In this edition of ValueTeddy’s writeups, we are taking a look at Joann, the sewing, fabric, and crafts retailer.
From a single store in Ohio founded in 1943, to the leading US fabric and craft retailer, JOANN operates approximately 850 stores in nearly every state. The company went public in march of 2021 at 12 USD per share, raising about 77 m USD in cash. All of this cash was used to pay down debt that was coming due in 2024. Before we get more into the debt situation, lets take a look at the income and cash flow statements.
Figures in USD, from the latest Q2 report and the 10-K for FY2020. For the first half of 2021 JOANN had about 1070 m USD in sales, where cost of goods sold was about 500 m, and SG&A was about the same. Depreciation and amortization was 40 m, leaving an operating profit of about 30 m. Sales were down from about 1200 m, but COGS and SG&A were also down, with D&A unchanged, leaving operating income unchanged compared to the first half of 2020.
They paid 28 m in interest expense, and booked 3 m in “debt related loss” (related to refinancing the term loan), and a further loss of 25 m resulting from a sale and leaseback. In the first half of 2020 they paid over 40 m in interest, and booked a 150 m “debt related gain”. The net income was 20 m in H1 2021, compared to 125 m in H1 2020. Diluted shares outstanding increased from 35.5 m to 41.5 m.
Moving on to the cash flows, JOANN reports an operating cash flow of -80 m, compared to 200 m for the same period last year. The negative operating cash flow could be in large part attributed to an increase in inventories of 75 m and a decrease in accrued expenses. In other words, expanded working capital. JOANN reports 30 m in capital expenditures for H1 2021, an increase from 20 m in H1 2020.
Last, but certainly not least, comes their rolling of debt. JOANN repaid 700 m on their term loan (2024) and took up a new term loan of about 670 m (2028). They also repaid 255 m on their revolving credit, and increased it by 280 m, they issued stock as mentioned earlier, netting them 75 m , and they paid a dividend of about 4 m.
The rolling four quarters sales, net earnings, and operating cash flow were as follows: 2625 m, 105 m, and 205 m. In other terms, the net profit margin is about 5% and the operating cash flow margin about 8%.
As you might have guessed, this case is all about the debt. JOANN has 135 m of equity on the balance sheet, and a total of 2270 in debt. The debt is made up of 770 m in long term debt (2028 term loan), 770 in operating lease liabilities, deferred tax of 85 m and other long term liabilities of about 55 m. There are 265 m in payables, and 135 m in accrued expenses, and a further 175 m in short term operating lease liabilities.
On the asset side, JOANN reports a total of 2405 m in assets, of which 535 m is goodwill or other intangible assets. This leaves 20 m in cash, 630 m in inventories, 80 m in prepaid expenses in current assets. And 265 m in property, equipment and leasehold improvement, 850 in lease assets, and 25 m in other assets.
In total, the net debt is about 400 m and the situation looks something like this:
As we can see, an important part of this story is the 2028 term loan at 675 m, and the revolving credit facility, and this debt comes with a couple of important covenants. These two sources of debt are lumped together as “The Credit Facility”, and JOANN calculated “Credit Facility Adjusted EBITDA”, which is used to test their compliance with certain ratios. These ratios are:
- “Consolidated Net Debt to CF Adj EBITDA below 4.9x” and “Consolidated senior secured net debt to CF Adj EBITDA below 3.6x”
- Consolidated senior secured net debt to CF Adj EBITDA above 2.5x or below 2x
- “Other provisions in our Credit Facilities utilize ratios including CF Adj EBITDA for calculating permitted limits for us to incur additional debt and make certain investments”
These ratios are measured quarterly on a rolling four quarters basis, except for 3 which is calculated annually in conjunction with the consolidated financial statements. Here’s how these covenants impact or restrict JOANN:
- If this covenant is broken, JOANN are not permitted to make prepayments on debt, or equity distributions as they wish. As of July, these ratios were both 2.7x.
- If this ratio is above the limit, JOANN will be forced to use a percentage of “excess cash flow” to repay principal on the term loan. This percentage goes from 50% to 0% as the ratio goes from 2.5x to 2x. For fiscal 2021 no such payment was required.
- These are not elaborated on further in the 10-Q, but I assume these limit taking on much further debt, or using cash that could have gone to repaying debt.
As of the latest report, the last 4 quarters FC Adj EBITDA was 296 m, but this number is very heavily adjusted, so I wouldn’t use it for anything but to track the covenant ratios.
Currently, JOANN is not immediately close to breaking any covenants, but the general debt level is arguably quite high. This could lead to the company having to use a large part of future cash flow just to manage its debt load.
At a price per share of 10.50 USD and 43.66 m shares outstanding, the market capitalisation is about 460 m USD. Adding back the debt less the current assets, but adjusting for the lease assets and debt, the enterprise value is about 1.8 billion USD.
Putting this in relation to the fundamentals, we get an EV / operating cash flow of about 9x and a P/E of about 4.5x.
Stitching it together
I think the gross profit margin is pretty good for a company that’s selling somewhat of a commodity. The operating cash flow for the first half of 2021 is quite bad, but the company tells us that their seasonality is similar to that of other retailers in that its sales is usually stronger in the second half of the year. However, the debt burden is quite substantial, and will require some time to get more under control.
Assuming no growth or operational improvement, the enterprise value will decrease at the current levels of profitability and as the debt is paid down. Unfortunately, cash used to decrease debt does not come to directly gain common shareholders in the same way as investments in assets or paying dividends.
The largest shareholders are Leonard Green & Partners, who took JOANN private in 2010 in a buyout deal valued at 1.6 b USD. LGP currently holds about 68% of the shares outstanding. Since they have now somewhat exited the deal, I expect LGPs shares of JOANN to be looking for new owners in a not too distant future (the 180 days lock-up ended on the 7th of September). Furthermore, management owns some shares, but most of these seems to have been awarded to them (presumably in relation to the IPO), and they all seem to have been awarded stock options with an exercise price at 12 USD.
Some concluding remarks, I think this is an interesting case. It looks really cheap on a P/E basis, but the debt burden is somewhat uncomfortable and it can hamstring the company. The next two quarterly reports will be quite important, first to see if the second half of 2021 can outperform 2020, and to see what they will do to improve the balance sheet. I think JOANN has some deleveraging to do, and that is not a great thing for equity holders. Also, I don’t know what LGP are intending to do, but sooner or later those shares will probably be sold. It’s also never a great thing that management don’t hold a significant amount of shares, but at least they have some shares, and options that incentivizes them to push the stock price north of $12.
I’m going to try to keep an eye on JOANN, but I don’t think the current potential upside warrants the downside. I’ll be mainly looking for if it for some reason should trade down at distress-level prices, or if they can successfully deleverage their balance sheet.
I hope you liked this edition of ValueTeddy’s Write-ups! If you want to suggest stocks for me to look at, you can tweet @ValueTeddy, and do check out valueteddy.com. Please note that this is for informational purposes only, and it is in no way financial advice and I’m not your financial adviser.