The Motley Fool, 9/25/97: The Daily Double

Thursday, September 25, 1997

Musicland Stores Corp.
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Phone: 612-931-8000
Price (9/24/97): $6 9/16

HOW DID IT DOUBLE?

Last January, this well-known music retailer was two steps away from discovering if Elvis is really dead. An ultra-competitive retailing environment and excessive expansion had Musicland doing $1.8 billion in sales but earning less than Lisa Marie makes selling tickets to Graceland.

Massive store closings promised to help matters eventually, but would the creditors wait? The company was in violation of its loan covenants, and its suppliers were hesitant to ship it more products. Bankruptcy was a real possibility. If the stock had a voice, at that point it would have sounded like Yoko Ono doing scream therapy. From $17 to $0.68 a share in three short years!

Then in February, the firm's largest vendors agreed to defer millions of dollars of Musicland's debt. Since then, growing signs of a recovery have filled the hills with the sound of music, the sweet music of capital gains. The recent lift has followed reports of growing same-store sales, which rose 1.8% in June, 9.1% in July, and 14% in August.

Musicland's important mall outlets have seen the strongest same-store growth, with increases of 3.8%, 11.3%, and 17.3% over the past three months. The mall division has now turned in two straight months of higher total sales relative to last year, despite 7% fewer outlets. Same-store sales were still down for the superstore division in June, but rose 5.1% in July and 7.7% in August. Overall superstore sales still trail 1996 results due to 22% fewer Media Play locations. Still, the company's total sales are improving, rising 5.5% in August versus the same period last year despite all the store closings.

The company reported a sizable loss of $18.3 million, or $0.55 a share, for the second quarter. Yet that was a considerable improvement over 1996. So despite negative cash flow, negative shareholder equity, and hefty interest payments that account for most of the loss, investors see operations improving enough to dance to the music.

BUSINESS DESCRIPTION

Based in Minneapolis, Musicland is the leading U.S. retailer of prerecorded home-entertainment products, operating 1,380 stores in 49 states. Its mall division includes 726 Sam Goody/Musicland stores and 411 Suncoast Motion Picture stores. Its superstore division has 68 Media Play and 156 On Cue stores. Half of sales come from CDs and audiocassettes while videos make up another 29%. Books and computer software generate most of the other 20% of sales.

Musicland's helter skelter expansion left it in dire straits -- like most other firms in the music and video retail business. Its mall stores couldn't compete on price against new discounters located in less-expensive strip malls, so it entered the superstore market by launching its Media Play stores, many of which failed to meet sales expectations.

To dig itself out of trouble, Musicland took a $138 million write-off in October 1995 and another $97 million write-off in 1996 to close 115 stores. Last year, it also wrote down $95.3 million in goodwill.

FINANCIAL FACTS

Income Statement
12-month sales: $1784 million
12-month income: ($156.3 million)*
12-month EPS: ($4.67)*
Profit margin: N/A
Market Cap: $219.8 million
(*Includes one-time charges for store closings)

Balance Sheet
Cash: $13.2 million
Current Assets: $486.4 million
Current Liabilities: $604.2 million
Long-term Debt: $142.3 million

Ratios
Price-to-earnings: N/A
Price-to-sales: 0.12

HOW COULD YOU HAVE FOUND THIS DOUBLE?

Musicland's sheer size made it a possible turnaround candidate since suppliers no doubt wanted it to survive if it could. While the store closings and write-offs began earlier at competitor TRANS WORLD ENTERTAINMENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TWMC)") else Response.Write("(Nasdaq: TWMC)") end if %>, that stock's recovery might have suggested that the overall market was stabilizing and that the beaten down Musicland shares might be ready to rock 'n' roll if the company could buy a little more time.

With support from its bankers and strong growth in same-store sales, Musicland's July 22 announcement of reduced losses might have made it an interesting speculation. The shares then traded around $3.

WHERE TO FROM HERE?

On September 15, Musicland said it now has access to another $50 million, giving it $100 million of unused capacity under a $325 million credit facility. It has also reached an agreement with its 10 largest vendors to return to normal credit terms.

The one stale analyst estimate calls for a loss of $0.30 this year. With the fourth quarter accounting for 40% of sales and all of Musicland's profits, the holiday season will determine the company's fate.

Musicland's precarious finances make the stock quite risky. Although the price-to-sales ratio remains low, the company's best net margins in the last five years were just 2.7%. On the other hand, Trans World's take-off suggests that an investor looking for a turnaround situation might want to take a closer look at Musicland and the recent consolidation in its industry. For now, though, Elvis will have to wait.

- Louis Corrigan, [email protected]

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