The Only Constant Is Change…
January 9, 2020
Tankers Are Tanking….
February 2, 2020

Exiting Stage Left…

Two months ago, I wrote about Stage Stores (SSI – USA) and its planned evolution from failing department store chain into an off-price retailer named Gordmans. My logic was that you had a free look at what happened over the next few quarters as the plan evolved. As I wrote at the time;

For me, this is a trade, not an investment. If you assume that comp sales keep ticking along and new conversions even sort of mirror comps from the 2019 vintage, the market will give these guys a pass on earnings, one-time charges for transition and pretty much anything else. 40% comps are just unheard of. Off-price retailing is one of the few hot sectors in retailing. The rest of the cohort trade at insane valuations even though off-price is increasingly becoming saturated. I sort of figure the market will give SSI a healthy valuation too—even if the plan only sort of works out.

Yeah, I know, weak thesis, but that’s why it was a trade and not an investment—however I was pretty confident that the market would get on-board with the thesis. In fact, I was surprised at how completely on-board the market got. At the same time, I was quite sanguine about the potential risks.

If the plan to convert all the stores to off-price stores even sort of works, SSI could be a home-run from today’s prices. Then again, stocks at $3.50 don’t usually work out and this one has a whole lot of debt as well.

In any case, holiday comps were reported January 13 and they were a disaster. I’ve been an active investor for two decades now—mostly in sectors that are at some stage of inflection. I’m used to these things not working and I’m always expecting surprises of one sort or another. However, I cannot think of another situation where a company raised guidance on November 21 and then missed this badly in the next five weeks. They either have no visibility into their business, they’re complete morons or both. In any case, I met with the CEO at ICR and came away no wiser as to what was going on at the business. In particular, the lack of comparable sales disclosure at the off-price stores and the evasiveness in answering questions leads me to believe that they’re missing their own internal expectations and they don’t know why. As a result, I made up my mind to sell on any uptick, which I have finally done. My average sales price over the past few days was a dime or two over what I paid.

In any case, I don’t want to fixate on what went right or wrong with the thesis—at least until we have more data from the company. Instead, I want to talk about asymmetry here. Basically, the thesis didn’t work out—if anything it was a complete disaster as adjusted EBITDA guidance on November 21 of $35 to $40 million will likely come in closer to zero. However, the important thing is that I didn’t lose money on SSI—instead, I actually made a bit. Why? Because I set this up as a situation where I was unlikely to lose if wrong, yet there was a lot of blue sky above me if it worked out.

Why was I confident that the downside risk was low when the balance sheet was such a mess? Due to the volatility of the results in a transition, I expected the market to give these guys a pass on any one quarter of results. Even today, the thesis isn’t broken, it’s just a bit dented, hence why the market took the shares back to roughly the starting point. This is because there is still quite substantial upside if they can figure out how to convert their stores to off-priced locations. Some quick math says the upside potential could easily be a 5% EBIT margin on $2 billion in pro-forma sales or $100 million of EBIT on 29 million shares. Or, they could bungle the whole thing and end up with nothing. In any case, we’re in an unusually forgiving market with a lack of “cheap” event-driven catalyst opportunities. Funds are going to keep clustering in those few opportunities that exist—particularly ones that are highly liquid. If results hadn’t been so awful, I would have likely stayed in that crowd myself. I am always attracted to situations where I can risk something small to potentially make ten or twenty times my money if right. I know others are as well.

I haven’t spoken much about the sort of concentrated investing that I practice (it’s deserving of its own piece) but the most important factor is avoiding permanent losses. This is due to the fact that each individual position is so large and material to overall performance. Therefore, when my confidence is reduced, I need to exit. If SSI has another bad quarter it will be trading back in the zone of bankruptcy—which is too much risk for me, especially with the thesis now having a dent in it.

In summary; there was a good set-up, the worst possible thing happened and the stock went back to the starting point. Anyone playing along had almost two months to take profits along the way (I booked a bit before ICR but clearly not enough). I continue to look for other similar situations, as a good percentage of them actually do inflect and continue higher for years.

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