Stage Stores, Inc. Rating: Hold

Transcription

1 HARDLINE/LEISURE Jeffrey Blaeser Company Update October 26, 2007 Key Metrics SSI - NYSE $17.79 Pricing Date 10/25/2007 Price Target NA 52-Week Range $24.24-$15.27 Shares Outstanding (mm) 41.4 Market Capitalization ($mm) $ Mo Average Daily Volume 476,727 Institutional Ownership 100% Debt/Total Capital 2.8% ROE 10.3% Book Value/Share $12.95 Price/Book 1.4x Dividend Yield 1.0% LTM EBITDA Margin 8.90% EPS($) FY: January Prior Curr. Prior Curr. 2007A 2008E 2008E 2009E 2009E 1Q-Apr A E 2Q-Jul A E 3Q-Oct E E 4Q-Jan E E FY E E P/E 14.2x 13.9x 12.1x EPS reflects 3:2 stock split, effective February 1, Revenue($mm) Prior Curr. Prior Curr. 2007A 2008E 2008E 2009E 2009E 1Q-Apr A E 2Q-Jul A E 3Q-Oct E E 4Q-Jan E E FY 1, ,557.1E -- 1,691.1E 1 Year Price History for SSI Q3 Q1 Q2 Q Created by BlueMatrix Company Description: Stage Stores Inc. ( is a small-format department store chain with units in small and mid-sized markets in the southern, midwestern, and eastern parts of the US. Its stores operate under the names: Stage, Bealls, Palais Royal, and Peebles. Its average unit is about 18,500 square feet and is usually located in a strip mall. The company is based in Houston, Texas Stage Stores, Inc. Rating: Hold Early Stages of A Growth Story; Hold Investment Highlights: Transferring coverage of SSI; now rated Hold. Small town locations/brand offerings provide differentiated shopping experience. Stage Stores operates 668 stores in small to mid-sized markets. With 85% of its store base located in market areas with less than 150,000 people, Stage is shielded from larger competitors unwilling to invest in the smaller markets. While overlap with retail giant Wal-Mart (WMT-$43.88-NYSE) exists, Stage differentiates itself through customer service and more extensive brand offerings. Accelerated store growth targets 70 new store openings annually. We believe Stage Stores can eventually increase its national presence to over 1,000 units. Internal expansion plans call for roughly 50 new openings this year with 70 targeted annually thereafter. New unit economics are fairly attractive with first year sales estimated at $1.6mm, versus an estimated $2.2mm company average, and an average cash-on-cash return of 26%. Comp sales gains should come from targeted merchandising initiatives. Stage is currently targeting three key categories for incremental sales growth. Cosmetics, footwear, and plus-size apparel have demonstrated elevated levels of comp growth and fit in well with Stage's customer base. We expect Stage to focus on these categories through increased offerings and shelf space. Additional merchandising initiatives could evolve in 2008 with the implementation of its SAS/MarketMax merchandising system, which should track customer purchasing patterns more closely. Strong balance sheet and history of giving back to investors. Stage currently holds minimal debt, debt to cap. of 8%, and a propensity to give back to shareholders. As of 9/12/07, the company has spent $227mm on stock repurchases while steadily increasing its dividend payment to $0.20 per year. Aggressive expansion program could limit future free cash flow. Investments associated with store development should expand from $72mm in FY07 to $95mm plus in FY08 and FY09. These increases could limit free cash flow going forward and force Stage to tap into its revolving credit program; thus potentially limiting future share buybacks and/or increased dividend payments. Near-term comps could be limited by economic/weather conditions. We currently project back-half comparable store sales to trend slightly negative as a challenging retail environment and heavy rains in the South and Mid-West might be limiting sales growth. Longer term, when conditions normalize, comp growth should return to positive territory, as has been the case for the past three years. Stage currently trades slightly above, on a FTM P/E basis, to its peer group multiple, yet slightly below, on an EV/EBITDA multiple. The Disclosure section may be found on pages 7-8 of this report.

