KIRK - Kirkland's: Holiday Sales Bring Little Joy

Summary

• Kirkland's relies heavily on seasonal Christmas and Harvest highs; however, both Q3 2022 sales and soon-to-be-released Q4 2022 have fallen short of expectations.
• Kirkland's debt is rising, free cash flow is increasingly negative, sales are typically much lower in Q1 and Q2, and there is much inventory to get through.
• I'm cautious of Kirkland's weakening fundamentals, industry headwinds and lack of growth potential.

Kirkland's, Inc. ( KIRK ) is another home furnishing company riding the current wave of the COVID-19 boom, followed by increased competition, demand drop, and ongoing economic headwinds. The market is losing faith in the business, which now only has a market cap of $46.94 million, while its annual revenue is much higher at $558.18 million. Over the last three quarters, the company has reported unprofitable results and missed EPS expectations.

The fundamentals of this company are deteriorating. We saw sales declining above estimations over the Christmas period , gross margins are diminishing, debt is piling on, cash flow is negative, and inventory is increasing. Although the stock price has grown over the last six months, this could be related to the high short interest. With the slump in home decor demand and the economy's slowdown, there is little to stick around for. Therefore I recommend a sell rating.

Overview

KIRK started in 1966 as a franchised gift shop. Today it is a specialty furnishings and home decor retailer operating 350 stores across 35 states and has one e-commerce website. One of its strengths has been maintaining a high gross profit margin due to its direct sourcing strategy. Its brand portfolio comprises the following; Kirkland's, Kirkland's Home, Kirkland's Home Outlet, Kirkland's Outlet and The Kirkland Collection. In the image below, we can see annual sales broken down per business segment.

Its revenue is highly seasonal. Holiday events, including Christmas and Thanks Giving "Harvest", are peak quarters, while summer is historically the weakest season.

Since 2020 KIRK has been cutting costs and streamlining its business by reducing its store count, relocating to more profitable areas and improving e-commerce which now makes up 27% of total sales last quarter. However, the industry headwinds have started to weigh heavier on the business; TTM gross profit margin is 26.96%, compared to 33.76% for FY2021, and TTM net income is negative $28.4 million, which should improve after Q4 2022 results. However, we already know that holiday sales have been much lower than forecasted due to lower customer traffic, and the Harvest season was disappointing in Q3 2022.

Financials

Things are not looking great for KIRK. In Q3 2022's transcript, the management emphasized its holiday season to increase sales and improve its inventory levels. However, we will continue to see increasing inventory and a dwindling cash supply. Revenue has slowly been decreasing, with TTM at $512.5 million, which is lower than in FY2015, impacted by reducing demand and restructuring efforts involving closing many of its stores. TTM net income is at a negative $28.4 million.

Free cash flow is dwindling, although there was a brief COVID-19 demand-induced spike. However, the business has not had a healthy cash flow for years which is essential to invest back into the company, give back to investors and pay off debt. TTM is a negative levered cash flow of $35.9 million.

If we look at the balance sheet, total debt has increased from zero over the last four years to $219.4 million. Keeping in mind that revenue last year was only $558.18 million, this becomes a very risky play. Even more, we see that the total debt-to-equity is 663.57%. Its total cash is $11.25 million. If we take the liquidity ratios, we can see an acceptable current ratio of 1.27. However, the quick ratio is meagre, even for the retail industry, at 0.10. The industry average is around 0.6 due to keeping relatively high inventory levels. KIRK's inventory has been creeping upward past healthy levels at $126.3 million.

The highly competitive home furnishing industry is doing poorly across the board. We've seen peers such as Tuesday Morning (TUEM), preparing potentially to file for bankruptcy soon, Wayfair ( W ) and Bed Bath and Beyond ( BBBY ) all in turmoil. Firms have all been impacted by unpredictable consumer spending and continued inflationary and recessionary pressures. Although KIRK's management team is optimistic about regaining stability in 2023, if we compare the stock across some critical metrics to these struggling peers, we can see that KIRK is in a similar dangerous boat. Its gross profit margin is only higher than discounter TUEM at 26.96%, although KIRK fairs better on net income margin with a negative 5.55%.

Across the balance sheet and cash flow, KIRK is very similar to TUEM, although TUEM has a positive free cash flow of $5.68 million compared to KIRK's negative free cash flow of $35.86 million.

Final thoughts

Although KIRK has restructured its business by reducing store count and increasing e-commerce to 27% of sales this past quarter, if we look at the business performance, ignoring COVID-19 fueled demand, free cash flow has been decreasing, debt has been rising, and sales are decreasing, even during peak holiday seasons. Amidst ongoing headwinds and unpredictable customer purchasing behaviours leading to surplus inventory and a lack of cash, I do not recommend buying this stock and fear that the performance will continue to hit new lows if we look at what is happening to similar peers in the industry. Therefore I recommend a sell rating.

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