Long Shot: Big-Time Value From Small-Town Retailer

 | Oct 12, 2012 | 12:30 PM EDT
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Real Money's Long Shot column is dedicated to trading ideas that are highly risky, but which present an opportunity for significant payoff if they work. Such ideas are sometimes characterized as "lottery tickets" and are for only the most risk-tolerant investors, as the potential for 100% loss is high.

With the exception of a few Real Money readers, I'd bet most of us have never heard of, much less set foot in, ALCO Stores (ALCS). And except for a few shrewd investors, ALCO is even less known to the investment community. Market participants may want to consider getting to know this micro-cap retailer, however, as it appears to offer a compelling upside for patient investors.

ALCO (formerly Duckwall-ALCO) is a general retailer that offers consumers a wide variety of products at low prices. The company started off as a single variety store in Kansas in 190; today it is a chain of over 200 locations that provides customers with a one-stop-shopping experience. Typical stores average around 21,000 square feet of selling space.

What differentiates ALCO from other variety retailers is that its stores are located in smaller American towns where access to full-line department stores such as Wal-Mart (WMT) is non-existent. Take Georgia, my home state: ALCO has three stores in three towns, two of which I've never heard and the other I may have heard mentioned a couple of times. These locations are not big enough to support a Wal-Mart or Target (TGT) but still demand a retailer that offers electronics, sporting goods, apparel, health and beauty, and other general retail products.

In fact, when you look at ALCO's footprint, its stores are concentrated in the central part of the U.S. in cities such as Lead, S.D.; Anthony, Kan.; and Pinedale, Wyo. By focusing its store development in locations where there is little chance of a national or regional retailer coming (i.e., where the population is often less than 20,000), ALCO circumvents the highly competitive caliber that is indigenous within the retail space.

Shares in ALCO are changing hands for $7 on a market cap of $26 million. Net debt sits at just under $60 million for an enterprise value of $80 million. A little over a year ago, shares were trading for nearly $17.

In 2011, overall sales grew by 4%, to $482 million, while same-store sales grew by a solid 3%. At the current market cap, the price-to-sales ratio is less than 6%, and the enterprise-value-to-sales ratio is around 15%. Even by retail standards, this is an incredibly low sales multiple. Price-to-sales ratios for Dollar General (DG) and Family Dollar (FDO) are close to 105% and 85%, respectively. (I realize that Dollar General and Family Dollar are very poor comparisons but they are instructive, nonetheless.) It's not difficult to pinpoint why ALCO trades at such a low multiple to sales; at the moment, profit margins are razor thin. The market is not going to place a value on sales if they aren't profitable sales.

In 2011, ALCO's net margin was 0.4%, low even in the retail world, which was a vast improvement from the negative-1% net margin in 2010. The key for ALCO is not merely continued sales growth but it has to be profitable sales growth, and the company seems to be heading in the right direction. For second quarter 2012, the company reported net profit of $2 million on $120 million in sales. Indeed, this is one quarter, but the point is that with nearly $500 million in sales, a net margin of 2% translates into $10 million in profits, a multiple of less than 3x today's current market cap.

To be sure, the small-town focus also has its disadvantages in that small towns offer little population growth. ALCO is currently in the midst of opening three locations in more populous Texas cities. If executed successfully, these locations could lead to an immediate improvement in margins.

Despite its small size, ALCO has some notably large shareholders, one being Michael Price of MFP Investments. Price is a highly respected investor, and he owns just under 10% of the company. Another point of interest is that earlier this week, ALCO announced that it had bought back 12% of shares in one transaction from a large shareholder. I reviewed the most recent proxy statement and the amount of shares the company bought mimics the share count held by a European investment group. I can only guess that this shareholder needed to raise cash and wasn't interested in owning shares in a tiny retailer because in addition to offering such upside sales leverage, ALCO shares also trade for 25% of tangible book value.

In any regard, at $7 a share, an investor is getting nearly $28 a share in book value and nearly $140 in sales per share. You don't need much to happen to create enormous value from the current valuation.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider ­­­­ALCS to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

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