Struggling department store operator Stage Stores (NYSE:SSI) suddenly turned into the hottest stock in the market in late 2019, with SSI stock rising from 50 cents to $10 in a matter of months. The catalyst? The company’s full-price to off-price store conversions gained traction and breathed life back into the company’s sales and profit trends.
Specifically, in the third quarter of 2019, Stage Stores reported a whopping 17.4% rise in comparable sales thanks to a 40% increase in sales at off-price converted stores (stores that were once full-price stores, but have since been converted to off-price stores in 2019). Management said on the conference call that they expected this robust sales growth momentum to continue into the holiday season.
It didn’t. Instead, Stage Stores reported a measly 1.4% rise in holiday comparable sales. Further, management cut their fiscal 2019 profit guide because in the face of weaker-than-expected sales growth, management had to run deep promotions to clear inventory.
The stock tanked on the news. From $10 to $3 in a few days.
Zooming out, I think this selloff is an opportunity to buy SSI stock at a very attractive price ahead of a very promising turnaround. Long story short, the holiday let-down had everything to do with the old (Stage Stores’ antiquated and struggling full-price stores didn’t perform up to par) and nothing to do with the new (Stage Stores didn’t even convert any full-price stores to off-price stores in the quarter). In 2020, the old will phase out, and the new will come front-and-center as Stage Stores converts all of its stores into off-price locations.
As this happens, history and data say that the company’s growth trajectory will materially improve, and depressed SSI stock will soar.
Out With the Old, In With the New
The bull thesis on Stage Stores is fairly simple.
As a full-price department store operator, Stage Stores was being squeezed out of the retail game because it lacked necessary differentiation to drive steady traffic growth in the face of increasing competition. But, management is attempting to differentiate the company by making Stage Stores an off-price retailer. To date, this transition has yielded promising results. About 100 stores have been converted, with sales up 40% year-over-year at those stores. Considering the bulk of this transition will play out in 2020 — about 550 off-price conversions are expected in 2020 — the best of this off-price turnaround in SSI stock is yet to come.
Nothing about this bull thesis changed with the holiday sales update.
Sure, holiday sales came in weaker than expected. But, that’s because of what management dubbed “lower pre-conversion department store sales.” In a nutshell, Stage Stores has been relying on last-time-ever department store sales, such as “Last Halloween Sale Ever,” to drive big growth at the full-price locations before they convert to off-price locations. Those last-time-ever sales were a big hit in Q3. They weren’t in Q4, as events like “Last Black Friday Sale Ever” and “Last Christmas Sale Ever” under-performed expectations.
This under-performance is why Stage Stores reported weak holiday sales. Note: it has nothing to do with the company’s off-price store conversions. Indeed, management didn’t convert any full-price stores into off-price ones in the holiday season.
In other words, Stage Stores’ holiday sales update was a glimpse of what has happened, not what could be. What could be is 550 off-price conversions coming in 2020. As this enormous off-price conversion materializes, Stage Stores’ growth trajectory will materially improve and SSI stock will bounce back.
Stage Stores Stock Could Fly
At $3, the stock is trading at just 0.06-times trailing sales. That’s just too cheap for a company that has the potential to stabilize sales and turn a profit thanks to off-price store conversions.
The math here is pretty simple to follow. Stage Stores will likely do about $1.7 billion in sales this year. About 100 off-price conversions to-date has sparked revenue stabilization. Another 550 off-price conversions coming in 2020 should spark mild revenue growth over the next few years. As such, Stage Stores’ revenue base will likely rise from $1.7 billion in 2019, to $1.9 billion or higher by 2025.
Gross margins presently hover around 24%. That number, too, should head higher over the next few years as revenue growth trend improvement drives less promotional activity and preserves pricing integrity. Assuming it hits 25% by 2025, then that gives Stage Stores about $475 million in gross profit (on a $1.9 billion revenue base).
Operating expenses are $465 million and dropping. They should keep dropping as management closes under-performing locations. Assuming mild opex cuts every year thanks to store base rationalization, I think that number could drop to $435 million by 2025.
That gives Stage Stores about $40 million in operating profit. Take out $15 million for interest expenses. Take out 20% for taxes. You’re left with about $20 million in net profit. There are roughly 28 million shares out, so that equates to a 2025 earnings-per-share target of about 70 cents.
Based on an apparel retail sector-average 20-times forward earnings multiple and a 10% annual discount rate, that implies a 2020 price target for SSI stock of just under $10, or about triple today’s price.
Bottom Line on SSI Stock
Stage Stores stock was cut by two-thirds in early January on a disappointing holiday sales update. But, that disappointing holiday sales update was driven by full-price store under-performance. For Stage Stores, full-price store under-performance doesn’t matter, because all those stores are being converted to off-price stores. As this happens in 2020, the bad growth trends from full-price stores will phase out, and the good growth trends from off-price stores will phase in.
This will spark a huge reversal in SSI stock, the likes of which could drive shares back up to $10.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
