Via https://newsapi.org online business online marketing online business opportunities Introduction
At Home is at the intersection of two powerful trends that are shaping the US economy, PE-backed financial engineering and digital disruption. The brick-and-mortar retail landscape is battle ground competing for market share against digital-native disruptors that offer innovation and increasingly superior economics. Even specialized players with good value propositions are starting to fall in the shadow of eCommerce.
We learned this the hard way recently on Destination Maternity (DEST), which at one point had great turn-around potential yet ended in disaster despite a new slate of directors and management, and activist backing. Home goods such as furniture, decor, and linens are no exception. There are challenges in both hardlines and softlines with Bed Bath and Beyond (BBBY) down over 90% from its all time high at the recent August low and Pier 1 Imports (PIR) reduced to a penny stock before a 20-1 reverse split in June.
Amid this, At Home Group was widely seen by the street as a unique high growth play, at one point valued at 116x P/E. At Home Group, which is only testing out eCommerce initiatives, operates massive stores packed with home decor inventory, many of which are located in struggling shopping centers where the rent is low. These stores don’t really generate a lot of cash flow, but At Home has been able scale rapidly, adding 122 stores in the last 5 fiscal calendar years. In this article we will examine how that was possible and take a clear eyed look at the sustainability At Home’s business model and financial strategy.
Via https://newsapi.org online business online marketing online business opportunities Company Overview
At Home Group operates 213 large retail stores that are about 105,000 sqft on average. Older stores are a bit larger than new ones, as this has decreased from 120,000 at the time of the IPO. With over 50,000 SKUs, At Home offers a wide range of home decor products including rugs, patio cushions, furniture, pillows, pottery, accent pieces, artificial plants, and wall art among other items. At Home also offers a wide array of holiday decorations. At Home does not sell online, but it does have a buy-online-pickup-in-store test in 28 locations.
At Home was originally founded as Garden Ridge Pottery in 1979 with the first location opening in San Antonio, Texas. The founder sold it to a group of investors in 1988, shortly after that the group “nearly bankrupted it” due to “excessive leverage and a failed expansion plan“. It was sold to another group of investors that took it public on the NASDAQ with 5 stores in 1994. Business was good with Garden Ridge generating $22.5M+ in revenue per store in 1997. Today, it does a fraction of that (see appendix).
Garden Ridge continued to grow, and went private at a $185M ($5.6M per store) valuation in 1999 (today it is valued at $10.5M per store). It continued to add stores until it filed for bankruptcy in 2004. This bankruptcy was necessary to renegotiate leases after expanding faster than the business could support.
It reemerged from bankruptcy, and by 2011 rumors were circulating that Garden Ridge was exploring a sale. This may have had something to do with At Home CEO Lee Bird’s failed attempt to broker a deal between the company and PE sponsors. Lee Bird was inspired to approach Garden Ridge after he found Range Rovers and Mercedes in the parking lot, an indication that Garden Ridge had strong customers. In the following year, AEA and Starr, two private equity firms, acquired Garden Ridge and called Bird in as CEO. They immediately began expanding, acquiring stores form former JC Penny, Sam’s, Sears, and Kmart locations.
In 2014 Garden Ridge was totally re-branded as At Home and in 2016 the company returned to the public market, with a $130M IPO valuing the company at around $1.4B (TEV, data provided by S&P). The combination of store, revenue, and comp. growth kicked off meteoric rise as the stock moved higher in leaps and bounds, ultimately peaking at nearly $41/share. As sell-side analysts touted bullish ratings as the PE sponsors began to sell. Just a year later, the stock had gone from $41 to $7. Buyout rumors circulated as the PE sponsors further reduced their holdings (according to data compiled by S&P).
(Image Source: Bloomberg/Author’s annotations)
The plummeting stock screened attracted a string of new investor entries, including Jeremy Grantham’s GMO and CAS–which is now the largest shareholder with 13.8% of the shares outstanding. The September 30th 13F filing date recorded 28 new entries according to data complied by S&P. This amounted to 26.5% of the shares outstanding.
(Image Source: Bloomberg)
The herd of new investors were not rewarded. After reporting a negative comparable store sales and weak sales trends on seasonal merchandise, the stock plummeted nearly 40%. This was the second time a plunge of that size has happened this year.
Why are investors so afraid? At Home is highly leveraged, with nearly $1.9B in debt and lease obligations.
