Investment Lessons From Stein Mart, Inc.’s Fall

When I reviewed Stein Mart’s business model in recent years, I was unimpressed on both quantitative and qualitative grounds. Quantitatively, I thought it was embarrassingly poor that Stein Mart only managed to earn $27 million in net profits at its cyclical high over the past five years. For a company with 300 stores that consume gobs of square feet, a net profit figure of only $80,000-$85,000 was terribly insufficient.

And the above-referenced numbers refer to Stein Mart’s 2016 highs. When Stein Mart’s profits evaporated and turned to an $11 million loss this year, it was clear that the business model was seriously defunct.

That is where the qualitative aspect comes in—the retailer sells a mish-mash of overpriced consumer clothing to an undefined market segment. The website is just bizarre. There are $24 Stein Mart dresses next to much more expensive options. This type of pricing completely ignores the psychology that drives fashion purchases—women who want to spend hundreds of dollars on dresses are not going to be incentivized to make that purchase when a nearby rack has a $49 option. It completely destroys the allure of exclusivity and scarcity that induces glamorous purchases. And the $24 dresses have to compete with the brutal Amazon, online, and chain retailers at the lowest price point—which is hard to sustain.

Financially, Stein Mart, like many of its big box brethren, carries an extremely high debt burden of $170 million. That’s why the price of the stock has fallen from $28 in recent years to $1 currently. That is an insanely high debt burden of 6-7x Stein Mart’s highest ever profits, and looms large when you consider that Stein Mart (SMRT) is now unprofitable during a period of generally favorable economic conditions.

The intelligent aspect of Stein Mart’s planning is that none of the $170+ million is due and payable until 2023 or later. The reason why the stock price has fallen to $1 in spite of that is because Stein Mart may lose $10+ million during the first third of 2018, and it is unclear how and if that will be financed—share dilution at this inopportune time? Terrible interest rates?

The most compelling aspect of Stein Mart’s business is that it has developed a private label credit card program in connection with Synchrony Financial (formerly of GE Capital) that has added anywhere between $3 million and $5 million to Stein Mart’s annual net income results (meaning that, yes, when you see those $11 million losses get reported at the stores, it is even worse than that because the store losses are really in the $15 million range and are propped out by gains at Stein Mart’s private label credit division).

I have no view of Stein Mart as a long-term investment. There are too many speculative elements revolving around near-term financing for me to make a prediction. Stein Mart could be bankrupt or increasing ten-fold within a year. I really don’t know.

But I do think Stein Mart provides an instructive lesson on corporate debt. For most of the past decade, we have grown numb to the notion that debt matters. When corporate borrowing is at 2%, 3%, or even 4%, it has a minimal impact on net profits and have been generally disregarded. In fact, the impact has been so minimal that many management teams have taken out substantial debt burdens to repurchase their own stock.

But Stein Mart is a reminder that balance sheets do manner, particularly when earnings unexpectedly disappoint. Picture a world in which Stein Mart was sitting on $30 million in cash and no debt, all else equal. The management could be talking about building up the credit card label, enhancing online product offerings (quick delivery of online ordered dresses that are easy to return if they don’t fit or look right?), or just generally riding out this first year of losses post-financial crisis.

Or, heck, if the private label credit card wasn’t already pledged as collateral for the $170 million in existing debt, the management team could spin it off or sell it to Synchrony and give a one-time cash distribution to shareholders to ensure that there was some type of payoff even as the business squandered.

It should grab your attention, and persuade how you manage your own household affairs, when you see the same fundamentals of finance reassert themselves time and again. People pretend that apps, social media, and the internet in general permit us to ignore historical truths.

But, of course, that isn’t so. Cash flows matter. The relationship between cash flows and debt obligations is the distinction between dynastic wealth and bankruptcy. Stein Mart may be a jenk business, but it’s generally profitable and has a lucrative credit card subsidiary. That would be enough to permit the retailer to crawl out of the swamp, but the debt is an anvil attached to its leg. We’ll see whether or not a lender comes bearing a bolt cutter.