2 We are transitioning coverage of Stage Stores with a Hold rating, based primarily on valuation Stage Stores is a small-format department store with 668 stores in small and mid-sized markets in the southern, midwestern, and eastern parts of the US. Its stores operate under the names of Bealls, Palais Royal, Stage, and Peebles. Its target customers are women 25 years and older with an annual household income of $35,000 and up. The company differentiates itself by selling national name brands in relatively underserved small towns in the US. The company's stores are also convenient to its small-town customers, who usually have to drive 30 miles to a regional mall to purchase brand-name items. The company has a high degree of geographic overlap with Wal-Mart, but differentiates itself by providing a higher number of branded lines and by offering more extensive customer service. Much like the concept of malls and/or outlet destinations, we believe Stage Stores actually benefits from a close proximity to Wal-Mart as it increases the incentive for customers to travel to the destination shopping area. Furthermore, Stage's store base can feed off of the higher traffic generated by Wal-Mart as customers shift over to Stage after purchasing their non-branded merchandise. Other, larger chains that occasionally occupy similar locations can include Kohl's (KSS-$55.85-NYSE) or JC Penny (JCP-$55.33-NYSE), as well as local mom-and-pop operations. Similar to Wal-Mart, Stage offers a larger supply of branded products than these competitors. In addition to its relatively unique locations, Stage attempts to offer superior customer service with well-trained sales associates, as each associate is evaluated on knowledge and ability to interact with customers, to facilitate repeat business. Each assistant is encouraged to open private label credit cards for customers, which further facilitate repeat business as well as a more intimate knowledge of current trends and purchasing patterns. Stage stores utilize a "racetrack" configuration on a single level, and are generally located in a strip mall to allow customers to quickly get in and out of the store. In order to maximize store efficiency, the products and racks tend to be arranged close together, and over 90% of the stores have "self serve" shoe departments. Signage is clear, and the stores have simple, basic fixtures. For the newer units, the company is able to use over 80% of gross square footage for selling space. The company monitors store activities and purchasing trends and adjusts merchandising mix accordingly. For example, cosmetics, footwear, and plus sizes have exceeded, on a Y/Y comparable sales basis, other categories and therefore have become a focal point for comparable store sales and square footage availability growth. Stage has invested in a SAS/MarketMax Merchandising Planning system to further optimize its assortments on a store-by-store basis with benefits and data points expected in Stage's growth strategy targets a total store base of 1,100 to 1,200 Stage's units are concentrated in Texas and the south-central region of the US and the average unit size is about 18,500 sq. ft. As of December 2006, 66% of Stage's stores were located in small towns with populations below 50,000, 19% in mid-sized communities with populations between 50, ,000, and 15% in metropolitan areas. The company has three distribution centers (DC): one in South Hill, VA, one in Jacksonville, TX, and a third soon to be opened in Jefferson, Ohio. The Ohio DC will occupy approximately 200,000 square feet. Projected investments toward DC include $12mm to $16mm in 2007 and 2008 for new machinery and equipment. The new DC should be able to support approximately 300 stores and bring total potential capacity for Stage up to 1,100 units. We expect near-term development to focus on store growth within existing states and a longer-term focus on non-populated states such as California and Florida. Current projections call for roughly 260 openings in existing states with another 280 targeted for new territories. In FY07, Stage Stores opened and acquired 108 stores, and added 14 more during the first half of FY08. For the remainder of the year, we project roughly 30 more unit openings, and expectations are for 70 new store openings annually thereafter. New unit economics are fairly attractive with projected year one cash-on-cash returns of 26%. First-year sales are projected at approximately $1.6mm, or $90 per sq. ft., with a five to six year estimated maturity phase expanding sales to roughly $130 per sq. ft., or $2.4mm in annual revenues. 2 MORGAN JOSEPH & CO. INC.

