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Why Is Michaels (MIK) Up 24.5% Since Last Earnings Report?

Zacks Equity Research

A month has gone by since the last earnings report for Michaels (MIK). Shares have added about 24.5% 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 the most recent earnings report in order to get a better handle on the important drivers.

Michaels’ Q2 Earnings Beat, Lifts FY19 View

Michaels reported solid second-quarter fiscal 2019 results. Notably, the bottom line reverted to a positive surprise trend after registering in-line earnings in the previous quarter and also improved year over year. The top line surpassed the Zacks Consensus Estimate, delivering third beat in the last four quarters.

Further, management raised earnings view for fiscal 2019 but lowered the sales forecast. Adjusted earnings per share for fiscal 2019 are now envisioned to be $2.31-$2.42, up from $2.29-$2.41 anticipated earlier.

Meanwhile, the company remains focused on executing against its priorities to build momentum in the second half of fiscal 2019 and long term.

Q2 Numbers

Michaels’ adjusted earnings of 19 cents per share surpassed the Zacks Consensus Estimate of 14 cents and improved 26.7% from the prior-year quarter. This upside can be mainly attributed to higher margins and lower operating expenses.

Net sales of this arts and crafts specialty retailer dipped 1.9% year over year to $1,033.7 million but outpaced the Zacks Consensus Estimate of $1,014 million. Sales declined year over year owing to impacts of the Pat Catan’s store closures in fiscal 2018, somewhat mitigated by a 0.3% rise in comparable store sales (comps) and sales from the operation of 11 net additional flagship stores in the fiscal second quarter.

Comps growth was backed by rise in average ticket, partly offset by decline in customer transactions. Moreover, the company delivered strong e-commerce sales again in the reported quarter fueled by higher traffic and conversion rates.

Gross profit slipped 1.7% year over year to $367 million, while gross margin increased 10 basis points (bps) to 35.5%. Higher gross margin was driven by gains from the pricing and sourcing efforts coupled with occupancy expense leverage. However, this uptick was offset by adverse impact of tariffs on inventory purchased from China as well as rise in promotional activity and a change in sales mix.

SG&A expenses, including pre-opening costs and restructure charges, decreased 1.1% to $295.7 million on lower expenses associated with the closure of Pat Catan’s. As a percentage of sales, SG&A expenses, including pre-opening costs, increased 20 bps to 28.6%.

Adjusted operating income grew nearly 5.8% to $75.2 million backed by higher gross profit and lower SG&A expense. Moreover, adjusted operating margin grew 60 bps to 7.3%.

Store Update

During the fiscal second quarter, the company inaugurated four Michaels stores alongside closing two and relocating one. As of Aug 3, 2019, it operated 1,262 Michaels stores.

For fiscal 2019, the company intends to open 16 net flagship outlets, which include nearly 12 Pat Catan’s stores that it plans to rebrand. Also, it expects to relocate 13 Michaels stores. In the fiscal third quarter, Michaels plans to open 13 flagship stores, of which 11 were Pat Catan’s. Simultaneously, it expects to shut down one and relocate five Michaels stores.

Financial Position

Michaels had cash and equivalents of $131 million, long-term debt of $2,655.4 million and total stockholders’ deficit of $1,587.6 million as of Aug 3, 2019. Total merchandise inventory fell 1.8% to $1,256.5 million at the end of the fiscal second quarter. However, average inventory per Michaels store inclusive of distribution centers, inventory in-transit and inventory for its e-commerce site grew 2.5%. This included a 170-bps negative impact of duties with respect to List 3 tariffs and higher inventory in-transit during fiscal 2019.

Management incurred capital expenditure of $32 million in second-quarter fiscal 2019 mainly due to investments in technology projects including investments for e-commerce and digital platforms as well as store-growth efforts. For fiscal 2019, Michaels expects to incur capital expenditure of about $135 million.

In the fiscal second quarter, the company bought back 3 million shares worth nearly $25.1 million under its share repurchase authorization. Following this, Michaels had an outstanding repurchase authorization of roughly $373 million.

Guidance

Management updated fiscal 2019 view, which reflects anticipation of lower sales in the back half of the fiscal year. For fiscal 2019, net sales are now projected to be $5.16-$5.19 billion, down from the prior estimate of $5.19-$5.24 billion and $5.27 billion generated in fiscal 2018. Comps are now anticipated to remain flat compared with the earlier projection of flat to up 1%.

Further, the company anticipates an uncertain tariff environment. It expects to incur applicable direct import product costs of $400-$500 million, when the List 4 China tariffs are totally implemented. However, any significant impact from the List 4 tariffs, based on the pace of turning the inventory, is not to be recognized till 2020. Moreover, management is relentlessly working to lower impacts of tariffs through sourcing actions, vendor negotiation, product reengineering and selective price increases.

Adjusted operating income is now estimated to be $625-$645 million for fiscal 2019 compared with $625-$650 million guided earlier. Due to transportation headwinds, adverse impact of tariffs and occupancy costs deleverages, the company expects gross margin for fiscal 2019 to be slightly below the fiscal 2018 levels.

However, gross margin is likely to somewhat gain from ongoing sourcing initiatives and improved management of promotions. Further, the company expects SG&A expense leverage in fiscal 2019 compared with fiscal 2018. This is mainly due to the absence of restructuring charges and investment spending of $16 million in the last fiscal coupled with higher cost savings realized in the previous quarter.

Interest expenses are expected to be about $153 million due to expectations of no additional tax increases this year. The effective tax rate for the fiscal year is expected between 23% and 24%.

For the fiscal third quarter, comps are projected to be flat to up 1%. Adjusted operating income is estimated to be $133-$142 million driven by expectations of flat rates for both gross margin and SG&A, as a percentage of sales, compared with the third quarter of fiscal 2018. Gross margin is likely to reflect occupancy deleverage and the impact of tariffs compensated with sourcing benefits and discount management. Further, adjusted earnings per share are envisioned to be 46-51 cents.

How Have Estimates Been Moving Since Then?

It turns out, fresh estimates have trended upward during the past month. The consensus estimate has shifted 6.09% due to these changes.

VGM Scores

At this time, Michaels has a subpar Growth Score of D, however its Momentum Score is doing a lot better with an A. Following the exact same course, 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 A. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been trending upward for the stock, and the magnitude of these revisions looks promising. It comes with little surprise Michaels has a Zacks Rank #2 (Buy). We expect an above average return from the stock in the next few months.



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