Why Is Michaels (MIK) Up 33.2% Since Last Earnings Report?

It has been about a month since the last earnings report for Michaels (MIK). Shares have added about 33.2% in that time frame, outperforming the S&P 500.

Will the recent positive trend continue leading up to its next earnings release, or is Michaels due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Michaels Misses on Q3 Earnings & Sales, Lowers FY19 View

Michaels reported dismal third-quarter fiscal 2019 results, wherein both top and bottom lines missed the Zacks Consensus Estimate. Earnings and sales also declined on a year-over-year basis.

Consequently, management trimmed sales and earnings view for fiscal 2019. Net sales are now projected to be $5.06-$5.08 billion for fiscal 2019, down from $5.16-$5.19 billion mentioned earlier. Notably, it generated net sales of $5.27 billion in fiscal 2018. Comps are now anticipated to decline 2% compared with earlier mentioned flat comps.

Further, the company now estimates adjusted operating income of $565-$575, down from previously mentioned $625-$645 million. Interest expenses are expected to be $152 million in the current fiscal year, with effective tax rate of 23-24%. Adjusted earnings per share are now envisioned to be $2.07-$2.12, down from $2.31-$2.42 stated earlier.

However, we note that the company is making efforts to get back on the growth track. It has been implementing initiatives to support its 'Maker' strategy, which is expected to boost its business.

Q3 Numbers

Michaels’ adjusted earnings of 40 cents per share lagged the Zacks Consensus Estimate of 49 cents and declined 16.7% from the prior-year quarter. The downside can be mainly attributed to lower sales and margins, somewhat offset by a fall in SG&A expenses.

Net sales of the arts and crafts specialty retailer dipped 4.1% year over year to $1,222.7 million and lagged the Zacks Consensus Estimate of $1,256 million. Sales declined year over year on the impacts of Pat Catan’s store closures in fiscal 2018 coupled with a 2.2% fall in comparable store sales (comps) and lower wholesale revenues. The decline was partly compensated by incremental sales from the addition of 18 net flagship stores since the end of third-quarter fiscal 2018.

Comps fell due to lower customer transactions, partly mitigated by rise in average ticket. However, the company delivered strong e-commerce sales again in the reported quarter, fueled by higher traffic and conversion rates.

Gross profit slipped 7.8% year over year to $441.6 million and gross margin contracted 150 basis points (bps) to 36.1%. Lower gross margin can be attributed to a decline in merchandise margin along with occupancy and distribution expense deleverage, which were partly offset by a decrease in inventory reserves.

SG&A expenses, including pre-opening costs, decreased 5.1% to $324.2 million. The decline mainly resulted from lower payroll-related costs that include performance-based compensation and expenses related to Pat Catan’s store closure. As a percentage of sales, SG&A expenses, including pre-opening costs, decreased 30 bps to 26.5%.

Adjusted operating income fell 16.9% to $117.4 million due to lower gross profit, somewhat offset by a decline in SG&A expenses.

Store Update

During the fiscal third quarter, the company opened 13 flagship stores, 11 of these were former Pat Catan’s outlets converted to the Michaels brand. Simultaneously, it shuttered one Michaels outlet and relocated five flagship stores during the same period. As of Nov 2, 2019, it operated 1,274 Michaels stores.

For fiscal 2019, the company intends to open 16 net flagship outlets that include 12 rebranded Pat Catan’s stores. Also, it expects to relocate 13 Michaels stores.

Financial Position

Michaels had cash and equivalents of $118.4 million, long-term debt of $2,649.8 million, and total stockholders’ deficit of $1,631.8 million as of Nov 2, 2019. Total merchandise inventory fell 1.2% to $1,423.4 million at the end of the fiscal third quarter. However, average inventory per Michaels store, inclusive of distribution centers, inventory in-transit and inventory for its e-commerce site, grew 2.9%.

Moreover, the company incurred capital expenditure of $32 million in third-quarter fiscal 2019 mainly due to investments in technology projects, including e-commerce and store-growth initiatives. In the first nine months of the fiscal year, it spent $90 million in capital expenditure. For fiscal 2019, Michaels expects to incur capital expenditure of $125 million.

In the fiscal third quarter, the company bought back 8.6 million shares worth nearly $80 million, under its share-repurchase authorization. Following this, Michaels had an outstanding repurchase authorization of roughly $294 million.

Guidance

Apart from lowering the fiscal 2019 view, the company outlined its guidance for the fourth quarter. For the fiscal fourth quarter, it projects 2-3% comps decline on existing business trends, a shorter holiday selling season in the same quarter and a potential adverse impact from the liquidation of A.C. Moore retail stores.

Adjusted operating income is estimated to be $271-$281 million. Moreover, net interest expenses are estimated to be $38 million. The effective tax rate is likely to be between 23% and 24%. Further, adjusted earnings are envisioned to be $1.21-$1.27 per share.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed a downward trend in fresh estimates. The consensus estimate has shifted -12.85% due to these changes.

VGM Scores

Currently, Michaels has an average Growth Score of C, though it is lagging a lot on the Momentum Score front with an F. However, the stock was allocated a grade of A on the value side, putting it in the top quintile for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of this revision indicates a downward shift. Notably, Michaels has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.

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