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Activist Track: Sew Up This Play

Olstein likes Jo-Ann Stores and is readying to become an activist in it. Value hounds take note.

This column was originally published on RealMoney on Jan. 24 at 10:57 a.m. EST. It's being republished as a bonus for readers.

Normally I don't get very excited over

yarn and other assorted crafts, but when Bob Olstein, Mr. Value himself, gets involved in any sector, my interest piques.

And so this week's activist track takes us to

Jo-Ann Stores


, a fabrics and crafts retailer located in the U.S. Olstein has been acquiring shares over the past two years and filed a 13-D on Dec. 19, 2005.

The filing does not shed much light onto his thinking:

"Olstein believes that the Common Stock of the Issuer is undervalued and that steps can and should be taken by the Issuer to increase the market valuation of the Common Stock. Olstein plans to communicate with the Issuer on alternatives for realizing the unrecognized value of the Issuer and suggestions for improving management of the Issuer. Olstein intends to continue its dialogue with, and to take an active interest in, the Issuer regarding, among other things, the Issuer's strategic direction and corporate governance and management."

Olstein has recently acquired shares at approximately $14.40.

There's a lot of hair on this story, which makes it a tricky play. The company's gross margins are declining, as is stated explicitly in the most recent quarterly filing:

"Our gross margin rate, as a percentage of sales, declined by 220 basis points, to 45.6% of net sales this quarter vs. 47.8% for the third quarter last year. This is due to a more price-focused environment, an increased level of coupon-assisted sales and an increased level of promotional and clearance activity compared to a year ago."

Second, the company's SGA expenses were rising, and this was also stated in the most recent quarterly filing:

"Our selling, general and administrative expenses ("SG&A") as a percentage of sales, excluding those expenses separately identified in the statement of operations, increased 210 basis points from 40.2% in the third quarter last year to 42.3% this year. The reduced leverage for the quarter stemmed from essentially flat same-store sales performance, coupled with higher advertising spending, logistics costs, and normal inflationary increases in operating expenses."

However, a lot of this is due to the company's expansion into superstores and the costs incurred with that expansion. Additionally, the company's inventory plus real estate holdings, minus its debt, is worth almost twice the $307 million market cap. If management can make any turnaround at all in cash flows then this stock will be severely undervalued at these prices.

Olstein's most recent thoughts on Jo-Ann Stores came in an interview with Whitney Tilson's Value Investor's Insight newsletter. He stated in the interview, "One of the screens we use in looking for ideas is market capitalization-to-sales. That sets up a margin play. What caught our attention about Jo-Ann Stores was a market cap less than $500 million while revenues are $1.8 billion."

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He goes on to highlight increased sales per square foot in the company's new, larger stores, and argues that earnings power could double from current levels within two years if management "gets it right."

I agree with Olstein, and I am bullish on the stock. As the company continues to transform itself into a full-line arts and crafts shop in contrast to its prior focus on just fabrics, the company will increase earnings potential greatly. A glimpse at the two-year chart shows that this stock is beaten down; with Olstein on its side, I believe it's heading north.

I own the stock with an initial target in the $17-$18 range.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Jo-Ann Stores to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Altucher and/or his fund was long JAS, although positions may change at any time.

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


Trade Like Warren Buffett

. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback;

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