Is the retail sector ripe for private equity investors?
Wall Street Securities retail analyst Brian Sozzi thinks so. Three names to watch are: American Eagle Outfitters, BJ's Wholesale and La-Z-Boy, he says.
"They have been beaten down a fair amount," Sozzi says, in an interview on CNBC. "These companies generate a significant amount of cash so it makes sense for private equity to at least take a look at this point in time."
Quick cash generation is one factor that makes the sector appealing to private equity, Sozzi says. That cash can be quickly redeployed to other activities.
In fact, earlier this week there was some market chatter regarding private-equity interest in American Eagle.
It could prove to be just that: chatter, Sozzi says. An acquisition of American Eagle might be a risky bet.
"The stock has been a beaten down dog for much of 2010, and it has all been deserved," he writes in a research note.
Not only does American Eagle operate in the struggling teen apparel sector, but it has made a number of missteps this year ranging from a disappointing product selection in the spring to too much exuberance for back-to-school, which made it stock too much inventory.
At the moment, American Eagle shares are trading at about 11.2-times 2011 earnings forecasts, which is roughly a 26 percent discount to other specialty apparel retailers, says Sozzi.
BJ's Wholesale may prove to be a better bet.
"It would be very opportunistic," Sozzi says. BJ's latest earnings fell short of analysts' estimates and the company lowered its forecast for the rest of year.
Already, the retailer is on the radar screen of private-equity firm Leonard Green & Partners, which reported a 9.5 percent stake in the warehouse clubstore earlier this summer.
The company finances most of its inventory using vendor financing, and it turns the inventory very quickly, meaning BJ's doesn't have to pay its suppliers quickly, Sozzi says. That would give a private-equity investor cash to make other investments that earn a return.
As for La-Z-Boy , the stock is down more than 55 percentsince it hit a 52-week high in March.
"Trading a stone's throw from book value, I believe the risk-reward is very favorable for a long-term investor [in La-Z-Boy]," Sozzi says.
Like many retailers, La-Z-Boy has been working hard to squeeze costs out of its business, and paying down debt in order to cope with the challenging retail climate.
But that tough environment also makes it difficult to price these companies as it is unclear when the economy will pick up and consumers will start spending robustly again.
That said, Sozzi is making a good case for private-equity investment.
This wouldn't be the first time. There were 91 leveraged buyouts totaling $48 billion in the retail sector between 2006 and 2007, Sozzi says.
Some of these deals flopped. Think Linens 'N Things, which went bankrupt in 2008.
But others have been more successful. Think Toys R Us, the retail deal that started it all in 2005. In May, the toy retailer filed for an initial public offering that could potentially raise $800 million.
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