Hard Lines

Retail & Consumer Products
Contact
Laura Champine, CFA
212-389-8056
lchampine@collinsstewartllc.com
Jason Smith
212-389-8059
jsmith@collinsstewartllc.com
New York
Collins Stewart LLC
350 Madison Avenue
New York
NY 10017
(212) 389 8000
San Francisco
Collins Stewart LLC
11th Floor
505 Montgomery Street
San Francisco, CA 94111
415 659 2222
London
Collins Stewart Europe Limited
9th Floor
88 Wood Street
London EC2V 7QR
+44 (0)20 7523 8000
Dublin
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Hanover Quay, Dublin 2
+353 1 635 0210
December 19, 2011
Retail Hardlines: Home-Furnishings
And RTO Offer Consistent Returns
Initiating coverage on 10 U.S. hardline retailers.
Our group consists of home-furnishings retailers, home-improvement
stores, discount retailers, and rent-to-own stores. We are launching
coverage with Buy ratings on six of the stocks, including Aarons, Bed
Bath & Beyond, Big Lots, Lumber Liquidators, Rent-A-Center, and
Williams-Sonoma. We rate Dollar Tree, Family Dollar, Home Depot, and
Lowes Neutral.
Home-furnishing retailers supported by healthy customer base.
Current valuations for BBBY and WSM do not fully reflect potential
long-term growth drivers, in our view, including significant E-commerce
opportunities and expansion of ancillary concepts. WSM is our favorite
stock in the group, trading at 14.5x our $2.60 2012E EPS estimate. Our
DCF-driven price target is $55/share. Excluding its $7-plus/share cash
balance, BBBY trades at 12x our 2012E EPS of $4.38. Our PT is
$69/share. With BIG's sales trends improving, we feel its stock is also
undervalued at 10x our 2012E EPS estimate of $3.51. Our
DCF-generated PT for BIG is $58/share, though we acknowledge that the
company will have to sustain SSS growth to achieve this price in the next
12 months.
A restrictive credit climate benefits rent-to-own operators.
The segments low-income customer base has limited access to
financing, making RTO the best available option. The RTO space, which
AAN and RCII dominate, has historically generated consistent returns
through most economic cycles. Expansion into retail locations and entry
into foreign markets is providing renewed growth at RCII, while AAN's
dabbling in the weekly-rental space holds some promise.
Housing weakness clouds visibility for home-related names.
A slow economic recovery and a stagnant housing market have
heightened consumer caution when making big-ticket discretionary
purchases. Retailers HD and LOW have seen a turnaround in some core
categories, but recent sales trends clearly indicate homeowners continue
to put off costlier home-improvement projects. We think valuations of HD
and LOW fairly reflect their risk/reward profiles at this stage of the cycle.
Shares of LL have declined sharply YTD, and we believe the pullback
presents a buying opportunity. Despite the current state of home-related
spending, we believe LL has specific growth catalysts that are not priced
into shares at 12x our 2012E EPS estimate of $1.33.
Dollar stores appear fully valued.
The dollar stores have benefited from the growing trend of value-driven
shoppers trading down, and have capitalized on this by expanding their
consumables assortments. We believe their success is already priced into
current valuations.
See each company's section for a discussion of valutation and risks.
Company Ticker Price Rec.
Aaron's AAN $26.20 BUY
Bed, Bath & Beyond BBBY $61.22 BUY
Big Lots BIG $36.62 BUY
Dollar Tree DLTR $82.82 NEUTRAL
Family Dollar Stores FDO $57.92 NEUTRAL
Home Depot HD $40.42 NEUTRAL
Lowe's Companies LOW $25.02 NEUTRAL
Lumber Liquidators LL $15.68 BUY
Rent A Center RCII $34.98 BUY
Williams-Sonoma WSM $37.72 BUY
Disclaimers regarding the content of this report as well as full disclosure of
Collins Stewart LLC's ratings and information on the firm's position(s) in
securities mentioned herein appear on pages 44 - 47 of this report.
We expect the home-furnishings group to continue to
generate consistent returns.
Demand for home furnishings has held up relatively well
throughout 2011, as spending within the group's largely
middle-income core demographic remains healthy. We are
launching coverage on Bed Bath & Beyond, Big Lots, and
Williams-Sonoma with Buy ratings, given our expectations
for consistent sales performances, numerous potential
growth drivers, and appealing valuations. BBBY owns the
dominant brick-and-mortar position within the home
furnishings space, and BG is the nation's largest broadline
closeout retailer. WSM operates a multi-channel, multi-brand
home-furnishings platform. Its $1.4B E-commerce business,
which comprises nearly 40% of total revenues, leads the
category by a country mile.

