A Rebound That Won’t Short Circuit

12/18/2007 12:00 am EST

Focus:

Michael Brush

Columnist, MSN Money

Michael Brush, contributor to MSN Money, says Circuit City Stores is a good value play in a deeply depressed retail sector.

As any good holiday bargain hunter knows, the best time to score a deal is when a product is on the shelves in the deep-discount section because nobody else wants to buy it.

That's not case with the flat-panel TV or game console you might want to put under the tree this Christmas. But it sure applies to one of the consumer-electronics giants where you might be buying them: Circuit City Stores (NYSE: CC).

Investors seem to think Circuit City has already lost the battle against Best Buy (NYSE: BBY) and that it's only a matter of time before it disappears. That's why they've knocked shares of Circuit City down to [below $7] recently from $30, where it traded in 2006.

[Circuit City is one of those so-called retail] value names that have gotten nailed by a double whammy: the negative sentiment toward retail stocks in general and some company-specific problems. Such problems can be fixed.

If I'm right that people are too gloomy on the outlook for the economy, these retail stocks will come roaring back once it becomes apparent that the overly depressive types got it wrong.

I'd buy Circuit City now for a double or a triple over the next three years. I think that's a likely outcome in part because Circuit City was recently on the Buy list of Robert Rodriguez of First Pacific Advisors, who has a knack for knowing when to buy troubled retailers.

What's going to make Circuit City come back? It slipped because prior management failed to reinvest well in the business. But now under new management, the consumer-electronics giant is in "major turnaround" mode, says First Pacific analyst Dennis Bryan.

Circuit City is now headed by Philip Schoonover, who worked for a decade at Best Buy, so he might be able to put in place some of the Best Buy magic. He's taking steps such as modernizing Circuit City's supply chain and deploying workforce-management systems to make better use of employee time and improve customer service.

The changes have been disruptive, so the chain has suffered. But Bryan thinks that when the dust settles, Circuit City should be able to lift operating profit margins to 3% from recent levels of 1%. That may not sound like much, but on the $14 billion or so in sales Circuit City should have a few years from now, it works out to $1.70 per share in earnings. Put a typical retail-sector price/earnings ratio of 14x on that and you have a stock that could trade in the low- to mid-$20 range in a few years.

Meanwhile, you have a good margin of safety with this stock because Circuit City has $2.00 a share in cash and little debt.

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