Pier 1 Continues To Perform At A High Level

By Stephen D. Simpson, CFA | December 12, 2012 AAA

It's a beautiful thing when a company makes the transition from turnaround to good operator, and home furnishings retailer Pier 1 (NYSE:PIR) seems to be doing exactly that. Comp growth continues to impress, margins are looking good and the company has several initiatives underway that should drive higher sales and/or margins. I wouldn't be in any hurry to leave this party were I already in the room, but new investors might want to consider the valuation today before diving in with their own money.

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Another Good Quarter in the Books
Although Hurricane Sandy was definitely a negative factor for the quarter, Pier 1 still delivered a pretty strong result.

Revenue rose almost 11% this quarter, with comp sales up 7.9% (against a 7% increase last year). With roughly 25% of the company's store base impacted by Sandy, that's impressive performance in my book. It's also worth noting that management said that comps would have been up more on the order of 9% were it not for the storm. Inventory did increase more than 13%, in part due to the company's attempts to build its ecommerce business.

Pier 1 also continued to make progress with its margin structure. While merchandise margins were flat at 60.5%, overall gross margin improved 70 basis points to nearly 44%. SG&A growth was also below the pace of revenue growth, and the company reported 18% operating income growth for the quarter.

The Going Gets Tougher, but Pier 1 Has Plans
Not unlike Bed Bath & Beyond (Nasdaq:BBBY), Williams Sonoma (NYSE:WSM) and TJX (NYSE:TJX), Pier 1 can't afford to rest on its laurels. Shopper traffic comes and goes, and relying only on good merchandising decisions is playing a risky game.

To that end, Pier 1 has a number of initiatives targeted at driving better sales and/or margins. It seems like this summer's ecommerce launch has gone well, and Pier 1 is investing the resources (including inventory) to support it. While I suspect shipping costs and the limits of shopping through a screen do put some limits on what companies like Pier 1 and IKEA can do with ecommerce for furniture, there's plenty that can be done with smaller items.

In addition to the ecommerce site, Pier 1 is looking to push its private label credit card, its rewards program and a new point of sale (POS) system for its stores. Targeted rewards programs are pretty much a proven way to boost sales and a better POS should improve inventory and supply chain management.

All of that said, investors should remember that Pier 1 has been enjoying a good run of same-store sales. While I do not believe that the company is going to lose its merchandising touch overnight, more difficult comps (an 11% year-ago comp for December) aren't going to do the company any favors. Likewise, more support from Bed Bath & Beyond for the World Market concept and from Williams Sonoma for West Elm could be threats on the margin.

The Bottom Line
There's plenty to like with Pier 1, including the improving margins, the good sales per square foot and the solid returns on capital. I also find it encouraging that the company is launching another $100 million buyback and hiking the dividend by 25% (to 5 cents per share per quarter).

All of that said, valuation is a little demanding. A free cash flow growth rate of 10% is arguably pretty robust for a company with a relatively mature store base and no new hot growth angle to the story. Even if Pier 1 gets the benefit of the doubt with a lower discount rate, it's hard for me to get to a fair value on Pier 1 shares above the high teens.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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