Joann Inc. (JOAN, Financial) operates as a specialty retailer of sewing and arts and crafts category products in the United States under the names Jo-Ann, Jo-Ann Fabrics and Jo-Ann Fabrics and Crafts.
The company has been in operation for more than 75 years and has about 850 stores across the U.S. It was taken private in 2011 by private equity firm Leonard Green L.P. and returned to the public market in March 2021. Leonard Green currently holds 66% of the shares and is the controlling shareholder.
Joann also operates an e-commerce site to distribute products domestically and internationally. The company provides fabrics, sewing supplies, yarn and needle arts, paper crafting, jewelry making, fabric crafting, craft lights, wedding decorations and home décor products. It generates maximum revenue from arts and crafts as well as home décor products.
The company has been a beneficiary of the Covid-19 pandemic and stay-at-home phenomena, where many people took up hobbies like sewing and knitting and engaged in enhancing and decorating their homes. However, with the economy reopening and people going back to work, sales (and profits) are normalizing. The company, however, said the pandemic may have bought in many new customers, some of which will continue to further develop their new hobbies.
Joann has developed a strong digital marketing expertise using social media and has a deep database of customers that it can reach online. Mangement argues that physical stores provide an advantage over e-commerce and mass merchandisers like Amazon (AMZN, Financial) or Walmart (WMT, Financial) as its core customers often want to see and touch the fabrics and merchandise and talk to the salespeople. The physical stores staffed by knowledgeable personnel also provide a venue for its core customers to increase their engagement and provides educational opportunities such as sewing and arts and crafts classes.
The company has only two similar competitors, Hobby Lobby and Michaels, which are both private. Michaels was taken private in March 2021 by Apollo Global Management (APO, Financial). Hobby Lobby and Michaels are more focused on arts, crafts and home decor, while Joann is a clear leader in sewing with about half the U.S. market. Given private equity interest in this niche industry, it is profitable hunting ground for value.
While publicly available sales data is sparse, an earnings power value analysis, shown below using conservative numbers, indicates a large margin of safety. By my estimates, the stock should be trading in the mid-$20s and not languishing in low $10s.
The earnings power value is a calculation based on Bruce Greenwald's method. The basic concept is that one should value a stock based on the current free cash flow of a company and not on future projections, which may or may not come true. It is arguably a better way to analyze stocks than discounted cash flow analysis that relies on highly speculative growth assumptions many years into the future. As for Joan, the assumption is current profitability is sustainable.
| Item | Value | Comment |
| Operating margin | 5.00% | Actual trailing 12-mongth operating margin is 5.88%. |
| Revenue | $2.2 Billion | Actual revenue is $2.6 billion. Lower figure used for post-pandemic normalized revenue. |
| Selling, general & admininstrative expenes (SG&A) | $1.1 Billion | Actual trailing 12-month SG&A might be overstated. |
| Tax rate | 24% | |
| Capital expenditure | $40.25 million | Capex (for reference; not used in calculation) |
| Maintenace capex | $50 million | Maintenance capex is for maintaining existing business. |
| Capex for EPV calculation | $50 million | Use lower of Maint. Capex or Capex |
| Amortization, depreciation & depletion | $80.50 million | For reference; not used in calculation. |
| WACC | 10.00% | Line used in EPV calculation (Greater of WACC 3 or Dividend Yield *1.5) |
| Normalized Ebit | $278 million | R*OM+Maintenace SG&A (10 -25% SG&A is assumed to be grow future sales) |
| Normalized net operating earnings after tax | $211 million | Normalized NOPAT or after-tax EBIT |
| Excess DDA (depletion, depreciation & amortization) | $31 million | Half of after Tax DDA is considered excess. |
| Normalized earnings= N*NOPAT+Excess DDA | $242 million | NE - Add back excess DDA to N*NOPAT |
| Interest-bearing debt (TTM) | $771 million | Long-term debt |
| Cash, cash equivalents, marketable securities (TTM) | $22 million | |
| Shares outstanding (diluted) | 44 million shares | |
| Earning Power Value per Share | $27 | ((NE-Capex / WACC) + Cash -LTD) / SO |
| Stock Price | $10.74 | |
| Margin of safety | 60% |
Balance sheet
The company is highly leveraged given its decade-long stint under private equity. Thus, the company is akin to a leveraged buyout but with publicly available shares. There is only a small sliver of equity on the balance sheet.
| Long-term debt consisted of the following as of July 31: | |
| Revolving credit facility | $112.5 million |
| Term loan due 2028 | $675 million |
| Total debt | $787.5 million |
| Less unamortized discount and debt costs | $(9.5) million |
| Total debt, net | $778 million |
| Less current portion of debt | $(6.8) million |
| Long-term debt, net | $771.2 million |
Debt does not appear to be too frightening, however, because the term loan does not mature until 2028 and the company has robust cash flows. Note the orange line below - which is free cash flow without changes in working capital. The company's working capital (inventory, cash, accounts payable and receivables) is highly variable and needs to be removed to get a realistic picture of cash flow. I think the company can generate about $150 million of free cash flow a year on a normalized going basis.
Recent insider activity has been positive, with several officers acquiring shares as the price dipped.
Conclusion
I think buying Joann is a wonderful opportunity to benefit from a niche and attractive retailer. Like many things in society, people are gravitating toward narrowly focused hobbies and crafts, which provide them with engagement and pleasure. For niche retailers like Joann, the 80/20 rule applies - i.e., 20% of the customers provide 80% of the profits.
Joann has a lock on the customers serious about sewing. Both of its major competitors are private and focused more on other crafts and decor. I would not be surprised if private equity further consolidates this niche and Joann is combined with one of the other two players. The following chart shows how Michaels (MIK), the arts and crafts retailer, fared when it was snapped up by Apollo Global earlier this year. The shareholders who held on did quite well. I have a feeling a similar pleasant fate will befall Joann when the current overlord, Leonard Green, decides to exit.