Via https://newsapi.org online business online marketing online business opportunities Thesis: Financial Engineering Time Bomb
What drove a $41 high-growth stock to $5/share? Much the same way that Garden Ridge was re-branded as “At Home”, the company has re-branded financial engineering as “growth algorithm“. Ordinarily, the ideal way for a business to grow is to generate cash and use that cash to expand. If the expansion opportunities aren’t optimal, perhaps it is best to return that cash to shareholders with a buyback or dividend. If the business generates a lot of cash, it can expand quickly. Amazon (AMZN) has generated $35.3B in cash flow from operations in the last 4 quarters.
At Home doesn’t really generate a lot of cash, just $63.4M in the last four quarters. It spent far more than that in capital expenditures alone, $298.5M. We estimate that the annual cash flow from operations is less than $500,000 per store on average and $300,000 after accounting for maintenance capex. The rapid growth of the company has been enabled by generating cash from debt, the IPO, and sale-leasebacks.
Imagine if you had a business delivering catered donuts for various doughnut bakers around town. You started out with one delivery truck, that you owned. You then sold the truck to a dealership, that then leased the truck back to you. You then buy another truck, and do the same thing, giving you cash to buy yet another truck. Suppose you kept doing it. Eventually you might have a fleet of leased doughnut delivery trucks. This plan works great as long as demand is growing, but there are many risks. Suppose that offices cut back on the morning doughnut catering, or that your doughnuts fell out of favor in light of some new healthier alternative, or perhaps there is an innovative new delivery app that you must compete with… in any of those scenarios you’d be in trouble pretty quickly.
This sort of financial engineering is exactly what At Home’s strategy has been, and the risk profile is similar. At Home acquires stores, sells them, then leases the store back from the buyer. The ownership of the store is shifted, generating cash that is used to expand into more locations, but At Home retains the risks.
If we decide to close stores, we are generally required to either continue to pay rent and operating expenses for the balance of the lease term or, for certain locations, pay exercise rights to terminate, which in either case could be expensive. Even if we are able to assign or sublease vacated locations where our lease cannot be terminated, we may remain liable on the lease obligations if the assignee or sublessee does not perform.
(Source: At Home Group 10-k)
At Home has followed this strategy because both management and investors and confident that it will work, despite the fact that the company has run into expansion related financial problems twice. This confidence comes from things like “20 consecutive quarters of same-store sales growth” and “22nd straight quarter of at least high teens revenue growth“.
- More revenue=more stores=more revenue=more stores. It’s not financial engineering… It’s a growth algorithm!
However, there is a problem. We ran the numbers and found that the long history of comparable-store-sales growth talking point that has been pitched to investors does not tell the whole story. A simple index of CSS shows that a store that has been in operation since Q1 FY17 should have done 63% more in sales by Q4 FY19—but revenue per store is flat to marginally higher.
A store is included in the comparable store sales calculation on the first day of the sixteenth full fiscal month following the store’s opening, which is when we believe comparability is achieved. When a store is being relocated or remodeled, we exclude sales from that store in the calculation of comparable store sales until the first day of the sixteenth full fiscal month after it reopens. In addition, when applicable, we adjust for the effect of the 53rd week. There may be variations in the way in which some of our competitors and other retailers calculate comparable or “same store” sales. As a result, data in this report regarding our comparable store sales may not be comparable to similar data made available by other retailers.
We also suspect that the non-GAAP adjusted EBITDA numbers also mask what is more mediocre performance.
At Home’s financial engineering looks like a savvy capital strategy only as long as the business is growing. If the trends start to be negative, the system starts to work in reverse. Suddenly sale-leasebacks get more expensive as buyers demand more to compensate for the risk—risk that is further enhanced by the leverage. Equity capital gets more difficult to raise at a depressed stock price. Higher costs weigh on the profitability. The ability to grow gets even more limited.
Finally there is the debt. In 2022 At Home’s term loan and revolver will mature, according to data provided by S&P. At Home will almost certainly need to refinance this debt again in the future, along with continued use of its revolver, of which it currently has nearly $300M outstanding. Though the coupon is only 5.8% (LIBOR+4), the term loan is currently priced at 11.56% yield according to data provided by Bloomberg. This is only after a couple quarters of negative comparable store sales. The revolver has a coupon of just 4%.
