (that has mostly gone to Wall St., not Main St.) goes down—and what if liquidity is even withdrawn because the US economy starts to perk up dramatically?

One is a name you might recognize. Michaels Companies (MIK – NASDAQ).Michaels owns and operates the largest arts and crafts retail chain in North America. They have over 1,200 stores in 49 states and Canada. In 2019 they did over $5 billion of sales.

Michaels suffered through the same store closures as other retailers in March, April and May. Their first quarter (which ends April) saw revenue decline nearly 30% year-over-year. The company went from 24c EPS in the first quarter of 2019 to a 43c loss this year.

Compounding the problem has been a debt load not conducive to long-term store closures. Michaels has $3.2 billion of debt, offset by a little over $900 million of cash.

But even though the first quarter saw a dramatic sales decline, the company did surprisingly well on the cash flow front. 

On the surface, operating cash flow was -$55 million, or nothing to write home about. But Q1 seasonally shows inventory and tax related cash outflows. Looking at the performance of the underlying business, cash generation remained positive.

Now stores are opening back up. If Michaels can generate cash at the worst of times, how well could it do once their business improves?

Michaels did over $2 per share in earnings last year. The stock is trading at under $8—but it’s up from just $1 in the middle of the pandemic. But if the economy comes back—4x earnings seems to allow for a lot of room for the stock to run if they can turn the business around.

A second name that has caught my eye is the At Home Group (HOME – NASDAQ). 

While Michaels is a distressed, turnaround story, At Home is geared to growth. 

In 2016, At Home had 81 stores across the United States. By the end of last year, they had doubled that.

Source: At Home Group Filings

 

At Home’s advantage is size. Their average store space is 105,000 sq ft – competitors like Bed Bath & Beyond, The Container Store, Ethan Allen, Havertys, Home Goods, Pier 1 Imports and Williams-Sonoma – have stores 10,000-35,000 sq ft.

Their store footprint allows them to stock the broadest assortment of products in the industry.

In their last fiscal year At Home did $175 million of EBITDA. At a $14 share price that puts the stock at 9x EV/EBITDA.

That is not expensive for a company that has been able to grow the top-line at a 20%+ CAGR the last five years.

Source: At Home Group Filing

At Home opened 32 new stores in 2019. They took a pause on new store openings in the first half of 2020 (not surprising given that many of their stores were closed).

But there is plenty of runway ahead of them. Management recently said that they believe they can expand to 600 stores in the United States long-term. At a run rate of 30 new stores a year, that is more than 10 years of growth.

A third name on the retail side is Hamilton Beach (HBB – NYSE). Hamilton Beach sells an array of small appliance brands. Familiar names like their namesake brand, as well as Proctor Silex and Weston.

The stock has moved a little too fast for me unfortunately, up nearly 80% in the last couple of weeks. But it could be worth pursuing on a pullback.

Hamilton Beach’s Q2 revenue already showed signs of a turnaround. It was up 5.5% year-over-year. The outlook was even better – the company expects a 10% to 15% revenue increase in the third quarter and for “demand to remain strong” the rest of the year.

The pop in revenue helps the bottom line. HBB expects operating profit to double sequentially in the third quarter. That measures out to earnings per share of around 65c.

Earlier this week when the stock traded under $15, that looked mispriced. But today, with the stock at $18, I am less sure. Still, I will be keeping a watchful eye on the name.

Another sector that has been hit hard by COVID is trucking. ArcBest (ARCB – NYSE) is one of the leaders in the less-than-truckload (LTL) space. LTL refers to transportation of relatively small freights – ie. less than a full truck load.

ArcBest offers logistics for LTL truck loads through their Panther Premium Logistics brand, which provides end-to-end supply chain services. They offer LTL freight transportation through their ABS Freight network.

The freight segment utilizes contract truckers for transportation but owns and operates the distribution centers. In total the company owns or leases 242 distribution centers across the country.

ABF Freight accounted for 69% of revenue in 2019, with the Panther logistics segments making up the rest.

This is a low margin business, but it can be a profitable one. In 2019 ArcBest posted earnings per share of $1.51. The prior year earnings were $2.51. 

A second and far more speculative trucking name is YRC Worldwide (YRCW – NYSE). 

YRC Worldwide was on the verge of bankruptcy only a couple of months ago. The company has always been a laggard in the LTL space due to its highly unionized (and therefore highly paid) workforce. 

The company also carries a large debt load—over $900 million.

The case can be made that YRC Worldwide should have been allowed to go bankrupt. I would not have been one to argue with that. But the reality is that it was not – instead the Treasury department gave the company a huge ($700 million!) low-interest loan.

The first tranche of that loan ($300 million) is being used to catch up on unpaid healthcare and employee insurance. But the next $400 million is earmarked for capital expenditures.

Apart from the drag of a unionized workforce, YRC Worldwide’s other big problem has been that its debt load has prevented it from renewing its fleet of tractors and trailers.

This has a spiraling effect. As the company noted on their second quarter conference call last week, maintenance costs for a 5-year-old tractor can run over $10,000 a year, versus 1/10th that amount for a brand-new tractor. Add on top of that fuel efficiency, safety and employee morale improvement and there is much to be gained by bringing on new equipment.

The $400 million loan allows them to do just that. YRC Worldwide plans to divide that loan up between brand new tractors and trailers.

It could save the company $10’s of millions in annual expenses. And it may tip the company back into profitability. Given years of underperformance YRC Worldwide has to be judged with a skeptical eye. 

Yet a refresh of the fleet that coincides with the return of the real economy they rely on could be a recipe for success, for the stock price if not for the business itself.

CONCLUSION—nobody knows for sure when the COVID-19 caseload in the US will start to fall—or what the stock market will do when that happens. But one thing does seem statistically certain—when it starts to fall, the number of cases will fall very steeply—see this chart again; it appears to happen ALL THE TIME.

There are really no exceptions to this—so far. So when the Market takes into account this swift new reality—the reaction could also be swift.

 

Keith