Hhgregg – weird name simple business.

Co-bloggers Frank Voisin (frankvoisin.com) and Saj Karsan (barelkarsan.com) have both yelled out loud about how cheap this unknown small cap is.  You may want to read their review has they are real financial bloggers and they are usually a lot better than I can be at spotting cheap stocks.

Barel’s blogs on hhgregg

Frank’s blog on hhgregg

Being a value investor, I think their analysis are great!  But being a value investor also implies you must make your own homework.  So I did mine… and it is a long one.  Hhgregg financials cannot hold in a bookshelf!  Only this fiscal year filing is 333 pages deep.  Any how, let’s resume.

What is HGG?

Description

hhgregg, Inc. (hhgregg) was formed in Delaware on April 12, 2007.  hhgregg is a specialty retailer of consumer electronics, home appliances and related services. It operates 173 stores in Alabama, Delaware, Florida, Georgia, Indiana, Kentucky, Maryland, Mississippi, New Jersey, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee and Virginia.

This company could be named Radio Shack or BestBuy with this description (ignoring the store count).  What is the difference between BBY, RSH or HGG?  HGG is telling us they differentiate themselves

[…] by providing our customers with a consultative and educational purchase experience. We also distinguish ourselves by offering same-day delivery on many of our products. Our superior customer purchase experience has enabled us to successfully compete against the other leading video and appliance retailers over the course of our 56-year history.

 Again this could have been taken from BBY financial statements or any other electronic retailers except for the one thing : same day delivery!  That is one nice additional features.  HGG also back this statement with facts:

[…]96% of salesman are full-time extensively trained employees.

That would surely help drive sales compared to student, part-time staff, being the bread and butter of many electronic retailers.

Financials

Growth

Impressively, management have kept a rapid store growth in the last years with successful market penetration. They are aggressively adding new stores (30-40 planned this year).

Sales are up mostly because of massive store openings.  Comparable store sales are down for the last 3 years (low 1 digit base point) but last fiscal quarter (Q1) showed massive comparable store decline at a whooping 13%!

Last year HGG opened 42 stores and EPS increased by 0.16$ from 1.03 to 1.19.  HGG released guidelines for sales of the next fiscal year and the said comparable sales should be -3% to flat (they may have missed on those estimates assuming the 13% decline in last quarter).  The number of new store opening for the year should be comparable (35-40).  EPS guidelines are between 1.20 to 1.35.  I would target flat to lower EPS current quarter.  31 new stores will be in operation before the end of Q2, I hope they will bring cash soon enough to recuperate the Q1 losses.

So my estimate is 1.19 to 1.30.

Debt and contractual obligations

A plus for the management, they’ve been aggressively attacking the debt in the previous years and ended 2011 fiscal year without any on their balance sheet.  The only thing to consider is the lease, they are leasing every single location they are using.  You may want to consider that contractual obligations are at 350M$ for the next five years!  That is a 70M$ obligation per year.  It is a reasonable amount on current sales of 2B$ and current profits of 48M per year.  The risk is very low of not being able to pay the obligations assuming they paid the 70M this year and generated free cash flow of 58M over this payment.

Compensation

Option is a useful tool in this company.  Over 3M$ worth of options have been issued in previous fiscal year to the six executive averaging 500k per executive employee.  Directors have also received 785k$ worth of stock options (70k shares) ni last fiscal year (112k each).

This is increasing the share count every year by over 370k shares diluting equity owners by 1% every year (without considering basic pay).  It is not overwhelming but must be considered.  This business must make up for the 1%.

Total option compensation plan cost exploded to 5.1M$ in 2011 or 8% of total income from operation!

One may also like to consider that outstanding options are at over 3.6M shares outstanding or almost 9% of the current share count.

Shares issuance/buybacks

HGG issued shares in most of the previous fiscal year diluting EPS by 10% every time.  It could happen again.  It helps reduce the risk but also reduces the award…

In the previous quarter, shares of the company were at their lowest in history.  Management found that out and started a share repurchase plan executed in Q1 at 1.2M shares bought back or 22.3 M$!  1.2M shares are representing 4% of current market cap!

How can we make profit out of this…

Takeover possibility

They have a poison pill and directors owns more than 54.5% of the company.  A hostile takeover is almost impossible.  We need to focus somewhere else to get profits out of this stock.

Dividends

No dividend have been paid on this stock and management does not plan to do so in the future.

Share price undervalued?

Risk is low in a no-debt company.  I try to find a margin of safety around 30-40% in those so I get a good share growth possibility in short-term and can wait for many years with double-digit return on current earning.

EPS of 1.19 to 1.30 at a P/E of 10 (low for a growing, debt free company) is resulting in fair price estimate of 11.90$ to 13$.  Current share price (2011-08-05) is 11.1.  Giving us a MoS of 7%.  Too low for my standards.  Too much is risked on future earnings.

Disclosure : Author owns shares of BBY.

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Posted in BBY, HGG, NASDAQ

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