We expect positive sales trends to continue within the
sector. Our estimates call for BBBY to generate SSS growth
of 5% in FY11 ending February on top of +7.8%, followed by
an increase of 4% in FY12. We estimate WSM's
comparable-brand revenues will increase 6.5% in FY11 on
top of +13.9%, followed by an increase of 8.1% in FY12. BIG
regained sales momentum in Q3, reporting SSS growth of
1.7% on top of +0.7%, following a H1:11 decline of 3.4%.
Current valuations underestimate the consistent EPS growth
of BBBY, BIG, and WSM, in our view, as well as potential
growth drivers, which include greater E-commerce
penetration and expanded operations in ancillary concepts
and new geographies. Based on our FY12 EPS estimates
and excluding cash, BBBY shares trade at a 12x multiple,
BIG at 10x, and WSM at 13x.

The rent-to-own space demonstrates resilience through
most economic cycles.
The RTO companies cater to a customer base that is unable
to afford and does not meet the necessary requirements to
obtain credit for purchases of home furnishings, electronics,
and appliances. Through the RTO option customers can
enter into a contract to rent the desired product, making
payments primarily on a weekly or monthly basis. Customers
have the option of taking ownership of the product after
making all the rental payments or returning the item to the
store prior to the contract's expiration. The sector is
dominated by Rent-A-Center and Aaron's, which own a
combined 60% share of the RTO market based on store
count and a larger position on a sales basis. The remaining
RTO market is extremely fragmented, with no one retailer
owning more than a 1% share according to the Association
of Progressive Rental Organizations. The current restrictive
credit environment has heightened the appeal of the RTO
option as consumers seek alternative means to obtain
desired home furnishings. Industry-wide RTO sales
increased steadily from 1999-2009, with the only yr./yr.
decline coming in 2007 at the start of the recent economic
recession.

Page 2 | Retail & Consumer Products | December 19, 2011
Table 1. Rent-to-Own Revenues ($B)

Source: Collins Stewart, APRO

In the current environment, we believe AAN and RCII will
generate consistent SSS growth in FY12 and beyond. Our
projections call for EPS to increase at a double-digit five-
year CAGR for RC and AAN. RC's growth is expected to
largely be driven by the expansion of its RAC Acceptance
kiosks into third-party retailers and an increased presence in
new geographic markets. We expect AAN to generate a
higher rate of unit growth within the core U.S. RTO segment,
and we believe its early entries into the weekly concept and
the U.K. may turn into material growth drivers over the next
few years. Given the consistent returns the RTO space has
historically generated, coupled with the attractive valuations
of AAN, at 13x our FY12 EPS estimate, and RCII at 11x
estimated FY12 EPS, we rate both stocks Buy.

LL's vaIuation and growth prospects stand out from
peers, in our view, as continued weakness in the U.S.
housing market limits visibility for most home-related
names.
Over the last few years, consumers have been extremely
cautious in making home-improvement purchases,
particularly on big-ticket items. Recent housing data has
shown some improvements, but overall data has been
mixed. The Census Bureau reported that new home sales
increased 8.9% yr./yr. in October. According to the National
Association of Realtors, existing home sales increased
13.5% yr./yr. in October, largely driven by declining prices.

