Keeping an Eye on Highly-Levered Pep Boys by: Market Folly January 28, 2009 | about stocks: PBY Market Folly Add to Your WatchlistAbout this author: Profile & More Articles Visit: Market Folly Become a Contributor Submit an Article Font Size: PrintEmail TweetThis During the lulls of major hedge fund activity, we like to try to focus on market commentary and equity analysis. This piece by the 10Q Detective David Phillips caught our eye, mainly because it was about a company that we, here at Market Folly, have been short on and off for a while now. David scours 10Q filings to find points of interest that could be potential soft spots of companies. In a recent post, the detective focused on Pep Boys (PBY), and wrote the following:
Pep Boys said it closed a new $300 million senior secured revolving credit facility, replacing a prior facility that was set to expire on December 9, 2009. The financing was expected and does little to change the auto parts retailer’s dependence on sale-leaseback transactions of owned properties to access funds vital for capital expenditures, inventory purchases, and store renovations. For the nine-months ended November 1, 2008, the company had completed transactions involving 63 stores, raising $210 million, according to the regulatory 10-Q filed with the SEC on December 10.
Chief Executive Officer Mike O’Dell told analysts on the third-quarter 2008 earnings call that the company’s “liquidity position remained strong.” Yes, there is no significant debt maturating until October 2013, but the balance sheet is highly levered, with total debt approaching 85 percent of stockholder equity. Working capital stood at $207 million, but currents assets were principally composed of $585 million of inventory. In addition, the company is struggling to meet debt servicing, with a loss from continuing operations (EBITDA) of $46.6 million and interest expenses of $11.5 million (at November 1).
We have been negative on Pep Boys for a while because the company is so heavily reliant on sale-leasebacks to free up working capital. While it hasn't completely derailed them yet, it's obviously a dangerous road to be on. As David points out, while its debt might not mature for a few years, the company has a highly levered balance sheet, and during a recession and a time of deleveraging all around, you want to be short anything to do with leverage.
While the macro environment for new cars is obviously sour, we actually think this fact plays to the auto maintenance companies like Pep Boys, AutoZone (AZO), and the like, as consumers try to get every last mile out of their current vehicles. So, even though this is not one of our larger shorts ( as we see better opportunities elsewhere), it is something to keep a close eye on.
It is definitely in the portfolio and we have been trading around our core position based on the technicals in the near term; shorting around $4 and $5 and covering in the $3 range. We're waiting for the ultimate collapse when investors start to realize just how potentially screwed this company really is. Such an event would be realized with a violent break of $2.60 to the downside
The article makes it seem as if sale-leaseback was only for working capital needs, but what about the reduction of longterm debt:
2006 - $586 million lt debt 2007 - $535 2006 - $400 most recent quarter - $330
I would say deleveraging is the theme here.
Also, we really need to address the "deferred liability from asset sales" which currently stands at $173 million. My understanding of this (and I'm happy to be corrected on this) is that this was done to defer taxes. That $173 is cash received from the sale of locations. It's not a true liability. It's cash.
How do you, or anyone reading this board, view that $173 million? Is it restricted? Should it be viewed as future lease payments that the sold properties will engender?
Overall, what I'm seeing is a balance sheet that keeps getting stronger, not weaker.
Also, the author "market folly" may pull the article because of certain numerical inaccuracies discovered by commenters on the piece.
There is rant among the commenters by a 10-year pepboys employees. Worth a read, very sincere. Ends like this:
"You see "WE CARE!!!" We just wish our company; Pepboys; would care as passionately about us as we do for our customers and their vehicles. Just wanted to let you know that Pepboys is not just a company. It's alot of people who love what they do and want very much to give that good feeling we have to our customers. Maybe our company will realize that its most important asset is its own "employees" and not just cash."
That first line is very close to a line from Rambo II --- "I just want my country to love me, the way I love my country."
Overall, makes me want to buy more. I'm such a sentimentalist.
The $173 million has already been used to reduce debt. It is an amortization issue where a portion of it each year is reported as a "profit" for lack of a better way of saying it to offset the "expense" that year for the lease payments. I believe the amount will be amortized over 15 years. It's a bean counters way of using the money now and paying for it gradually over the life of the leases. There's a more technical explanation but I wanted to put it in layman's terms. The fact they didn't have to pay taxes at current corporate tax rate of say 38.5-40.0% gave PBY about $69 million to reduce more debt this past year. As they pay 1/15th of the tax on the gain each year in future years, the lease expense will offset most if not all of it so they will ultimately pay little or no tax on the gain. Pretty smart. DaninFW