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Michaels Down 60% YTD: Can Growth Efforts Revive the Stock?

Zacks Equity Research

The Michaels Companies, Inc. MIK is going through tough times, thanks to its strained margins over the last few quarters. Quite apparent, the company delivered fifth straight quarter of gross margin decline in first-quarter fiscal 2019 with the sixth consecutive quarter of operating margin contraction.

In addition, the company slashed its margins and earnings per share outlook for fiscal 2019 due to the increase in tariffs on List 3 goods from 10% to 25% and expectations of additional tariff on List 4 goods. This has been hurting investor sentiment, clear from the stock’s drab run on bourses. Shares of Michaels have lost 59.8% year to date against the industry’s 2.2% growth.

Let’s Delve Deep

In the fiscal first quarter, gross margin contracted 130 basis points (bps) due to rise in distribution-related costs and occupancy cost deleverages. Moreover, an adverse sales mix resulting from strong sales of lower margin categories like technology and storage hurt gross margin. Also, the adverse impact of tariffs on cost of goods sold negatively impacted Michaels’ quarterly performance. Meanwhile, adjusted operating margin fell 160 bps on account of higher SG&A expenses, as a percentage of sales, and lower gross margin.


 

For the current fiscal year, adjusted operating income is estimated to be $625-$650 million, down from the previously mentioned $640-$665 million. Moreover, it expects about $400 million of product costs to be subject to higher duties in fiscal 2019.

We note that the company is consistently making efforts to lower impacts of tariffs through sourcing actions, vendor negotiation, product reengineering and selective price increases. However, the imposition of List 4 tariffs may further hurt the company’s bottom line and margins.

Furthermore, the company expects gross margin to be slightly below the fiscal 2018’s level due to additional duties as well as the ongoing transportation headwinds, higher occupancy costs and investments toward strong e-commerce growth. Adjusted earnings per share for fiscal 2019 are now envisioned to be $2.29-$2.41, down from the $2.34-$2.46 projected earlier.

Strategic Efforts Might Aid Growth

While the afore-mentioned factors demonstrate that Michaels is likely to remain in rough waters, its efforts to enhance omni-channel experience and in-store operations might cheer investors in the long term.

Michaels’ focus on integrating its e-commerce and in-store operations to enhance the omni-channel experience is an added positive. Notably, its e-commerce platform has been a significant growth driver for the company’s top line.

In the fiscal first quarter, the company completed a major step in the evolution of its e-commerce business by exiting third-party fulfillment providers for online orders. Currently, it has in place a new order management system supported by an in-house customer care team to manage all online transactions. All orders from Michaels.com are now fulfilled by its stores or owned distribution center. Elimination of third-party providers positions the company for improved e-commerce sales growth in the future.

Moreover, it continues to gain from omni-channel capabilities like “Buy Online Pick Up in Store” (BOPUS), which is also a cost-effective way of fulfilling online orders as it eliminates shipping costs. Going forward, the company remains focused on easier and faster fulfillment of BOPUS orders through a new app for team members and enhancements to replenishment process. Michaels’ is also putting together additional data analytics into its supply chain, inventory, and marketing programs, which might drive operating margins over time.

Furthermore, Michaels plans to focus on three areas — improving current sales trends, executing against the 2019 priorities to build momentum in the second half and refreshing long-term growth strategy. To this end, it expects to become more customer-centric by improving in-store customer experience and incorporating customers’ requirements in its decisions at the store support centers.

Meanwhile, Michaels is on track to fix issues with the pricing strategy and coupon distributions to enhance customer value perception and combat declining sales. Backed by the initial success of these actions, the company expects to improve value perception and sales trends in the remainder of fiscal 2019.

Currently, Michaels carries a Zacks Rank #3 (Hold).

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Fossil Group, Inc. FOSL delivered positive earnings surprise of 79% in the last four quarters. The stock currently has a Zacks Rank #2 (Buy).

Ulta Beauty, Inc. ULTA has an expected long-term earnings growth rate of 18.4% and a Zacks Rank #2.

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