Triple Shorts

09/24/2004 12:00 am EST


Jamie Dlugosch

Editor, The Rational Investor

Given the higher risk of short-selling, we don't often feature short-selling ideas in the Digest . But with Jamie Dlugosch’s conservative value focus, his recommendation to short-sell several seemingly successful retailing stocks caught our attention. Here’s his review.

"Kmart Holding (KMRT NASDAQ) is a remnant of the old Kmart that fell into bankruptcy a few years back as a result of cash losses that prevented the company from meeting its obligations. Unfortunately for old shareholders, Kmart bondholders held all of the cards. In exchange for releasing the company from debt covenants, bondholders gained a large percentage of equity in the new Kmart. Such a deal resulted in old stockholders being completely wiped out. What a sad story indeed. Flash forward a few years and we now see new KMRT flush with cash, making a profit, and selling real estate at top prices. New owners of KMRT have seen the stock triple in value since the beginning of the year. On the surface, it would appear that all is well with KMRT, but a closer look tells us otherwise. For starters, it is unimaginable that those former bondholders agreed to the final deal without truly understanding the value of the company, including the real estate. More importantly there is little hope for the retail business model of this company. Sales continue to fall and the company has demonstrated little interest in investing in the business. The whole deal smells of an opportunistic bond/distress story. The vultures stole the company and are now selling off the parts. What it will do with the cash is another story. I’m not optimistic. Fundamental valuation measures are flashing warning signs. I expect KMRT shares to fall in value as the real estate candle burns to the wick. I would sell shares short at these levels and my target for KMRT is $40 per share.

"Aeropostale (ARO NYSE) is a specialty mall based retailer that caters to the teenager set. ARO is a trend-setter that offers hip active-oriented fashion basics merchandise. The company operates some 500 outlets and is in the process of opening an additional 100 stores during the current fiscal year. ARO has been a blazing success in its target market and investors have pushed shares of ARO to record highs. The stock has soared some 500% since hitting its lows at the end of 2002. Once again, the story with ARO has been nothing but success and that’s why it may be time to turn cautious with respect to the company’s future. ARO has benefited from a perfect operating environment that has seen sales rise dramatically. Weakness in consumer spending could have a detrimental impact on ARO’s growth prospects. The company is expected to grow at a 24% rate, at a time when business conditions seemingly can’t get any better. Same store sales in August greatly missed Wall Street expectations and therefore the company may see some downward revisions in earnings estimates. In other words, we are starting to see some weakness in consumer spending that may negatively impact companies like ARO. Another factor to consider is the fickle nature of the teenage market. ARO has been a hot commodity and that may or may not continue in the future. History has shown that tastes can change at the drop of the hat. Should ARO come up short on the fashion scale, sales may suffer. Too many things can go wrong in the current environment to pay such a rich price for ARO. I will short shares at current levels and my target is $15.

"Tiffany & Co. (TIF NYSE), the jewelry store of the elite, has a storied past and rich history. Capitalizing on the upscale trend, Tiffany has enjoyed a tremendous run over the past several years. Sales have grown to exceed $2 billion and its reach has become truly global. The little blue box has a meaning and significance beyond the treasure found inside as consumers around the world discovered how special it was to own Tiffany jewelry. Up until this year, investors had been enamored with TIF as well. The stock had doubled in value as the entire market recovered in 2003. This year has been a different story as the stock has dropped from its highs above $45 to its current level just above $30 per share. Over the last four quarters the company has had trouble meeting expectations thus explaining the pullback. Its most recent quarter missed expectations by $.04 as the company announced that it was having trouble with its overseas units in Japan. Still analysts expect the company to post a healthy profit of $1.55 per share in the current fiscal year and $1.78 in the next fiscal year. Unfortunately, that only translates to 14.8% earnings growth. The stock trades well in excess of that number and with the history of recent earnings misses, it is more likely than not that TIF will have a difficult time meeting expectations. In a weakening economy, expect consumers to cut lavish spending first. I expect further weakness at TIF. We may have missed out on the first gap down, but there could be more losses to follow as the market adjusts to the new economic reality. Should TIF miss its number, further valuation contraction must surely follow. I will short TIF at current levels and my target is $20."

Related Articles on