$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
$7.0
$8.0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Existing Home Sales Increase Yr./Yr. For Four Consecutive Months

Source: National Association of Realtors

The S&P/Case-Shiller 20-city Home Price Index reported a
3.6% yr./yr. decline in September, with national home prices
currently at Q1:03 levels. Although the increase in existing
home sales does provide some optimism for the home-repair
group, the continued weakness in pricing remains an
obstacle. In our view, current homeowners may be less likely
to invest in home repairs, especially costlier projects, as the
value of their homes remains on the decline. Although
Lumber Liquidators is exposed to these risks, we believe
company-specific catalysts should drive significant growth
over the long term, which does not appear to be fully
reflected in current valuations. We are initiating coverage on
LL with a Buy rating.

We believe LL is at the beginning of a significant earnings
recovery, as it has begun facing easy comps following the
botched SAP implementation in Q3:10. We believe the fully
implemented technology will result in operational
efficiencies. LL should generate significant cost savings as a
result of its multi-phase sourcing initiative, which includes
comprehensive line reviews. The acquisition of its supply
chain partner in China has effectively removed the cost of a
middle man for 90% of its purchases from mills in Asia. LL
expects the bulk of these savings will flow through to the
bottom line, but it intends to utilize some of the funds to
shore up opening price points. In addition, LL has the
highest unit growth potential of all the stocks in our
coverage, and we estimate EPS will grow at a five-year
CAGR of 18%. The stock price has declined approximately
37% YTD, compared with the S&P 500 index's 3% decline.
LL shares are attractively valued at 12x our FY12 EPS
estimate and 6x FY EV/EBITDA.

We are initiating coverage on HD and LOW with Neutral
ratings, given the lack of visibility surrounding housing and
home-related spending. Sales trends within the home-
improvement segment have improved somewhat of late, but
we believe this tepid recovery is already priced into the
stocks. According to the Q3 GDP report from the U.S.
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct.
Bureau of Economic Analysis, residential fixed investments
increased 3% yr./yr., to an annual spend rate of $337.3B.
HD reported SSS growth of 4.2% in Q3 and an increase of
5.6% on a 2-year basis. LOW's SSS increased 0.7% in the
October quarter, and the two-year stacked trend was +0.9%.
Storm repairs boosted sales in the quarter, but some core
categories such as electrical and plumbing improved, as
consumers seem more willing to address smaller home
repairs. Larger discretionary projects continue to decline.
Sales remain weak in categories such as millwork, which
includes doors and windows, lumber, and cabinets.

The dollar stores have performed well and appear fully
valued.
Shoppers looking to save money amid a heightened
inflationary environment continue to trade down to discount
chains. Consumers have responded to the value proposition
at Dollar Tree, with everything in its namesake locations
priced at a $1, and Family Dollar, where most merchandise
is priced under $10. Increased customer traffic and higher
average ticket drove SSS growth in the mid-single-digits for
both discount retailers in their most recent quarters.

We expect expanding consumable assortments to remain a
primary driver of traffic for DLTR and FDO, and we believe
both should benefit from aggressive store expansions. At
current prices, however, these catalysts already appear
baked into valuations. DLTR currently trades at 17.5x our
FY12 EPS estimate, while FDO trades at 15.5x estimated
CY12 EPS. We are Neutral on both stocks.