If things continue to trend negative, these costs could be substantially higher when refinanced. If the interest expense were to double or triple, it could wipe out the entire bottom line, and push operational cash flow into negative territory. With just $14.1M in cash on the balance sheet and around $2.2B in total obligations, At Home could quickly implode under the weight of its financial leverage.
Via https://newsapi.org online business online marketing online business opportunities Industry Trends: The Fuse Is Lit
Target and TJX have both addressed the challenge of eCommerce disruption in part by shifting their product mix to include more home furnishings and decor items. We suspect this is taking market share from At Home and is a very difficult trend to reverse. A key part of At Home’s strategy has been to put stores in struggling retail centers where rents are low ($5 per sqft on average). This was pitched to investors as an innovative new use-case for emerging opportunities in real estate, part of the company’s overall strategy to bring “everyday low prices” that “can be up to 60% lower for similar products“.
In fact, At Home may not even be the low-cost leader, or the difference may be extremely marginal. We are highly skeptical of the company’s claims. Here are some examples on near-identical items that competitors offer online, but At Home only offers in store as it does not sell online…
On the other hand, all brick-and-mortar furniture and decor businesses are facing increased competition online. One of the most difficult problems in shopping for furniture and decor items online is sifting through the mind-blowing number of items. Wayfair has over 8,000,000 SKU’s. Amazon offers some of the best and most innovative solutions such as a style quiz, curated offerings, virtual design, and a like/dislike recommendation engine.
At Home’s answer to online competitors is a 28 store buy-online-pickup-in-store (BOPIS) test, that it plans to roll out to more locations. Part of the difficulty in rolling this out is that we found At Home’s stores packed with highly disorganized inventory. The stores have few employees on site, and we believe At Home will need to hire more employees in order to make BOPIS possible, and just a few more employees per store could really eat into the bottom-line. Imagine trying to comb through these shelves to fill an order on an item that may not even be in the right location.
A pivot to develop a more robust online retail strategy seems impossible. At Home is already highly leveraged and simply does not have the cash resources to do it. At Home operates two distribution centers that mostly serve as cross-dock facilities to coordinate distribution of inventory to stores. The only other inventory carried on the back end is warehouse spaced used for initial inventory build‑up for new store openings.
The struggles of Pier 1 Imports, which offers products in many of the same categories as At Home, illustrate the difficulty of pivoting and competing in the dynamic changes that are happening in furniture and home decor. In Q3, an article on NASDAQ.com describe Pier 1 as being on “life support“. So far its turnaround efforts have been unsuccessful, despite having both a CEO and CFO with turnaround experience.
Trends elsewhere don’t offer much hope either. On comparative store check, we visited a Hobby Lobby location with most of the store marked down 40-50%, including an extensive array of holiday decor items. This seems notably early in the holiday shopping season for such deep markdown. Additionally, each competitor we visited offered a robust holiday decor assortment (including Walmart, Lowe’s, Target, Hobby Lobby, and Home Depot) which could explain why At Home has seen sluggish sales in seasonal sales–historically a revenue driver.
Via https://newsapi.org online business online marketing online business opportunities Conclusion: A Bridge Too Far
It is possible that At Home will find ways to reverse the negative comparable store sales trend and remain competitive, diffusing what we view as a financial time bomb. However, we view this as highly unlikely given the company’s high leverage and limited capital resources. If our thesis is correct, many of the new investors that have recently entered the stock thinking it was undervalued will be forced to exit unless they want to stick around for what could be a messy turnaround story.
- We do not believe that At Home has a differentiated model or a unique concept. The only thing unique/differentiated is that it does not sell online, which puts the company at a competitive disadvantage.
- We are highly skeptical that At Home is the low-cost leader, and in fact have found evidence that they are actually at a cost disadvantage compared to rapidly growing competitors that offer both lower prices and fast delivery in similar items.
- We believe At Home’s ability to address these challenges is limited, and that risky financial engineering in the form of sale-leasebacks will drive the company into financial distress within the next 2-3 years, as the company will need to roll a significant amount debt. Current debt prices indicate that this could be 11.56% or higher if conditions worsen, according to pricing data provided by Bloomberg.
For these reasons we are short HOME with a 3 year PT of $0-$0.50
Via https://newsapi.org online business online marketing online business opportunities Appendix
(Source: Author’s work/Company website)
Disclosure: I am/we are short HOME. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.