Right before the Thanksgiving break, I singled out
Barnes & Noble (NYSE:
as a stock that looked vulnerable to overly-optimistic
Read the original article here
At the time, I noted that an imminent quarterly
release merited a great deal of scrutiny. Barnes & Noble had
been expected to generate a small $0.02 a share quarterly
, "but rising expenses may make that impossible."
I had no idea how prescient that forecast would prove.
The bookseller indeed went on to post a massive spike in expenses,
causing it to register a $6.6 million
, or $0.17 a share in its fiscal second quarter ended Oct. 31. In
fact, the company has been missing consensus
earnings per share (
forecasts by at least a nickel for each of the past four quarters,
setting up further pain for the company's supporters.
reacted as they should, falling nearly $3 on Dec. 1 to $14.59. Yet
eternal, and shares have already made a decent bounce back toward
the $16 mark. Importantly, what looked like a reasonable case for
short sellers now looks like a powerful one. Simply put, Barnes
& Noble may just spend it itself into oblivion as it chases
increasingly elusive shadow.
Going the wrong way
For most business models, rising sales typically
rising profits. But Barnes & Noble, which is losing money on
every Nook e-reader tablet it sells (when hardware and marketing
costs are accounted for), is clearly going the wrong way.
Management doesn't break down margins on hardware devices, but
thanks to Amazon's aggressive pricing of the Amazon Kindle -- which
Barnes & Noble must match to stay competitive -- the company is
likely yielding a loss on every unit sold.
Management contends that Nook sales will really take off in the
current quarter, in part due to heavy promotional activity. Yet
rising sales won't necessarily yield a surge in profits on
these devices. Besides, it's fair to wonder how much
this business can grow anyway because it already faces tough
competition from the No. 1 tablet in the
iPad, along with Amazon's Kindle e-reader (not to mention its new
Fire tablet computer).
After all, sales of Nook readers (and associated content) fell
sequentially, from $277 million in the fiscal first quarter of 2012
to $220 million in the quarter ended October. That's the first
sequential drop in six quarters. Management blames the drop on
seasonality, but the rising installed base of hardware should be
yielding a fast-growing book download business. This doesn't appear
to be the case. (Management doesn't actually break down hardware
and software sales for the Nook platform, which strikes me as a red
Baking in the recent data points into fiscal (April) 2012 and 2013
forecasts, it may be some time before this company can show a
profit. Barnes & Noble lost $1.19 a share in fiscal 2011, and
analysts just expanded their projected per-share loss for fiscal
2012 from ($0.23) to ($0.58). The fiscal 2013 forecasted profit has
just been slashed nearly 80% to just $0.10. And I have my doubts
that this small profit will even come to pass, as this company
serially fails to meet its targets.
Why do I think losses will continue at least through fiscal 2013?
Because many analyst forecasts appear to fail to take into account
any cannibalization of traditional book sales by e-readers.
Analysts say the combined strength of traditional book sales and
digital book sales should push the company's overall sales up 5% by
fiscal 2013. Yet it's worth noting Barnes & Noble hasn't posted
this kind of growth (on an organic basis) since fiscal 2005. The
steady drop in time spent reading traditional books and more time
spent surfing the web is a trend that shows no signs of abating.
And this presents the real challenge to the
. It costs a lot of money to operate traditional retail stores.
Retailers need to generate a certain level of sales at each store
to generate an incremental level of profit. Fall below this level,
and we're talking about incremental losses. And this is what looks
set to happen at an increasing number of stores, as e-reader
downloads rise in
, displacing traditional book sales. Same-store sales in the fiscal
second quarter fell 3.3% from a year earlier. A random walk through
any Barnes & Noble -- outside of the all-important holiday
season -- provides a glimpse of slowing foot traffic. The company
operates more than 1,300 stores, and it will be interesting to see
how many of them slip from profitable to unprofitable if same-store
sales keep dropping .
Risks to Consider:
When shorting stocks like this, you need to stay abreast of
intra-quarter data points. If it appears Barnes & Noble's Nook
sales start to trend well above expectations, then it would be wise
to close your short position and revisit the investment thesis
after the holiday selling season.
Action to Take-- >
Short sellers remain squarely focused on the current holiday
season. The fiscal third quarter is the only profitable one for
Barnes & Noble, generating almost enough profit to offset
losses in the other three quarters. Yet the sobering just-released
doesn't provide hope for a solid fourth quarter. If Barnes &
Noble misses expectations in the current quarter and analysts have
to lower their forecasts once again, then even this stock's most
ardent supporters could throw in the towel, likely causing shares
to move quickly below $10. I know I'd want to if I owned shares. If
you think that's likely to happen, then you should short this
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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