3 Improved profitability within existing stores; expect Peebles units to improve $5 per sq. ft. per year With a total base of 668 stores, Stage Stores, which include Bealls, Palis Royal, and Stage, account for 386 and the Peebles and BC Moore units account for 282 stores. Sales made under the Stage name are currently estimated at $153 per square foot while Peebles and BC Moore come in below that total at roughly $102 and $90 per square foot, respectively. Some of the difference can be attributed to some Stage units being located within larger markets. As we mentioned above, these markets are not a focal point for the company but remain within the overall base as they were established early in the development process. Excluding these larger markets, which can generate sales of approximately $300 per square foot, we believe a more realistic expectation for the Peebles and BC Moore units is $125 per square foot. Peebles, on a comparative basis to Stage, struggled last year due to reduced inventory levels and ongoing transformation into the Stage Store format. By improving in-stock levels and merchandising mix, Stage expects to expand sales within the Peebles units by $5 per square foot each year over the next four years. Within both the Stage and Peebles units, the company is looking to boost sales through a more targeted and effective merchandising mix. In addition to the implementation of its SAS/MarketMax merchandising planning system, which should provide more extensive purchasing data for ongoing merchandising analysis in 2008, we expect Stage Stores to focus upon high-growth opportunities such as cosmetics, footwear, and plus-size clothing. These categories have recently exceeded Y/Y growth levels of other categories (cosmetic FY06 comps up 7.3%, footwear FY06 comps up 3.3%, plus-size FY06 comps up 15%) and appear to be well-situated for ongoing gains. Cosmetics showing strong sales growth In F2Q08, cosmetic comparable Y/Y sales expanded 10.2% as the company continues to roll out Estee Lauder and Clinique counters. During the second quarter, Stage added one new Estee Lauder and three new Clinique counters in its Peebles division, which brought the total number of counters up to 96 Estee Lauder and 87 Clinique counters. During the second half of the fiscal year, we expect 59 additions with 38 in existing stores and 21 in new units. In addition to driving improved sales results, we believe the cosmetic counters can add to foot traffic while giving additional reasons for customers to make the trip out of their small town and into a Stage or Peebles store. Cosmetics currently account for roughly 6% of the company's total sales base and the category has expanded, on a comparable store basis, 1.5%, 6.7%, and 7.3% in FY04, FY05, and FY06, respectively. During the company's latest quarter, cosmetics expanded Y/Y 10.2%. Additionally, dresses, which could have been positively impacted by counter additions, expanded Y/Y 13.5%. Stage Stores the place to go for shoes in small town USA Footwear accounts for roughly 12% of Stage's total sales base. Whereas Kohl's and JC Penny footwear categories account for 8% and 6%, respectively, Stage's rural settings limit competition from primarily footwear-based retailers and positions Stage as a feature destination for shoes for the entire family. Stage's footwear category saw its comps grow 5.7% in FY04, 4.4% in FY05, and 3.3% in FY06. The company looks to further grow through improved breadth of style and brand selections. Plus-size market represents a big opportunity The plus-size category is, and has been, Stage's fastest growing apparel category. Plus-size comparable store sales expanded 16% in FY04, 23% in FY05, and 15% in FY06. Similar to cosmetics and footwear, we expect Stage to continue bolstering this category with added selling space and a more diverse merchandise mix. According to two NHANES surveys featured on the Centers for Disease Control and Prevention, among adults 3 MORGAN JOSEPH & CO. INC.

