This week, Durig Fixed Income 2 (FX2) focuses on an extreme value retailer whose performance in its current fiscal year has shown impressive growth. 99 Cent Only Stores have registered increases year over year in each of its first three quarters for its 2018 fiscal year. Its most recent quarter is a great example of that growth.
- Adjusted EBITDA increased by 91.6%.
- Same store sales were up 11.3% year-over-year.
- Net sales increased 10.7% compared to the prior year.
Although internet shopping is a very competitive way for consumers to ensure the best price for their purchases, for the type of inventory that 99 Cent Only Stores sells, online shopping simply doesn’t work. For these types of purchases, there will always be a market for extreme value retailers. 99 Cent stores have been building momentum over the past three quarters and looks poised to post an outstanding year. The majority of the company’s 2019 bondholders recently agreed to a bond exchange, so the remaining bonds will be sought after due to the current discounted price, giving them an excellent yield-to-maturity of 12.79%. In light of these factors, these bonds have been selected for addition to Durig’s Fixed Income-2 (FX2) managed income portfolio, the 2017 year-end, aggregate performance of which is displayed below.
Third Quarter Results
99 Cent Only Stores recently posted its fiscal year (FY) 2018 third quarter (Q3) results. Its results are impressive, especially considering the fast evolving landscape of brick and mortar retailers. Here are some of the highlights from its most recent reported financial results:
- Adjusted EBITDA increased by 91.6% to $16.5 million compared to the prior year.
- Net sales increased to $553.6 million, up 10.7% year-over-year.
- Same-store sales increased by 11.3% compared to the prior year.
- Gross margin, as a percentage of net sales also increased to 29.4%, up from 29.0% in the same quarter last year.
Source (both slides): 99 Cent Only Q3 FY 2018 Earnings Presentation
99 Cent Only Stores have also recorded a solid FY 2018 so far, with impressive increases in each quarter.
For its FY 2018, 99 Cent stores have registered year-over-year increases in key financial metrics for each quarter. In FY Q1 (three months ended April 28, 2017), the company increased net sales by 6.7%, and same-store sales increased 6.9%. Also in Q1, gross margin increased 70 basis points from 29.0% a year earlier to 29.7% in Q1. Finally, adjusted EBITDA increased 22.3% as compared to the prior year.
In Q2, the company continued its successful track record, showing an 8.9% increase in net sales, as well as a 9.0% increase in same-store sales. Gross margin also increased in Q2, from 28.4% a year earlier to 28.8%. Adjusted EBITDA in Q2 increased a whopping 93.2% from the prior year.
99 Cent stores have had a banner year so far and appear to be building momentum. The stores are showing ongoing success in its turnaround plan, which is driving its performance and improving profitability.
About the Issuer
The first official 99 Cent Only Store opened in 1982 in Los Angeles. Founder Dave Gold came up with the concept (everything for 99 cents) and soon the company began to grow. Over the years, the Company grew with new stores in California, and after the Company went public in 1996, 99 Cents Only Stores began opening locations in new markets including Arizona, Nevada and Texas. The company now operates 391 stores across the southwest United States and Texas. 99 Cents Only Stores has become the leading extreme value retail chain in the Western United States. 2012 marked a turning point for the Company when it celebrated its 30th anniversary and decided to go private by partnering with Ares Management and the Canadian Pension Plan Investment Board. This partnership has been instrumental in the company’s continued expansion, both in the number of new stores and new markets.
Turning the Tide
In 2014, 99 Cent Only Stores introduced the Go Taller campaign. Billed as a “dramatic canvas for visual merchandising” the main tenet of the plan was to give shoppers a broader array of goods by making shelves higher and stacking everything, from groceries, detergent, baby goods and dog food, on shelves that reached to six-and-a-half feet tall. Instead of increasing sales and margins, it did just the opposite. Go Taller led to increases in spoiled foods, inventory costs, shoplifting and broken products as merchandise tumbled into the aisles.
Enter Geoffrey Covert, a former Kroger executive, who took over as chief executive officer in September 2015. He discontinued the Go Taller campaign and immediately began improving the stores’ grocery assortment and marketing. Shelves were left at the Go Taller size, but with less product stacked, giving a less-cluttered look and products are more current. Covert has also reduced inventory by 42% from Go Taller’s peak levels, which has cut costs and improved margins. The continued effects of these initiatives can be seen in the company’s FY 2018 performance so far. It’s latest sales figures (for Q3) increased 10.7% over the prior year, due to higher customer traffic (5.1% higher) as well as higher average ticket per customer (5.8% higher). The steady improvements in gross margin in this fiscal year has been due in large part to lower inventory shrinkage as well as higher product margins. Clearly, Covert’s methods are working.
Debt Restructuring / Extension
In early November, 99 Cent Only Stores announced an exchange offer for existing holders of these 11% 2019 bonds. As a result of this offer, the company reported the final results on December 8, 2017. A vast majority of bondholders – nearly 97% – agreed to the exchange offer. Bondholders had two choices: (i) newly issued 13% cash / PIK (payment in kind) Notes, maturing April 2022 or (ii) shares of new PIK series A-1 participating stock of Number Holdings, Inc., the direct parent of 99 Cent Only Stores. The settlement date is expected to be on or about December 14, 2017.
The company was also able to amend its existing term loan facility in Q3, including extending the maturity date of certain first lien term loans by three years, to January 2022.
The risk for bondholders is whether 99 Cent Only Stores can continue to post solid improvements in revenues and profits, while improving their debt picture via the recent exchange offer. The company has posted solid results throughout all of its fiscal 2018 and appears to be on track to continue its year-over-year growth. Also, the debt exchange will provide the company with much needed time to get their financial house in-order before it needs to refinance or pay down some of its outstanding debt. These short 24-month bonds are not widely available but with the company showing such dramatic improvements this fiscal year, these bonds will be much more attractive to investors. Given these considerations, the nearly 13% yield-to-maturity on these bonds does appear to outweigh the risks identified.
Currently, 99 Cent Only Stores have less than 1.0x interest coverage. The company’s recent bond exchange should help alleviate some of the interest expense, which should increase coverage levels.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
99 Cent Only Stores has significantly improved its performance, most notably in its current fiscal year. The new CEO, who sharpened his skills at Kroger, appears to have a solid understanding of retail and what it takes to improve traffic as well as sales. While retail continues to transform due to the increase in online shopping, there will likely always be a market for extreme discount retailers. These very short 24-month bonds are currently selling at a discount, giving them a yield-to-maturity of over 12%. Given 99 Cent Only Stores’ recent performance improvements, these bonds make a great addition to an already diversified portfolio such as the Fixed Income 2 (FX2) managed income portfolio, the 2017 year-end, benchmarked and aggregated performance of which is shown above.
Issuer: 99 Cent Only Stores
Ratings: Caa2 / CCC
Yield to Maturity: ~12.79%
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