Unless you're interested in scrapbooking or crochet, you've probably never shopped at Michaels Stores, the big-box retailer of arts and crafts. But if you're interested in retail stocks, check it out.
You'll probably find the stores crowded this weekend, as shoppers pick up material for Easter baskets and bonnets. (Yes, people still make those. People who keep Michaels in business.)
Reports surfaced earlier this week that Blackstone Group and Bain Capital, the private equity investors who took the company private in 2006, had hired JPMorgan Chase and Goldman Sachs to file a stock offering in April. Michael's owners haven't filed an offering document, or even announced the IPO officially, but they recently closed the books on the latest fiscal year, which gives us a chance to peek under the hood.
The company's 10-K for the fiscal year ended Jan. 28 shows it's turned profitable since going private and it's been growing modestly, adding only an average of about 20 stores a year, to reach 1,064 at the end of fiscal year 2011. But the latest report says the company plans to pick up the pace, to open 45 to 50 this fiscal year, and believes it can handle up to 1,600 locations in the U.S. and Canada.
Michaels does have one weakness: a load of debt. According to the filing, the company had $3.49 billion in debt at the end of January. Let's assume the IPO will put a dent in that.
Michaels is also working out the aftereffects of a massive data breach that exposed customers' credit card information. The filing says the Secret Service found 90% of its terminals had been tampered with. That's sparked seven class action lawsuits at last count. It's safe to assume this will be settled quietly once all the suits are lumped together, as it often happens with consumer class action suits.
Now the good news: Michaels has gone from a loss of $29 million in 2007 to net income of $176 million in fiscal year 2011, up 72% from the year before. According to the 10-K, cash is up, inventories are lower and stable, and comparable sales (for stores open at least a year) rose 3.2%, better than the 2.5% growth in 2010. Sales per square foot went up 2.4% to $213 in 2011, and private-brand items are now 50% of sales, up from 36% in 2010, which is good news for sales margins.
So with all the profit-and-loss numbers stuff out of the way, should you invest in Michaels? With the IPO not official yet, there's no news on the size or pricing of the offering, so it's hard to even scratch something on the back of an envelope. But the company's executive bonus plan set a fair market value of $24.09 per share on the last day of fiscal year 2011. Using that as a guide, and 118.27 million shares outstanding mentioned in the balance sheet on the latest 10-K, earnings per share would come in at $1.49 and the P/E ratio on 2011's $176 million net income would work out to 16.2 -- a healthy valuation, but average for the retail sector.
And the macro trends are turning in Michaels' favor. The improving economy is leaving room for households to spend on discretionary items. The latest U.S. Commerce Department sales numbers show Americans have spent 6.4% more so far this year in hobby and sporting goods stores than the same time last year.
Also, Michaels' filing noted that nearly half its sales come from children's and crafts items, not home-related or decorative items, so the continued weakness in the housing market isn't as direct an issue here as it is with other home-and-hearth retailers like Bed Bath & Beyond (NAS: BBBY) .
Industry observers think Michaels could be the thin edge of the wedge for retail IPOs, which had been in a holding pattern lately, with Toys R Us still toying with going public again two years after its private-equity owners made their first moves. The only recent retail IPOs of note have been relatively small, on the order of Teavana (NYS: TEA) and Chefs' Warehouse (NAS: CHEF) , both under $1 billion in market cap, compared to the potential $5 billion-plus potential size of Michaels. Even the successful IPO of Michael Kors (NYS: KORS) at the end of last year was due more to the strength of the luxury goods market than to that of the retail segment.
So keep an ear to the ground for a Michaels' announcement, and check out the pricing on the IPO. If the valuation comes in around $25, and the company sticks to its knitting, it could be a winner.
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At the time thisarticle was published Mercedes Cardona does not own shares in any of the companies mentioned in this article. Follow her onTwitteror on herwebsite.The Motley Fool owns shares of JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group and Bed Bath & Beyond.The Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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