4 aged years, the prevalence of obesity increased from 15% (in the survey) to 32.9% (in the survey). A geographical study from the same source identified states with an elevated level, as a percentage of the state's total population, of obese adults. The majority of these states have a significant number of Stage and Peeble's units located within these territories. We are not suggesting that all plus-size consumers are obese, but we believe the data sufficiently points to geographic trends and opportunities for sales growth. Strong balance sheet should support aggressive store expansion program Stage Stores currently boasts a strong balance sheet, in our view, with $19.5mm in cash and $47.6mm in total debt, or a debt to capital ratio of 8.2%. The debt, which has ranged from a low of $16.6mm in F4Q07 to a high of $77.3mm in F3Q06, has traditionally been low, and it typically peaks in the third quarter as the company stocks up holiday inventories. The company's borrowings are primarily held within a $250mm revolving credit facility that matures on August 21, Inventories appear in check and below recent levels as the company anticipated slightly slower sales growth, primarily resulting from heavy rains in Texas and a relatively sluggish economy, therefore keeping inventories as a percentage of cost of goods at roughly 31% in F2Q07. This is roughly in line with last year's comparable ratio but lower than historical norms, which have trended in the high 30% levels. Free cash flow fuels store growth and returns to investors via stock buy backs and dividend payments Stage Stores generated free cash flow of $85mm, $31mm, and ($17mm) in FY05, FY06, and FY07, respectively. Although inventories per square foot remained relatively flat, inventories in FY07 represented a $48mm use of cash; and therefore was the primary reason for the negative free cash flow. Capital expenditures in FY07 were $72mm and we expect that total to increase to $95mm in FY08 and $105mm in FY09. The increased capital expenditures are primarily targeted for new store openings, relocations, remodels, and counters. Therefore, while we expect cash from operations to increase Y/Y from $55mm in FY07 to $108mm in FY08E, the increased capex should keep free cash flow at a relatively modest $13mm. While the cash payments should benefit the company in the long term in the form of new store development, sustaining such unit growth while buying back shares and paying an annual 20 cent dividend to shareholders without further tapping into its revolver may prove challenging. However, without any further repurchases, we believe the company can fund the growth and its current dividend payment. Historically, Stage Stores has a strong track record for enhancing shareholder value via share buybacks and increased dividend payments. Since the program was initiated in 2002 and as of 9/12/07, the company has spent $227.2mm on stock repurchases with 13.7mm shares bought back. Currently, the company is not authorized to repurchase shares, but it could revisit the program if deemed appropriate. Additionally, the Board has steadily increased the company's dividend, which was initially declared in August 2005 at 2.5 cents/share per quarter. In June of 2006 the Board doubled the dividend to 5 cents/share while maintaining the 5 cent dividend in March 2007 despite implementing a 3 for 2 stock split, which essentially expanded the dividend payment by 50%. Challenging weather and market conditions limiting comp store gains; Y/Y growth appears stunted by LY's liquidated sales Despite adding roughly 113 units over the past six quarters, first-half fiscal year sales expanded only 1.6%. Heavy rains and flooding conditions in many of the company's South Central markets negatively impacted second quarter results, resulting in relatively flat overall comparable store sales. Additionally, during the first 4 MORGAN JOSEPH & CO. INC.

