Summary
- Michaels reported a (predictably) difficult Q1 on Thursday, June 4th, but surprised analysts with an +11% same-store sales comp in May.
- The shares staged an enormous rally but still trade today with a trailing P/E of only 4.8x.
- The company is substantially undervalued and oversold, with 38.76% of shares sold short. Fundamental improvements we are bearing witness to are likely to lead to a near-term short squeeze.
On Thursday, June 4th, before market open, The Michaels Companies (MIK) reported an EPS loss of -$0.43 per share on revenues of $799.9 million, both substantially below the headline “consensus expectations” for $0.15 of EPS on $1.03 billion in revenue. The stock took off, closing the day on its high, +9%. The next day, it broke through $5 and closed the week at $5.51, up 43% in the past 5 trading days. While it seems tempting to dismiss gains at the highly levered retailer as symptoms of the speculative fervor that has overtaken the broad market indices, I would suggest that, on closer examination, MIK is sufficiently capitalized to benefit from the ongoing resurgence in sales of arts and crafts supplies, and that MIK shares have much, much farther to run.
On Valuation
Inclusive of Thursday’s $0.43 loss, MIK has generated $171 million in net income over the last 4 quarters, or roughly $1.16 per share (the actual weighted average share count over the trailing period is different due to ongoing repurchase activity, etc.). Set aside for the moment that the most recent reported quarter is not representative of the underlying demand for Michaels’ merchandise, but rather the fact that fewer than 500 of the company's 1,300 stores were open by quarter end. MIK is trading at a trailing P/E ratio of 4.8x.
Of course, the P/E ratio can only be understood in the context of the company’s substantial indebtedness. With roughly $4 billion in net debt as of quarter-end (4.3x trailing EBITDA), MIK trades at roughly 5.2x EV-to-trailing EBITDA.
What this valuation implies to me is that MIK is not valued as a going concern, but rather as a call option on the mere survival of the franchise. If investors were reasonably assured of the retailer’s survival and disputing merely the outlook for same-store sales comps, would anyone blush at a valuation of 10x trailing, coronavirus lockdown earnings and 6.1x EBITDA? Should it ever trade at those conservative multiples, MIK shares would be worth $11.60, over 100% higher than where they closed Friday.
On Short Interest
Michaels was brought public in 2014 by private equity sponsors Blackstone and Bain Capital, which still own roughly 50% of the 147.33 million shares outstanding today. That insider ownership substantially reduces the float of shares available to borrow, but it has not dissuaded short-sellers who had borrowed a whopping 28.3 million shares (38.76% of the float!) to short as of May 15th.
The bear thesis goes like this: (1) Many retailers will go bankrupt. (2) Retailers without an e-Commerce presence will be disadvantaged during pandemic-related lockdowns (less than 2% of MIK 2019 sales were consummated online). (3) Michaels is highly levered because of its history of private equity ownership and habit of repurchasing shares at prices above today’s ticker tape.
