hhgregg, Inc.: I want my HDTV

Paul Rolfes | Jan 04, 2008 6:20am EST | Comment

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American consumers are in love with cutting-edge electronics and appliances to enhance their lifestyles. Witness the crowds that piled into stores at the wee hours of Nov. 23, “Black Friday,” through closing time on Christmas Eve.

Heightening the demand for big-screen, flat-panel televisions is the coming age of high-definition television and the switch to digital from analog signals in February 2009.

Despite the potential potholes in a field crowded with some better-known competitors, Midwest chain hhgregg, Inc. (NYSE: HGG) decided to make the leap and became a public company last summer.

The competition among big-box retailers is intense, forcing stores to slice their profit margins razor thin. In addition to sector leaders Best Buy Co., Inc. (NYSE: BBY) and Circuit City Stores, Inc. (NYSE: CC), along with home-improvement chains like The Home Depot, Inc. (NYSE: HD) and Lowe’s Companies, Inc. (NYSE: LOW), there are thousands of independent retailers that are struggling to survive.

For hhgregg, it was a long journey to the New York Stock Exchange for a family-operated company that began selling appliances in its hometown of Indianapolis in 1955. Not limiting its product mix to what can be found elsewhere, hhgregg targets customers who want competitive prices on higher-end goods, ranging from electronics and appliances to office equipment and Serta bedding.

Now a chain of 84 stores, hhgregg reported $1.1 billion in sales, earnings per share of $0.73 and same-store sales growth of 5.5% for its 2007 fiscal year. Unlike many other retailers, hhgregg boasts a mostly full-time sales force that works on commission.

As a result, analysts covering hhgregg mostly offer favorable opinions about its potential. In a Thomson Financial tally of six analysts, five have hhgregg at “buy” or “strong buy,” with a median price target of $19.25. On Thursday, hhgregg closed at $13.41.

Small-cap investors looking for a quick profit probably shouldn’t be looking at retail right now. Market volatility triggered by weak consumer confidence is usually magnified in the retail sector and many cautious consumers are reluctant to let go of their disposable income or to tap into home equity lines of credit for new toys.

Admittedly, hhgregg’s stock hasn’t fully bloomed since the July 20 initial public offering at $13. Shares have risen as high as $17.22 on Nov. 14 — ahead of the holiday shopping season — and dropped below the IPO price during a fall retrenchment, to $10.10 on Sept. 28.

Since pulling back in the midst of a dicey holiday season, shares of hhgregg have idled in the $13 to $15 range — not much better than the IPO price.

But neither has hhgregg wilted the way Circuit City has. When that chain reported a third-quarter miss and a loss that was double what analysts were expecting on Dec. 21, a 29% one-day drop in stock price resulted. While Circuit City pulled down the consumer electronics sector, hhgregg’s shares fell just a penny.

On Nov. 14, hhgregg released its results for the quarter ended Sept. 30 that showed some growing pains. A one-time refinancing charge related to the stock offering, used to pay off debt early, led to a $6.9 million loss amounting to $0.22 per share. Ignore that $21 million charge and hhgregg had net income of $5.8 million in its fiscal second quarter, with an $0.18 a share profit that beat analysts’ expectations.

Net sales increased 21% to $287.9 million from a comparable three months in 2006. Big-ticket sales fueled an 8.9% increase at stores open at least a year.

At the same time, hhgregg did raise its outlook for the fiscal year ending March 31. The company is looking for earnings of $0.95 to $1.03 for fiscal 2008, up from the prior guidance of $0.87 to $0.97, thanks to expected same-store sales growth of 3.5% to 5.5%. It expects to open 13 to 15 new stores in fiscal 2008 and is entering Florida.

In reports following the earnings report, analysts did not find fault with the numbers.

Analyst Brian Nagel at UBS Securities reiterated a “buy” rating with a $20 price target following the “strong Q2 results,” reminding clients that “HGG remains under followed by investors.”

The Wachovia Capital Markets team headed by Ralph Jean has hhgregg at “outperform” and a $17 to $20 range for the next 12 months. “We believe that investors focused on small-cap, unit expansion specialty retailers should accumulate positions in HGG,” said the Nov. 14 note, in which Wachovia raised its earnings expectations slightly.

Credit Suisse analysts Gary Balter and Seth Sigman called the quarter “impressive” in a Nov. 15 note, writing that hhgregg “continues to defy expectations and we believe that it is well positioned to continue to do that.” They have the stock at “outperform” with a $17 price target.

Analyst Mitchell Kaiser of PiperJaffray saw enough in the Q2 results to raise his price target $0.50 to $19.50 along with his earnings estimates, while keeping an “outperform” rating. “HGG has shown an ability to educate and upsell customers to feature-rich products…” which Kaiser predicts could result in annual sales growth of near 25% and EPS growth of close to 30%.

Lehman Bros. hosted hhgregg management at a New York luncheon on Nov. 15. In a follow-up note, Lehman’s Bradley Thomas told clients: “We came away from the meetings increasingly confident in management’s ability to execute its merchandising and store-opening plans.” The report also reiterated an “overweight” rating and a $19 price target.

J.P. Morgan Securities stayed on the sidelines until after second-quarter results were posted before initiating coverage. A glowing Nov. 15 report from analyst Stephen Chick on Nov. 15 contained an “overweight” rating, noting that hhgregg has held a “52-year niche” and that it “differentiates itself with superior customer service” that should help the retailer continue to post long-term sales growth of 18% to 23% annually. J.P. Morgan has Best Buy at “underweight” and is “neutral” about Circuit City.

Only one analyst backed off from a previous “buy” recommendation. KeyBanc Capital Markets Jeffrey Stein trimmed his rating to “hold” on Oct. 31, based solely on valuation.

The hhgregg game plan includes the launch in four cities of “Fine Lines” boutique stores that sell only high-end brands. Think the Fine Living cable channel instead of HGTV. Fine Lines gives buyers home-like showrooms that go beyond the typical line-’em-up-and-roll-’em-out big-box stores. The stores also offer demonstrations by local chefs and cooking classes.

For investors in small caps who want to add a retailer with some name recognition, leading candidates are beaten-down Circuit City and hhgregg. Given the positive sentiments expressed by analysts, hhgregg could be worth a look in a time of market turmoil, with a wager that it could head considerably higher once the economy stabilizes. On Feb. 14, Valentine’s Day, hhgregg (HGG) could deliver to investors the love they crave, with solid results from the holiday quarter.