5 half of LFY, Stage liquidated roughly $50mm in acquired BC Moore inventory, which skewed last year's results higher. Based on first-half trends and general economic conditions, we maintain a relatively conservative view upon second-half comp results. We currently forecast comparable store sales declines of 2% and 1% in F3Q08 and F4Q08, respectively. Upside to our numbers could exist as August comparable store sales declined only 2.6% versus expectations for high single digit Y/Y declines with September comparable store sales increasing 2.3%. Despite expectations for slightly negative Y/Y comps and sales, the company's tight inventory controls should limit promotional activity; thus keeping gross margins relatively flat Y/Y. SG&A should expand slightly. We currently project third quarter earnings per share of $0.06 and fiscal year 2008 EPS of $1.28. Without having to compare against a boost from acquired/liquidated sales, we expect a truer reflection of top-line growth to materialize in FY09 with expectations for Y/Y gains of 8.6% to $1.7bn. While merchandising initiatives may identify gross margin growth opportunities, we expect these potential benefits to be offset by slightly higher promotional activities during the year and we project FY09E gross margins to remain relatively flat. SG&A should de-leverage slightly due to higher sales while EBIT margins are expected to increase Y/Y 30 basis points to 6.3%. EPS should expand 15% to $1.47 with EBITDA increasing 9.2% to $156mm. Valuation - Shares trading in-line with peer group; transferring coverage with a Hold rating SSI is currently trading at 13.3x trailing twelve month earnings. Based off of our forward 12-month and FY09E EPS projection of $1.34 and $1.47, the shares now trade at P/E ratios of 13.3x and 12.1x, respectively. These results fall roughly in line with its peer group multiple of 11.7x on a FTM basis and the company's five year historical average. While trading below its current peer group multiple of 6.6x 2008E EV/EBITDA, SSI's current FTM EV/EBITDA multiple of 5.5x falls slightly ahead of its historical average multiple of 5.2x. We do note that the company's historical averages are slightly skewed due to lower multiples having been attributed to the company coming out of bankruptcy in 2003, and that its multiples have trended higher recently. We believe Stage Store's small-town customer base, which most likely has not benefited as much as its metropolitan neighbors in recent years from steadily increasing real estate prices, has less exposure to the sub-prime credit crunch, which has somewhat shielded the company from concerns over consumer confidence and retail buying patterns. We are assuming a conservative approach on SSI at this time, but would certainly revisit our valuation and rating should economic factors improve. We are encouraged by the company's aggressive store expansion program and we believe cash from operations should be able to fund the expansion, but debt levels could gradually increase during the growth process. 5 MORGAN JOSEPH & CO. INC.

6 Stage Stores Inc. (In Millions, Except Per Share Data) FY Q1 Q2 Q3 Q4 FY Q1 Q2 Q3E Q4E FYE Q1E Q2E Q3E Q4E FYE Quarter End 2006 Apr-06 Jul-06 Oct-06 Feb May-07 Aug-07 Nov-07 Feb May-08 Aug-08 Nov-08 Feb Sales % Increase 8.1% 10.8% 17.0% 15.5% 17.3% 15.3% 4.3% -0.8% -0.3% -0.8% 0.4% 6.9% 9.4% 9.2% 8.9% 8.6% Cost of Goods Sold As % Sales 70.9% 71.0% 73.6% 71.6% 67.8% 70.7% 72.6% 70.6% 71.8% 68.5% 70.7% 72.3% 70.5% 71.5% 68.4% 70.5% % Increase 7.7% 18.4% 17.6% 17.5% 9.3% 15.1% 6.6% -4.8% 0.0% 0.2% 0.3% 6.5% 9.2% 8.7% 8.7% 8.3% Gross Profit Margin 29.1% 29.0% 26.4% 28.4% 32.2% 29.3% 27.4% 29.4% 28.2% 31.5% 29.3% 27.7% 29.5% 28.5% 31.6% 29.5% % Increase 8.9% -4.3% 15.5% 10.6% 38.8% 15.9% -1.3% 10.4% -0.9% -2.8% 0.7% 7.8% 9.9% 10.3% 9.2% 9.3% SG&A