Oh KIRK, you schlock-teasing little minx.  Money McBags has defended you over the past few quarters as an undervalued gem (like the delightful, and yet soon to be overvalued Hayley Atwell thanks to her role in the upcoming Captain America movie) as you seduced him with your expanding margins, your bouncing back sales, and your new real estate strategy.  Yet all you have done since then is go down on him in ways more painful than a snaggle toothed Amy Winehouse with mangled braces and a severe case of mouth herpes.

In the history of the award winning When Genius Prevailed, Money McBags has only been wrong about a stock like this on 2 or 3 occasions (and yeah Money McBags is looking at you IBKR), so it is time to reevaluate, say our mea culpas, and wish very bad things on everyone in the Southeast who failed to buy a wine bottle tart burner (and Money McBags isn’t just puzzled that he recommended a company that sells something called a “wine bottle tart burner,” but also that according to the link, the tart and burner in the “wine bottle tart burner” are sold separately.).

So where has it all gone so wrong?  Is it the fact that in this economy people no longer feel that buying statues of pedophiliac giraffes is a status symbol or is it that KIRK’s improved margins and management changes were just a fata morgana mirage (as opposed to a fatty Morganna massage)?  Money McBags is trying not to take it personally, but KIRK has assraped his poor earnings model to the point where it has imploded on it self in a mass circular reference.

So Money McBags will attempt to objectively take a look at KIRK’s quarter and see if the business can fool him for a third time (though to be fair, KIRK did way outperform Money McBags’ worst case scenario after last Q in which he thought the stock was cheap, so the 18% sell off feels more overdone than Heidi Montag’s face or dong shots on chatroulette).

The Positives:


1.  Net Sales were up .4%. Ok, this is positive in the same way that learning that your health insurance company is going to be picking up a higher percentage of your AZT prescriptions is positive (because either way, you will still fucking have AIDS) as it screams pyrrhic victory with same store sales down, discounting up, and pseudo competitor PIR putting up 11% comp sales last Q (they report this Q in a few weeks).  But up sales are better than down sales Money McBags guesses.

2.  New stores still going strong. This is one of Money McBags’ drivers for liking the stock as they have been moving out of their expensive shitty mall locations (where they were getting way too much traffic from people simply trying to find the mall’s glory hole) and in to cheaper, better located off-mall stores.  So this is something we can feel good about, especially as they plan on opening 38 new stores (net 20ish) in 2010 and grow store count by ~10% in 2011.  The benefits of this strategy show up as store occupancy costs decreased by 77 bps, so good on them.

3. EPS was positive. They earned $.11 per share, only $.01 below analyst guesses and only 50% less than last year’s eps (so um, scratch that last one as a positive).

4.  They still have a fuckload of cash. $60MM to be exact and they are forecasting $85MM for the end of the year.  With a current market cap of ~$220MM, that is a hella nice cushion, even nicer than the cushion on their Cheetah bar stool or Jessica Simpson.

5.  Malin Akerman will be taking over the role of Linda Lovelace from Lindsay Lohan in the upcoming biopic.  This has nothing to do with KIRK, but we can all agree it is very positive as Ms. Akerman is quite an upgrade.

Negatives (and this may take a while):


1.  On average, fewer people were buying shit and at lower prices. Comp store sales were down 2.4% despite a 6% uptick in traffic which lead to 1.6% more transactions but a lower average ticket price as their conversion rates dropped despite increased discounting.  This is a more worrisome trend than people on reality shows thinking they have talent (and Money McBags has no idea who that person is but watching 1 minute of that caused his tympanic cavity to more than tym-fucking-panic).  KIRK said a few of their categories which had been fueling growth showed declines such as their Art category because $70 pictures of Santa Claus are somehow falling behind spending on food, clothing, and well, anything fucking else in consumer’s hierarchy of needs.  They say they are working on this, but not being aligned with customer trends and needs is bad fucking news.

2.  Gross margins were not just gross, put bordering on disgusting.  Gross margin were down from 41.1% in Q3 last year to 38.8%. with 200bps of it due to higher inbound freight costs.  Though inbound freight costs weren’t the scariest part of the rise, rather it was that…

3.  Markdowns were up. As mentioned in #1 above, they had to reduce prices to get shit out the door.  To Money McBags, this is the most worrisome event because if they are not offering a compelling item or if consumer trends have passed them by, no amount of cost cutting, new store openings, or half off merchandise can fix this.  And this has been one of the core positives of Money McBags’ thesis.  With staycations increasing faster than Kate Middleton‘s bank account, people should be buying little trinkets for their homes to make those long days waiting in the unemployment lines feel special.  So even though poor people (KIRK’s target market) are still fucking poor and not spending on shit, the middle class is trading down which has caused an uptick in sales at dollar stores, Target, McDonald’s, and Tara Reid‘s pants.

