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Tuesday, October 19, 2010

Why Buy More 1-800-Flowers.com (FLWS)? Consider an Owners' Perspective

In our Who's Driving the Bus? post back in September, we mentioned we'd come back to Weight Watchers (WTW) and 1-800-Flowers.com (FLWS). We touched on Weight Watchers the other week and, actually, have had most of the below in our back pocket for awhile. Now, with a few edits, we come back to "Flowers."

This Thursday, 1-800-Flowers.com (FLWS) reports Fiscal 1Q 2011 results before market open. Admittedly, we're not really sure what to expect given the ongoing weak consumer environment and cautious management commentary back in August (no guidance). We hope to see margin improvement -- even if the top-line remains challenged -- particularly in the Consumer Floral segment. That said, we think the company's current market valuation already reflects the difficult operating environment and significantly undervalues the company's cash generating assets.

In our Saturday 8/21 post, Double Dip? Check "Selfish" Discretionary Spending versus "Gifting" Discretionary Activity, we shared some surprisingly strong retail figures from a variety of discretionary retailers. Following lackluster results from 1-800-Flowers.com two days prior, we reached the following conclusion: what we'll call "selfish" discretionary retail segments are clearly outperforming "gifting" discretionary segments. We added that this current trend is negative for our 1-800-Flowers.com and makes life more difficult for a company with low historic margins and seasonality.

Well, that Monday a large institutional investor seemingly threw in the towel and shares plunged 11% on 17 times average trading volume (versus an approximately flat day for the S&P 500 index):

Of course, someone is always on the other side of any trade and, thus, someone accumulated a large number of 1-800-Flowers.com shares that day. Why would a buyer step in following disappointing results and a still weak, hyper-competitive consumer environment?

We think the answer is fairly simple: the company isn't going anywhere and generates plenty of excess cash flow (which underpins our core 1-800-Flowers.com long thesis). To illustrate the cash generation as well as capital allocation, let's revisit management commentary from the Q&A portion of the 8/19 conference call - thanks to SeekingAlpha.com:
  • Anthony Lebiedzinski – Sidoti and Company: During the year, you guys did a good job of generating free cash flow. I realized that you haven't given guidance for free cash flow. But what would your objective be for free cash flow usage during fiscal '11?
  • Jim McCann - Chairman & CEO: Well, I think you have to look historically first to get the best indication. And what we've seen here is, over the last two years – and I'll answer this because Bill is suffering terribly here from a cold.... What we've done with free cash flow is, we've said – we used to say we have three usages for our free cash flow, return it to our shareholders, make strategic investments, or improve our balance sheet and pay down debt.
  • Well frankly, in this environment, we're not looking to return it to shareholders. We're looking to maintaining our flexibility, increase our flexibility. So this year, we paid down $32 million in term debt. And over the last two years, it's over $60 million that we paid down our debt. So the evidence, historically, is as we're fortunate enough to generate excess free cash flow, we're using that to strengthen our balance sheet.
  • Going forward, we'll continue to strengthen our balance sheet. We'll continue to be prudent in the use of that cash. And generally, we hope to increase our cash generation over time from our operating side of the business and use that to [grow the] business either by improving the flexibility in our balance sheet or perhaps there's something we find that would be a perfect fit with one of our platforms that we already have in place that offers a broader package and leverage in revenue activities we get into.
HENCE, Mr. McCann correctly identifies the uses of excess cash we seek in our companies: return it to our shareholders (dividends or share repurchase), make strategic investments (reinvest in business or make acquisitions), or improve our balance sheet by paying down debt. YET, for the time being, he makes clear that the company will continue to use excess cash to de-lever the balance sheet, which is perfectly fine by us. He also makes clear that the company's operating businesses generated significant excess cash over the past two years, enough to repay $60 million of debt.

Here's a look at the top portion of the annual cash flow statement from Yahoo Finance (YHOO) over the past three years (click to enlarge):

SO, while 1-800-Flowers.com has encountered tough fundamentals over the past several years given (1) the weak consumer economy (widely recognized) and (2) aggressive competition from Liberty Media Interactive's (LINTA) ProFlowers.com, cash generation has NOT been a problem. Importantly, capital expenditures remain nominal for the "asset light" business with favorable working capital dynamics. Also, we still believe 1-800-Flowers.com has competitive advantages that should mitigate competitive pressures and support margins over time.

NOW, let's frame the long thesis another way: if someone presented you with the opportunity to purchase a diversified, established business that would give you and your family a 15-20% annual yield (normalized) in perpetuity (assume all FCF is paid to you and your family = the owners), would you take it?

Simple, readily apparent answer: Yes, indeed.... Ah, but wait: what's the catch? No catch - just like the Yahoo opportunity we've detailed, there's absolutely no catch. Only a bumpy economy that requires patience.

Finally, while some of you may like See's Candies, we continue to recommend Fannie May Fine Chocolates, especially Pixies:
Milk Chocolate Fall Leaves and Fall Balls
Milk Chocolate Fall Leaves and Fall Balls
Dark Pixies®
Dark Pixies®
Give them a try and, as you enjoy the chocolates, consider that the standalone value of only 1-800-Flowers.com's chocolate businesses to an informed private market buyer might be equal to the entire company's current enterprise value, which means you get everything else for free! We don't think this situation will or should last, even in a tough gifting environment. But, it gives us great comfort in owning and even buying more shares of the company.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long WTW, FLWS, YHOO.
© 2010 Jeffrey Walkenhorst
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