As % Sales 22.1% 24.3% 23.8% 25.6% 18.8% 22.8% 23.7% 24.5% 26.1% 19.5% 23.1% 23.6% 24.3% 26.0% 19.0% 22.9% % Increase 8.1% 19.2% 21.3% 22.4% 13.7% 19.0% 1.5% 2.0% 1.7% 2.7% 2.0% 6.4% 8.6% 8.7% 6.1% 7.4% Store opening costs As % Sales 0.2% 0.2% 0.5% 1.1% 0.2% 0.5% 0.2% 0.1% 0.6% 0.2% 0.3% 0.4% 0.4% 0.4% 0.3% 0.4% % Increase 47.8% -14.7% 160.1% 212.0% 373.1% 143.8% -7.4% -74.7% -50.4% -24.2% -48.4% 98.7% 208.6% -25.0% 87.5% 48.5% Operating Expense As % Sales 22.3% 24.6% 24.3% 26.7% 19.1% 23.3% 23.9% 24.6% 26.7% 19.7% 23.4% 24.0% 24.7% 26.4% 19.3% 23.2% Operating Profit Margin 6.8% 4.4% 2.1% 1.6% 13.1% 6.0% 3.5% 4.7% 1.5% 11.8% 6.0% 3.7% 4.8% 2.1% 12.3% 6.3% % Increase 10.3% -53.9% -32.1% -62.5% 100.0% 1.2% -16.9% 128.8% -6.9% -10.3% 0.0% 12.3% 11.1% 50.3% 13.3% 14.9% Interest Expense Other Income Pretax Profit Margin 6.6% 4.2% 1.7% 1.3% 12.8% 5.7% 3.3% 4.4% 1.2% 11.6% 5.7% 3.5% 4.5% 1.8% 12.1% 6.0% % Increase 10.0% -55.7% -40.6% -69.3% 100.7% -1.0% -17.6% 160.3% -3.6% -10.2% 0.9% 12.8% 11.6% 63.2% 13.6% 15.6% Taxes(benefit) Rate 37.0% 37.3% 37.2% 37.3% 36.9% 37.0% 37.8% 38.2% 38.0% 37.6% 37.8% 37.8% 37.8% 37.8% 37.8% 37.8% Net Income--Oper Margin 4.2% 2.6% 1.1% 0.8% 8.1% 3.6% 2.1% 2.7% 0.8% 7.2% 3.5% 2.2% 2.8% 1.1% 7.5% 3.8% % Increase 8.8% -55.9% -40.8% -69.4% 101.0% -1.0% -18.4% 156.3% -4.7% -11.2% -0.4% 12.8% 12.3% 63.7% 13.3% 15.5% EPS--Operations % Increase 10.5% -54.4% -39.2% -69.5% 94.1% -1.2% -20.7% 157.3% -0.3% -6.0% 2.0% 16.4% 12.3% 59.9% 10.9% 14.7% Shares Out. Basic Shares Out. Diluted Source: Company reports and Morgan Joseph estimates 6 MORGAN JOSEPH & CO. INC.

7 Required Disclosures Rating and Price Target History for: Stage Stores, Inc. (SSI) as of /02/07 I:Buy:$26 06/08/07 Buy:$ Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q /1/07 3:2 stock split Research coverage transitioned to Jeffrey Blaeser on October 26, Created by BlueMatrix I, Jeffrey Blaeser, the author of this research report, certify that the views expressed in this report accurately reflect my personal views about the subject securities and issuers, and no part of my compensation was, is, or will be directly or indirectly tied to the specific recommendations or views contained in this research report. Research analyst compensation is dependent, in part, upon investment banking revenues received by Morgan Joseph & Co. Inc. Morgan Joseph & Co. Inc. intends to seek or expects to receive compensation for investment banking services from the subject company within the next three months. Investment Banking Services/Past 12 Mos. Rating Percent Percent BUY [B] HOLD [H] SELL [S] Meaning of Ratings A) Buy means reasonable outperformance relative to the market over months. B) Hold means market-type risk adjusted performance; potential source of funds. C) Sell means expected to underperform the market. Other Disclosures The information contained herein is based upon sources believed to be reliable but is not guaranteed by us and is not considered to be all inclusive. It is not to be construed as an offer or the solicitation of an offer to sell or buy the securities mentioned herein. Morgan Joseph & Co. Inc., its affiliates, shareholders, officers, staff, and/or members of their families, may have a position in the securities mentioned herein, and, before or after your receipt of this report, may make or recommend purchases and/or sales for their own accounts or for the accounts of other customers of the Firm from time to time in the open market or otherwise. Opinions expressed are our present opinions only and are subject to change without notice. Morgan Joseph & Co. Inc. is under no obligation to provide updates to the opinions or information provided herein. Additional information is available upon request. Copyright 2007 by Morgan Joseph & Co. Inc. 7 MORGAN JOSEPH & CO. INC.

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