Martha's Newly Fashionable Stock


By Eric Wahlgren It was time to break out the buttermilk peppercorn dip at Martha Stewart's New York headquarters on Mar. 20. Martha Stewart Living Omnimedia (MSO) had just gotten the word: A bankruptcy judge would allow struggling Kmart to continue its merchandizing relationship with Stewart's media and homeware products juggernaut.

The judge's blessing clears the way for Martha Stewart Living to receive the $12.3 million it's owed for the Martha Stewart Everyday linens and housewares Kmart peddles. More important, it preserves Martha Stewart Living's sweet deal with the struggling discount retailer, which includes contractual guarantees of double-digit increases in annual revenues for each year of the pact, which runs until Jan. 31, 2008.

For fiscal year 2001 ended Dec. 31, merchandising (of which sales to Kmart represent some 80%) accounted for about 12% of Martha Stewart Living's total revenues of $295.6 million. But the Kmart business was very important to the company's books: It generated about 20% to 25% of Martha Stewart Living's total cash flow, according to Kathleen Heaney, an analyst at Brean Murray Research in New York.

GURU OF GOOD TASTE. With the Kmart situation resolved -- at least in the short-term -- investor interest in the company founded by Chairman and Chief Executive Martha Stewart is bound to pick up. Since her top-selling Entertaining hit the bookshelves in 1982, the New Jersey-bred former stockbroker and model has parlayed her talents into a fast-growing merchandising empire and positioned herself as America's premier guru of good taste and domestic style (see BW, 3/25/02, "Q&A: Martha Stewart Thriving" and Video Views for an extended version).

The stock, which closed at $18.94 on Mar. 22, has come back strong, jumping 50% since its 52-week closing low of $12.61 on Sept. 26. That's still way off the $40 level the shares hit shortly after the company went public at $18 in October, 1999. Many analysts believe it has more room for growth in 2002. Kevin Gruneich, publishing/information analyst for Bear Stearns, thinks shares could rise 15% to 20% in the next 12 months. He rates the stock a buy.

Why? Martha Stewart Living's diversification across four business segments helped it post increases in both revenues and profits in 2001 even as many other companies, particularly pure media players, saw declines. Revenues rose 3.5%, and net income grew 3%, to $21.9 million from $21.3 million. That's partly because a 46.1% boost in merchandising revenues and a tiny uptick in revenues from publishing -- including the flagship Martha Stewart Living magazine -- offset decreases in the television and Internet/direct commerce units. The latter includes the high-end Martha By Mail catalog and marthastewart.com.

"YOUNG COMPANY." "I think this is a company that is much more diversified than people would think," says Gruneich. "They have been able to take ideas and merge them across different media and into merchandising. It is still a relatively young company that is low in its maturation phase."

Laura Richardson, better living analyst at Adams, Harkness & Hill in Boston, says she believes Martha Stewart Living could sustain 25% annual earnings growth once the economy improves. "If I were looking out five years, I would recommend the stock," Richardson says. "I think in five years there will be more Martha Stewart products in more places driving earnings growth." A magazine entitled Martha Stewart Martha, for instance, will be published six times this year in trend-crazed Japan.

One concern is the company's dependence on advertising, which accounts for 61.5% of revenues. When it posted a 3.3% drop in fourth-quarter profits on Feb. 20, Martha Stewart Living warned that its earnings for the full year would range between 50 cents and 55 cents a share, which was at the low end of analysts' estimates.

WEB WOES. Gruneich's bullishness comes with one caveat: It presumes the domestic advertising climate will improve and boost the publishing unit, which accounts for nearly two-thirds of the company's annual revenues. While ad pages were down 21% at Martha Stewart Living in the fourth quarter, they were flat for the February, March, and April, 2002, issues. James Follo, Martha Stewart Living's chief financial officer, points out the magazine is outperforming the overall industry. "We expect this trend to continue," he says.

Changes at Martha Stewart Living's money-losing Internet and direct-mail operation could help reduce the unit's drag on performance in 2002, analysts say. Last year, its $48.8 million in revenues represented about 16.5% of the total business. On Mar. 15, the company said it would cut 40 jobs at the unit, or about 6% of Martha Stewart Living's total workforce.

Also, the company in January recruited Shelley Nandkeolyar, a top executive from the e-commerce division of tony home-products retailer Williams-Sonoma, to be president of the online/direct-mail operation. Heaney thinks redesigns of the catalog and Web site could also boost sales.

LIFE WITHOUT KMART? She still expects the Net unit to lose $16 million to $18 million before interest, tax, depreciation, and amortization (or EBITDA, which is a common measure of cash flow for media companies) this year. But that's better than the $24.8 million it bled in 2001. Says Heaney: "They are committed to having the business break even by 2004."

Martha Stewart Living faces some other challenges. Richardson says any more trouble at Kmart, which plans to close 284 stores and cut 22,000 jobs in an effort to climb out of bankruptcy, could hurt Martha Stewart Living in the short run.

"I am not sure the terms would be the same" if the company had to find another outlet for its wares, Heaney says. But she also says Kmart needs Martha Stewart more than Martha Stewart needs Kmart. "I am fairly confident that there is someone out there who would want to pick up the business," she says. With the Kmart relationship maintained for now, Martha Stewart Living is expanding into furniture and floor coverings, which it plans to sell through specialty retailers.

AFTER THE ICON. Of course, it's always possible that Martha Stewart could stop being one of America's favorite go-to people for tips on how to cook, garden, decorate, clean, and make things like yarn flowers and bunny ears. But most analysts think her reign as the queen of doing-things-just-so is assured for some time, thanks to her top-notch design team and her increasingly global reach.

More of a concern is how well the company would fare without Stewart as its icon (see BW Cover Story, 1/17/00, "Martha Inc."). "That is the No. 1 concern on the list," Gruneich says. He points out that the company is already working to build a brand not solely identified with Martha Stewart, who has long been a very hands-on executive. Nowadays, she's rarely featured on the cover of her eponymous magazine and the television unit is working on new programs that won't feature Stewart, he says.

"[Coco] Chanel and Estee Lauder were people who lived on as strong brand names," says Richardson. "And I think the same will happen with Martha Stewart." Who knows if Martha will attain the immortality of Chanel or Estee Lauder. But if you're looking for something extra to dress up that plain wicker Easter basket, some shares of Martha Stewart Living might do the trick better than gingham and pom-pom chicks. Wahlgren covers the markets for BusinessWeek Online


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