Tuesday Morning: Running on Momentum Alone?

Tuesday Morning (TUES) is a discount retailer of home furnishings, apparel, and a wide variety of low ticket merchandise with 858 stores nationwide. As Bespoke Investment Group recently reported, TUES is the top performing stock in the Russell 3000 on a year-to-date basis (http://bit.ly/bNOU9S) and thus warrants investors’ attention as either a break-out or short candidate. After conducting a detailed review of TUES, my opinion is that it falls neatly into the latter category.

Frankly, I have been bewildered by the price performance of TUES over the past three weeks, during which time it skyrocketed 56%. The only piece of news during this time period was that Madison Dearborn Partners (“MDP”), the widely respected Private Equity group, completely exited its large position in TUES (at between $4.30 - $4.76 per share) in order to return funds to its limited partners. It also relinquished its board position. Given MDP’s stellar long-term track record, this hardly seems like a good explanation for the rally.

At Friday’s closing price of $6.90, TUES’ trailing P/E ratio is 53x. Using management’s FY2010 guidance of $0.06 and $0.10 per share (note 6/30/10 year-end), TUES is selling for a P/E ratio of 69 - 115. It recently surpassed its two year high and is trading at a level which hasn’t been seen since late 2007. According to Yahoo! Finance, TUES is only covered by one analyst whose price target is $3/share, which essentially assigns a value to TUES under a favorable liquidation scenario. This valuation is not supported by earnings growth. From 2005 through 2009, TUES’ revenues fell 13% (from $932mm to $811mm) while earnings per share dropped a jaw dropping 91% from 1.46 per share to 0.13 per share as net income margins fell from 6.55% to 0.66% of revenues.

When one takes a closer look at TUES’ competitive environment, it begins to make sense why the company performance has been so lackluster over the past five years. According to its most recent 10K, TUES’ target customers are “women ranging in age from 35 to 54 from middle and upper-income households” who are “brand savvy and value-conscious.” This segment of the discount market has been very competitive: Ross Stores (ROST) and TJ Maxx (TJX) have arguably been the biggest winners with 2005 - 2009 revenue increases of 64% and 32%, respectively. TUES has also been pressured by Target (TGT), Nordstrom Rack (JWN), and Bed Bath & Beyond (BBBY) for higher ticket items and a host of discount variety franchises for lower ticket items. This opinion is affirmed by the following disclosure in TUES’ 12/31/09 10Q: "The retail home furnishings industry has been negatively impacted by increased supply and competition within an already highly competitive promotional environment, a trend we believe is likely to continue in the near term and potentially longer."

One could argue that TUES is inexpensive based on its low Price-to-Book (“P/B”) ratio of 1.16x and conservative, debt-free capital position. However, I would counter that P/B is misleading given the illiquid nature of the firm’s assets. The majority of Tuesday Morning’s assets are comprised of inventory which has already been resold once and is comprised of thousands of unusual Stock-Keeping-Units, many of which are highly illiquid. It should also be noted that they lease all but one of their retail outlets. They do own their corporate headquarters and most of their distribution centers; however, it is unlikely that their long-term assets are worth anything near their most recent Property-Plant-and-Equipment valuation of $72mm, especially given the condition of the commercial real estate market. It is also reasonable to presume that MDP would have conducted sale-leasebacks or driven down inventory levels if they felt that Tuesday Morning had been fundamentally under-valued on a balance sheet basis.

My analytical conclusions about Tuesday Morning were further supported this weekend when I conducted site visits of Tuesday Morning, Ross Stores, and TJ Maxx near my home in San Mateo, CA. Tuesday Morning’s outlet was dirty and had a depressing feel to it. In contrast with TUES’ stated target demographic, customers appeared to be lower to lower-middle income and seemed to be more interested in browsing than buying. The check-out line was empty. Inventory was plentiful and they didn't appear to be turning over product. In fact, the store felt more like a rummage sale than a sales outlet because so much of their inventory was outdated and kitschy. For example, their wares included figurines of retired or obscure athletes (e.g., Patrick Ewing) and an array of oversized New England Patriots and Oakland Raiders outdoor thermometers (San Mateo is 49er country!). As a former Private Placement analyst, I have conducted many site visits and I have only seen inventory levels this bloated on one other occasion.

Later I visited the nearest Ross Stores and TJ Maxx outlets, which are both located in the same shopping plaza about a mile away from Tuesday Morning’s location. Despite their proximity, both sites had substantially more foot traffic than I had seen at TUES. Ross in particular was absolutely booming with customers lined up for check-out halfway into the store. When I asked the store manager at Ross if he worried about Tuesday Morning as a competitor, he said "No, not at all. We blow them out of the water." Ultimately, my site visits further added to my suspicion that Tuesday Morning continues to lose market share to its primary competitors.

In conclusion, Tuesday’s current valuation appears to be remarkably stretched. The company is astonishingly over-valued on a P/E basis and there is no compelling reason to buy the stock based upon the book value of its mostly illiquid assets and seemingly bloated inventory. It is also technically overbought with a Relative Strength Index (“RSI”) of nearly 80%. It seems to be an exceptionally good short candidate with a current value of $6.90 and a reasonable price target of $3.

Disclosure: author holds secular short positions of TUES in personal and familial accounts