Williams-Sonoma (WSM): Buy

Investment Summary and Conclusion
We are launching coverage of WSM with a Buy rating and
DCF-generated PT of $55. Williams-Sonoma stands out in
the home-furnishings space on the strength of its multi-
channel, multi-brand platform. The company operates its
Williams-Sonoma, Pottery Barn, Pottery Barn Kids, PBteen,
and West Elm brands through brick-and-mortar locations
and a direct-to-consumer business that marks WSM as the
industry's dominant online retailer, with approximately $1.4B
in 2011E online revenues. We estimate that E-commerce
sales will climb from 38% of total revenues in FY11 to 47%
by FY15. Despite WSM's significant E-commerce
penetration, there is still vast growth potential for the
company online. n our view, WSM's sales growth and
earnings power are increasingly driven by the E-commerce
channel. We expect the shift in mix to this higher-margin
business to continue to drive higher returns and result in
ROIC increasing from 13% to 18% out to FY15. Shares of
WSM are down approximately 17% since reaching a 52-
week high in early May, while the S&P 500 index and the
RLX index are down 9% and 5%, respectively over the same
time frame. At 14.5x our FY12 EPS estimate and 6x
EV/EBITDA, shares appear attractively valued to us based
on our long-term growth projections. Our DCF model
indicates WSM shares hold significant upside potential.
Demand trends appear healthy across most brands. As a
greater number of customers are using multiple channels to
shop WSM's brands, we believe comparable-brand
revenues to be a more-accurate indicator of sales trends.
Comparable-brand revenues increased 7.3% on top of
+12.5% in Q3, 30bps above the high end of management's
earlier guidance. Comparable-brand revenues were up
across all business segments, increasing 27% on top of
23.6% at West Elm and rising in the mid-single-digit range
on top of double-digit increases in the Pottery Barn, Pottery
Barn Kids, and PBteen concepts. The Williams-Sonoma
concept has experienced the slowest rate of growth in recent
quarters, up 0.1% in Q3 on top of +2.3%. We believe WSM's
targeted marketing, largely based on customers' purchase
history, Web browsing, and market data, coupled with
promotional initiatives, should help improve multi-channel
traffic across all concepts.

WSM dominates the E-commerce channel in home
furnishings. According to Internet Retailer magazine, the
$1.2B WSM generated in revenue in 2010 was three times
higher than the next-largest competitor and just about as
much as the top-five competitors combined. WSM's
dominant position should enable it to capture market share
as the consumer shift to online shopping continues.
According to nternet Retailer's research, WSM's nternet
growth rate of 27% in FY10 was greater than the growth
rates of each of its top 10 home furnishings competitors, with
the exception of online-only Wayfair.

FY Ends
Jan. FY10 FY11 FY12
Rev.
($MM)

Q1 718 771 818E
Q2 776 815 880E
Q3 816 867 934E
Q4 1196 1250E 1355E
FY 3504 3703E 3986E

Op. EPS

Q1 $0.23 $0.30 $0.34E
Q2 $0.31 $0.37 $0.45E
Q3 $0.35 $0.41 $0.49E
Q4 $1.08 $1.18E $1.32E
FY $1.95 $2.25E $2.60E

Key Data

Current Price $37.72
52-week High $45.48
52-week Low $27.90
Shares o/s (MM) 105.7
Short Interest 2.6%
Mkt. Cap. (MM) $3,987.8
Net Debt (MM) ($386.8)
Cash/share

$3.73
CY12E P/E

14.5x
CY12E P/FCF 17.0x
CY12E EV/EBITDA 6.2x
Price Target

$55

The E-Commerce opportunity is substantial. WSM's
online sales increased at an annual rate of 25% to $1.2B
and grew from 6% of total revenues to 34% in the decade
ending FY10. According to a report by Forrester Research
that WSM management cited in a June 2010 presentation, e-
commerce penetration in the U.S. home furnishings industry,
which WSM estimates to be a $100B market, is expected to
grow by 500bps to 14% over the next five years. At the same
time, we believe WSM is gaining market share, as its FY10
Internet sales increased 27% versus a 15% increase in total
U.S. e-commerce sales as measured by the U.S. Census
Bureau. n the first three quarters of FY11, WSM's nternet
sales increased 18% yr./yr., versus a 16% increase in total
U.S. e-commerce sales. International shipping adds another
potential avenue for growth. Through a partnership with
FiftyOne Global Ecommerce, WSM is now able to ship to 80
countries in over 40 currencies without having to
immediately commit a sizable amount of capital to build
international infrastructure. According to the World Bank,
87% of the world's 1.8B nternet users reside outside the
U.S., so there is a tremendous opportunity to drive e-
commerce sales internationally. We estimate WSM's total E-
commerce sales will grow at a healthy five-year CAGR of
15% to over $2.4B, contributing around 47% of total
revenue.
Greater online penetration should drive improved
margins and ROIC. We are forecasting about 20bps of
annual gross margin expansion and about 35bps of annual
SG&A expense leverage out to FY15. The DTC segment
does not incur store occupancy or store payroll expenses, so
an increasing mix of DTC sales should be beneficial to
margins (the benefit is partially offset by higher advertising,
shipping, and damage costs). The 8% sales growth that we
are forecasting out to FY15, largely driven by the E-
commerce channel, should result in leverage of corporate
overhead and other fixed expenses. As a result, we expect
EPS to double, from $1.95 in FY10 to $3.89 in FY15.
Increasing penetration of the high-return e-commerce
business has been a boon to WSM's consolidated ROC, as
well. Between FY00 and FY10, WSM's ROC improved from
9% to 13%, despite 80bps of deterioration in the retail
segment's pretax return on assets. Based on our forecast for
online sales to grow at a double-digit five-year CAGR,
compared with 5% growth in the retail business and a 4%
decline in catalog sales, we project ROIC will improve from
13% in FY10 to 18% in FY15.
Valuation & Price Target
We are establishing a PT of $55 based on our DCF model.
Shares currently trade at 11x FY12E EV/NOPAT.
Considering our expectations for NOPAT growth out to FY15
and a long-term growth rate of 5%, our model indicates
shares should trade at a 16x multiple. This indicates
potential upside of 45%.

