The more minuses Wall Street finds in the home furnishings sector, the greater the rewards could be for patient fans of a little-known retailer called
Investors have taken a wrecking ball to the specialty home furnishings sector lately, and looking at the numbers, it's no wonder. Just months after winning the Warren Buffett seal of approval,
Pier 1 Imports
posted a 9% drop in November same-store sales. Rival
( BBA) reported a 13% slide in comps, and
slashed its fourth-quarter guidance by 14%.
For its part, Cost Plus is down over 15% in the last month, and analysts say the stock probably has further to fall after a shaky third-quarter performance and a string of sales disappointments. Still, some observers see opportunity in the smallest player in this once red-hot sector.
Analysts say Cost Plus has room to grow and targets a lucrative demographic with an unusual merchandising mix. Add to that a stock that even now is trading at a discount to its peers, and you may just have the makings of a climb out of the bargain basement.
"It's definitely a good concept," said William Armstrong, an analyst with C.L. King & Associates who doesn't own shares of Cost Plus. His firm has no investment banking relationship with the company. "At the right price, it's a great investment."
On Monday, Cost Plus fell 64 cents to $31.21.
Room to Grow
Fans of Cost Plus start with what they see as the company's unique retailing concept. Based in San Francisco, Cost Plus stores offer imported home furnishings and decor along with gourmet consumables like candies, sauces, spices, cheeses, wines and microbrews. The theme is home entertaining, attracting a sophisticated customer that is 80% female between the ages of 22 and 54 with annual household income above $50,000.
"As a specialty retailer in this environment, you've got to offer distinctly different merchandise and a compelling shopping experience in order to just maintain market share," said Joan Storms, an analyst with Wedbush Morgan Securities. "Cost Plus is a winner in that."
With just 237 stores in 30 states -- less than half as many stores as Bombay and less than a quarter of Pier 1's total -- Cost Plus also has ample room to grow. With the recent addition of its new distribution center on the East Coast (in Virginia), the company is poised to establish a presence in the Northeast, which will inevitably raise its profile on Wall Street.
"Going through their stores is almost like a treasure hunt from department to department, and it's almost intentionally disorganized, which makes it fun," said Storms, who doesn't own shares in Cost Plus and whose firm has no investment banking relationship with the company. "Their average customer spends 40 minutes in the store -- a long time."
For 2004, Cost Plus plans to add a total of 33 new stores, followed by 38 new stores in 2005. Meanwhile, its strong balance sheet and healthy cash flows should allow the company to fund its growth internally without returning to the public market for financing.
D.A. Davidson & Co. analyst Crystal Lanigan estimates that Cost Plus could expand its concept to the 600-store range. Combine that with her prediction that it will develop an effective Internet and catalog business within the next few years, and she sees a five-year price target of $70.
So far, the company's growth record is impressive. The company averaged 21% annual revenue growth over the past five years, as it more than doubled its store base while averaging 5% annual increases in comps. In 2005, analysts estimate sales will increase by 16%, followed by a 15% increase in 2006.
At a forward price-to-earnings ratio of about 19.9, Cost Plus trades below the industry average, which is closer to 24.5. While specialty home furnishing stores have had troubles of late, some analysts think the space will eventually benefit from a trend towards spending on the home that is expected to strengthen as the baby-boomer generation retires.
"We call it the 'reinvestment economy,'" said Craig Johnson, the president of Customer Growth Partners. "People have made the bulk of their investment returns in recent years on their homes, and they're increasingly focusing their spending on that investment. Even if the housing market loses steam in the future, we don't anticipate this trend slowing down anytime soon."
That said, these stocks have been taking a beating. Even after Buffett turned the spotlight on the sector in August with his 9% stake in Pier 1, the bleeding has continued.
So Cost Plus' rivals have spelled out their intentions to combat the lackluster spending environment with increased holiday promotions. Cost Plus, which doesn't report monthly comps, is hoping to keep margins flat in order to hit its fourth-quarter earnings estimate of $1.30 a share.
Given all the available data, Pacific Growth Securities analyst Andy Graves thinks that's optimistic.
"We expect an increasing tenor of promotions in the coming days at Cost Plus Stores," Graves wrote in a research note Friday, adding that the stock could sink into the high $20s in the near term. Pacific Growth Equities makes a market in shares of Cost Plus, but it does not have an investment banking relationship with the company.
Part of the recent difficulty for the sector stems from a backlash from big department stores and mass merchandisers that have woken up this business.
"Now, I think there's some shift going on in the industry where the big guys have realized that they've left this great category behind, so they're going after it pretty aggressively and are starting to fight back," Storms said.
Aside from macro difficulties, Cost Plus posted bad third-quarter results due to some execution problems involving inventory purchasing and some hurricane exposure. Its profits dropped to $400,000 from $900,000 in the same quarter last year.
"While there is not much that retailers can do about forces of nature, we were dismayed by the inventory issues, which speak to poor execution," said Morningstar analyst Anthony Chukumba. "We'll be keeping an eye on that."
Still, even Chukumba concedes that there's opportunity here. "The management team is usually pretty solid," he added. "They have a unique store concept that works and has a lot of growth potential."