Danger Zone: Tuesday Morning (TUES)

Discount retailer Tuesday Morning (TUES: $16/share) is in the Danger Zone this week. Brick and mortar stores continue to struggle against the onslaught of online retailers, and TUES is not positioned well to meet this challenge. With no online store, inferior operational metrics to its peers, and an ill-defined target market, TUES should struggle just to stay afloat. Add in an expensive valuation, and this is one stock investors should steer clear of.

Declining Profitability

Online retailers have already taken their toll on TUES. Return on invested capital (ROIC) has declined for the past three years, from 5% to 2%. It’s hard to believe that only a decade ago this company earned a 21% ROIC. Figure 1 shows just how steep this decline has been.

Figure 1: ROIC in Decline

Sources:   New Constructs, LLC and company filings

Most of the drop in ROIC comes from the decline in TUES’s after-tax profit (NOPAT) margins, which dropped from 2.5% in 2010 to 1% in 2013. The apparent increase in TUES’s margins for the first two quarters of 2014 is illusory. A $42 million write down was included in TUES cost of sales for 2013, which artificially decreased its gross margin for that year. Removing the effect of this write down, we see that TUES’s gross margin actually has continued to decline from 36% in 2013 to 35% for the first six months of 2014.

At the Bottom of Its Industry

TUES lags behind its industry peers in almost every category. Among discount retailers, TUES ranks dead last in terms of bothROIC and NOPAT margin. Expand that group to all multiline retailers, and only Sears (SHLD) and JC Penney (JCP) rank behind TUES. Those are not companies anyone wants to be compared to right now.

As we dig deeper into TUES’s numbers, they look worse. TUES spends 3.3% of its revenue on advertising, proportionally more than almost any of its competitors. However, it gets back only ~$0.30 of NOPAT for every dollar it spends on advertising. That’s a poor return. By comparison, competitor Pier 1 Imports (PIR), which spends slightly more on advertising, earns ~$2.40 of NOPAT for every dollar it spends. Figure 2 shows the breakdown TUES and its competitors. Note that TUES has the very worst return in terms of NOPAT per dollar spent on advertising.

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David Trainer, Sam McBride, and German Perez-Vargas receive no compensation to write about any specific stock, sector, or theme.

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