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Don't Hang Your Hat on Pier 1


The furniture is nice, but that's about it.

If you step foot into my apartment back in the US, you might get the impression that I'm a major shareholder in Pier 1 Imports (PIR). Each room is decked out in Pier 1 furniture and decorations: the wall hangings, my bed frame, my dishes -- all Pier 1. But I'm not a major shareholder. In fact, I've never owned any piece of the furniture retailer.

That's because there's a distinct difference between brand and operational structure. From a consumer standpoint, I obviously really like the products. It's classic yet modern style and moderate pricing level is appealing.

Its business operational performance is not. Just three years ago, the stock nearly hit $20 per share. Today it sells for less than $4.

But the company seems to be making strides with its turnaround strategy, and since reaching its lows at less than $0.50 a share earlier this year, the stock has more than tripled.

Today alone it's up 12% from reporting second-quarter earnings.

The big question, then, is if Pier 1 Import's progress justifies the rallying stock price.

Admittedly, I'm rarely bullish on a turnaround play -- particularly one in the retail industry -- during a recession or sluggish economy. That said, I think Pier 1 is making a lot of right moves to regain momentum as a successful retailer.

Sure, sales fell 10% and comps dropped 7.6%. But keep in mind that every furniture retailer -- be it Ethan Allen (ETH), Furniture Brands (FO), or La-Z-Boy (LZB) -- is struggling to grow revenue.

Turns out that selling stuff that fills houses that people are foreclosing on isn't easy. So I'm pretty much overlooking the sales drop this quarter.

I'm more interested in management's ability to improve the gross margin by 270 basis points, as that indicates promotional activity was reined in. I also like the $43 million dollar inventory reduction and the decrease in selling, general, and administrative (SG&A)expense. Overall, the efforts paid off and resulted in an operating-loss improvement of 46%.

One of my biggest concerns about Pier 1 in the past was its leveraged business model. In order to improve its liquidity position, the company retired $69.5 million in convertible senior notes. Since the beginning of the year, it's retired $148.4 million.

Shareholders consequently have taken a hit as the retirement has diluted investors' ownership.

However, I think it was the right move as hefty interest expenses can be deathly to profitless companies -- particularly companies that currently aren't growing sales.

Despite all the progress, I certainly wouldn't buy Pier 1 stock right now. I'm far more optimistic about the company today than I was a year ago, but management still has tremendous work to do to get itself back on track.

I think investors are pouring money into the company too prematurely and the stock has been way overbought given its financial condition.

Teetering companies that are on the brink of failure are typically very volatile, so one piece of bad news could sink the stock. Perhaps Pier 1 can get its act together, but I'm not willing to bet money on it just yet.
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No positions in stocks mentioned.
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