Activist Track: Pep Wanes in Pep Boys

Who wants to put money into a company that sounds like the Three Stooges?

Peter Lynch made this wisecrack about the auto parts and service chain Pep Boys -- Manny, Moe & Jack (PBY - commentary - Cramer's Take). However, a group of investors led by Barington Capital are enamored with Manny, Moe and Jack. Barington Capital and friends have obtained approximately a 6% stake in Pep Boys at around $13.50 a share.

Pep Boys makes 60% of its sales from the do-it-yourself market, and the other 40% from its service centers. Currently it has over $900 million worth of property, plants and equipment. Its real estate portfolio includes 593 stores with over 6,000 attached service bays. Pep Boys owns the land and buildings on 55% of these properties; for another 30% they have ground leases at attractive terms. With a market cap of $830 million, it is clear that real estate plays a major role in the valuation of Pep Boys.

After Lawrence Stevenson took up the reins of the company as CEO in 2003, Pep Boys embarked on a turnaround plan with the stated goal of becoming the dominant retailer for automotive maintenance and accessories.

In a DFAN14A filing from Dec. 6, Barington pans the effort, saying that it has yielded minimal sales growth and no corresponding increase in profits. Barington says that Pep Boys' retail operations have seen modest revenue growth to the detriment of margins, and the service centers have lost sales and margins due to ineffective execution.

Barington claims that the turnaround plan has led to a nearly $40 million increase in Pep Boys' operating expense base, leading to further reduction in EBITDA performance, and investment initiatives have eroded the company's strong historical base of free cash flow. Furthermore, credit quality has deteriorated due to weakening fundamentals and near-term maturities.

"In our opinion, the approximately 50% decrease in stock price from recent high was primarily due to management's poor execution of turnaround plan," Barington says in the filing. "We are convinced that the Company's asset value is providing main support in market."

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James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Buffett. At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback; click here to send him an email.

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