The point is, Money McBags thought that part of the middle class trade down would involve buying some of the cheap tchotchkes KIRK sells but apparently becoming poorer doesn’t affect taste as much as Money McBags thought.  So while the middle class is struggling, perhaps pineapple doormats just aren’t the thing to cheer them up.  This is something very important to which to pay attention to because if KIRK can’t get the trade down crowd, they may be in for a rough next few quarters.

4.  Operating expenses were up, profitability was down. Operating expenses rose from $26.8MM to $29MM due to higher marketing costs (which is a bad thing since that extra marketing spend seemed to be less effective than any of Lyndon LaRouche’s presidential runs) and more transactions using credit/debit cards (which may be positive as a sign that the middle class is trading down).  All in, combined with the gross margin deleveraging, this led to operating income down from 8% of sales to 3.8% of sales and eps down from $.23 to $.11.

6.  Guidance sucked dick (not that there is anything wrong with that for Money McBags’ vagina challenged brothers), but it didn’t just suck any dick, it sucked a scabies infested donkey dick.  Full year 2010 guidance was reduced from 4% to 6% top line growth to 2% to 4% topline growth (which implies mid to high single digit sales DECLINE in Q4, so fuck you very much) and Q4 operating margins forecast to be down 350 to 450 bps.  EPS guidance was given as $.60 to $.72 for Q4 and $1.25 to $1.29 for the year.  Money McBags is giving them no credit for growth for the year which gets him 9% topline decline in Q4 and EPS of ~$.56 or $1.15 for the year, which means the company is trading at ~10x this year’s earnings.

7.  Things may not be getting any better.   On the call, management said October was the weakest month of Q3 and the Christmas season has started slowly as not even Jesus would drop $90 on a holy family statue (though that may be an unfair data point since like Money McBags, Jesus also eats chinese food on Christmas and everyone knows Money McBags’ people only buy wholesale).  They did say that sales have accelerated recently but due to the fairly slow start in the early part of November, they remain somewhat cautious.  Shit like this scares Money McBags more than having to play find the button with RuPaul.

Conclusion/Valuation:

So what thee fuck do we do with KIRK?  We don’t want to be continually fooled by the level of their cheapness, but yet, they are so fucking cheap.  Analyst guesses for next year are $1.25 eps, $420MM sales (~4% growth), and $55MM EBITDA which implies gross margins ~40%.  Those numbers are possible, but Money McBags currently has no faith in KIRK being able to keep their margins given that freight costs don’t seem to be getting any better and they had to discount a bunch of shit to move it off the shelves.

These are the two numbers that worry Money McBags, 29% and 34%.  And no, those aren’t the percent of Money McBags’ sentences that don’t contain grammatical errors, rather they are KIRK’s gross margins from 2007 and 2008.  The story has been that KIRK has reinvented itself by optimizing their real estate and focusing their SKUs, and that worked for the past 2 years, but now that the stimulus is gone (well except for QE2), can KIRK maintain their 40%+ margins or will they drop back to pre-bail out levels?

If Money McBags holds growth in 2011 flat, throws out $120MM for operating costs (which may be a long nut hair high, better known as a  Peter North, but whatever), $12.5MM for depreciation, and 40% for a tax rate, and then throws on a 40% gross margin, he gets ~$.88 of eps next year.  At a 35% margin, he gets to only $.28 of eps which means the stock is trading at ~40x that worst case, though not implausible, scenario (though EBITDA would be ~$23MM in that case so it would be trading at only ~7x EBITDA).  And honestly, at this point in time Money McBags has no fucking idea where gross margins are going.  They were 38.5% in Q3, so this is something on which you really need to keep an eye (though it is perhaps more important to keep an eye on this).

Basically, with flat sales, every 1% hit to gross margin has a ~$.12 hit to eps so you need to figure out if:  A.  The discounting they did in this last Q was just temporary.  B.  Freight costs will get better.  C. Sales can even hold flat.  D.  Danielle Fishel is fugly or just plain butt ugly.  Because if all of those swing in your favor (except perhaps the last one) and KIRK can hit the ~$1.20 eps that analysts are guessing, then the company remains cheap, especially as it would be at <3x EV/EBITDA.

Unfortunately Money McBags has no insight right now as to where margins will be next year and he can only go by the current trend and what management has said, which is not good.  As Money McBags has fallen for their story twice, he is going to be hella cautious not to do it again and thus in the absence of other data he is not going to be buying any here until he sees another Q to see if the trends have turned.  He’s also not going to be shorting because there is too much uncertainty and shorting something with high uncertainty is likely to turn out as well as one of Andy Reid’s kids.  So the company should earn between $.28 and $1.20 per share next year (and yes Money McBags knows that is a huge and worthless range, but it is what it is), so make your gross margin assumption and fire away.

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