Every Monday, I like to look at all the stocks that saw fresh
rounds of insider buying in the previous week. Such so-called
insider buying can alert you to undervalued stocks before most
investors take note. That's because insiders (defined as any
officer or director of a company, or any investor that owns more
than 5% of the company's stock) have deep insights into how a
business performs. Insiders must file a copy of their activities
with the U.S. Securities and Exchange Commission . Several
websites, including insiderinsights.com and edgar-online.com, track
Most weeks, I am lucky to find one or two intriguing insider
purchases that merit further research. But I noticed an unusual
cluster of buying last week. At least two separate insiders stepped
in to buy up large chunks of stock at three different retailers.
Taken together, insiders at these companies snapped up more than $8
million in stock in last week. Investors have been selling off
retail stocks throughout the summer, and these retailers seem to
have been especially hard hit. Let's take a deeper look to see
which one of these stocks holds the most appeal right now.
Looking over my notes, here's what I wrote back in April: "Analysts
at Jefferies have a bit of egg on their face today after talking up
on Monday. The analysts' bullish preview of first quarter results
pushed shares up above $9 on Monday to a 52-week high on an
intra-day basis. Shares gave back all of those gains -- and more --
in Tuesday trading, as sales and profits missed estimates."
Not only did shares of this office supply store fall on that late
April morning, but they've fallen ever since and are now below $4
-- roughly the same price they traded for back in 1993. Simply put,
has taken Office Depot to the cleaners. Shares of Staples have
risen more than +2,000% since 1993. Staples has delivered more
appealing stores, generated higher sales per store and has been
vastly more profitable.
And when you see how investors are valuing each of these companies,
you start to see a stark disconnect. For example, Staples sports an
EV/sales ratio of 0.66, while Office Depot has an EV/sales ratio of
just 0.10. And Staples is valued at a+ 40% premium in terms of
|Market Cap ($M)
|Enterprise Value ($M)
|2009 Gross Margins
|2009 Operating Margins
|2009 EBITDA ($M)
|2009 Free Cash Flow ($M)
|2010 Sales Growth
Free Cash Flow
The gap is understandable. While both retailers generate 27% to
28% gross margins, Staples does so with a vastly more efficient
and can generate solid 8% operating margins, whereas Office Depot
hasn't been able to generate positive operating margins since 2007.
(Though the company would have generated about $200 million of
operating profit in 2009 were it not for some one-time charges.)
But changes are afoot, which explains why the company's insiders
bought a collective $1 million in stock last week. There is little
that Office Depot can do to improve sales until the
improves and unemployment drops, but management can certainly
squeeze more profits out of the business. And that process has
Gross margins have risen in each of the past four quarters and are
up more than 100 basis points from a year ago. Operating expenses
are on track to drop about $300 million this year, which should
push EBITDA from around $200 million last year to around $300
million this year. Analysts at Citigroup expect further costs cuts
to boost EBITDA to around $400 million in 2011 and $500 million in
2012. The company is valued at about 2.5 times that 2012 forecast.
And while the company generated negative free cash flow in June,
2009, free cash flow improved to $62 million in the most recent
quarter. Office Depot used to generate more than $400 million in
annualized free cash flow, until a disastrous acquisition in Europe
sapped all those
. These days, free cash flow is likely to be in the $100 million to
$200 million range, but could perk back up above $300 million once
the economy starts to add jobs. As the entire company is valued at
just $1.2 billion on an
basis, $300 million in free cash flow translates into a free cash
of 25%. It will take a few years to get back to that free cash flow
level, but will require only a small rebound in sales and continued
operational streamlining. You can understand why insiders are so
bullish, even if investors are not.
American Eagle Outfitters (
This retailer has also played second fiddle to a rival, which in
this case is
Abercrombie & Fitch (
. While Abercrombie has a reputation for premium clothes, American
Eagle is seen as a value-focused retailer, and has weaker profit
margins to show for it. And teens have been cool to the company
recently. Sales growth routinely exceeded +20% annually in the
middle of the past decade, but have turned flat during the past few
years and few analysts expect sales to rebound in the near-term,
while the economy remains in a funk.
In its favor, American Eagle has nearly $600 million in net cash
($3 a share), which helped fuel a 10 million share buyback last
quarter. Shares trade for a very reasonable 3.6 times projected
2011 EBITDA -- roughly 20% less than its peers. It's also
noteworthy that the company's Chairman, Jay Schottenstein, just
bought nearly $7 million worth of stock with his own money.
But it's hard to get excited about the company's near-term outlook
since it doesn't trade at such a sharp discount to rivals. Down the
road, that mega-purchase is likely to make the chairman a lot of
money, but insiders often arrive early to a party with their
bullish buying activity. In this case, Mr. Schotttenstein looks to
be early by a couple of years.
Collective Brands (
This operator of Payless ShoeSource and Stride Rite shoe stores
reported quarterly results on September 1st that badly lagged
forecasts, pushing shares down to a 52-week low. Demand for shoes
has been very weak, and sales are unlikely to rebound sharply until
the economy turns up. The shares were likely oversold, and have
risen for five straight sessions -- likely propelled by investors
that have noted the recent $600,000 in insider purchases.
Even as management can do little to boost sales right now, it can
improve Collective Brands' financial performance. The company
acquired the Stride Rite business in 2007 in hopes of gleaning real
synergies. Payless would gain access to Stride Rite's impressively
lean wholesale shoe operations, and Stride Rite would benefit from
and real estate expertise, according to analysts at Morningstar.
Those gains have been elusive, but they should still be evident in
time and help boost margins.
"With integrated retail and wholesale operations, Collective Brands
more closely resembles competitors like
Brown Shoe (
. These footwear companies have benefited from scale advantages and
multiple distribution channel opportunities associated with
, and Collective Brands is poised to do the same, in our opinion,"
wrote analyst R.J. Hottovy last week.
If he's right, then shares of Collective Brands have considerable
upside. Shares trade for about seven times trailing free cash flow
(which translates into a 14% free cash flow yield). Brown Shoe, the
company's closest rival trades for more than 10 times free cash
flow. And as noted above, Collective Brands has several paths to
improved financial results, which should fuel higher free cash
flow, even if sales growth remains anemic.
Action to Take -->
While insiders at American Eagle Outfitters appear to need a lot of
patience to make their big bet payoff, Office Depot and Collective
Brands may start to win back investors by delivering improved
expense control and higher
. Office Depot looks to have considerable upside, perhaps +100% or
+200% if management can stay focused on squeezing out costs.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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