hhgregg: Back in Value Territory

Shares of hhgregg (HGG) fell off a cliff last week after the company reported preliminary numbers from its all-important holiday quarter that were below expectations. But is the company really only worth two thirds of what it was worth last month? It appears likely that hhgregg's price fluctuates to a far greater extent than its actual value, which could provide an opportunity for value investors.

This is actually not the first time hhgregg has been discussed on this site. hhgregg traded in this price range about 6 months ago, and was thus highlighted here. The stock then saw huge gains as positive sentiment returned, as discussed here. It now trades at a P/E of less than 10 despite strong returns on capital and significant revenue growth.

The biggest risk to this industry is of course competition from online retailers. Bricks and mortar retailers like Best Buy and hhgregg are having to compete with web retailers like Amazon who appear to care a whole lot about market share, and not a whole lot about margins. This dynamic has hurt the profits of everyone this year, as the battle for market share is on. But there are a few reasons to believe the threat is a little bit overblown in the long term.

First, there is a large customer segment that prefers to shop in stores. This is seen by the strong returns on capital companies like Best Buy and hhgregg still generate, even though web retailing is not new. Even with hhgregg's recently reduced earnings guidance, the company will earn an ROE of about 14% this year.

Even when customers shop online, however, the retail presence still plays an important role. Best Buy reports that 40% of those who order online choose to pick up the item in store rather than wait for delivery.

This highlights an important aspect of the competitive relationship between Amazon and bricks and mortar retailers. When Amazon innovates, the bricks and mortar retailers can choose to copy. But Amazon cannot copy the innovations of the bricks and mortar companies that involve physical stores. As such, with competent management, bricks and mortar retailers should not only be able to survive, but also thrive.

On that subject, hhgregg has a proven management team that has successfully guided the company while it has gone up against some tough competition for the last several years. The directors and executive officers of hhgregg own more than $200 million of the company as well, which serves to align their interests with those of shareholders.

Finally, hhgregg has grown and generated its strong returns despite sales tax advantages web retailers have enjoyed in most US jurisdictions. This advantage has finally caught the eye of lawmakers, who are now starting to clamp down on Amazon. This will serve to level the playing field between the bricks and mortars and the web retailers.

Just because a stock is cheap doesn't mean it won't go down more. But for long-term shareholders who don't mind the sometimes violent price swings in this stock, hhgregg could turn out to be a rewarding investment...again.