Risks
Risks to our investment thesis include a significant slowdown
of E-commerce penetration within the home-furnishings
category, as well as a greater pullback in brick-and-mortar
sales. Competition is a concern for any retailer, on-line or
off-, but we believe WSM's on-line dominance and
established brands give it a material advantage over
newcomers and less sophisticated or focused home
merchants.

Williams-Sonoma, Inc. (WSM)
FY: January (000s)
Consolidated income statement
2010A 2011E 2012E 2013E 2014E 2015E
Apr-10 Jul-10 Oct-10 Jan-11 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Jan-13 Jan-14 Jan-15 Jan-16
Q1A Q2A Q3A Q4 FY Q1A Q2A Q3A Q4 FY Q1 Q2 Q3 Q4 FY FY FY FY
Net revenues 717,637 775,554 815,516 1,195,451 3,504,158 770,825 814,750 867,176 1,250,009 3,702,760 817,935 879,609 934,349 1,354,526 3,986,419 4,353,663 4,756,783 5,207,889
COGS 446,621 487,823 503,961 690,158 2,128,563 474,942 506,029 535,213 722,905 2,239,089 503,887 543,234 572,934 780,912 2,400,966 2,614,751 2,848,297 3,109,039
Gross profit 271,016 287,731 311,555 505,293 1,375,595 295,883 308,721 331,963 527,103 1,463,670 314,048 336,376 361,415 573,614 1,585,453 1,738,912 1,908,486 2,098,850
SG&A expense 229,171 231,115 252,037 317,847 1,030,170 242,661 244,636 263,219 327,853 1,078,369 256,101 259,273 278,470 350,389 1,144,233 1,233,970 1,331,103 1,438,589
EBITDA 80,847 91,495 94,141 223,571 490,054 86,100 97,106 101,618 232,552 517,376 92,859 112,048 118,817 260,268 583,992 649,176 723,165 808,169
EBIT 41,845 56,615 59,518 187,446 345,424 53,222 64,085 68,744 199,251 385,302 57,947 77,103 82,945 223,225 441,221 504,942 577,383 660,261
Interest (income) expense, net 128 123 78 25 354 1 69 (7) 0 63 0 0 0 0 0 0 0 0
Pretax income 41,717 56,492 59,440 187,421 345,070 53,221 64,016 68,751 199,251 385,239 57,947 77,103 82,945 223,225 441,221 504,942 577,383 660,261
Income taxes 16,084 22,519 21,732 71,641 131,977 20,617 24,707 25,330 75,715 146,369 22,017 29,299 31,519 84,826 167,661 192,383 219,405 251,559
Net income 25,633 33,973 37,708 115,780 213,094 32,604 39,309 43,421 123,535 238,870 35,930 47,804 51,426 138,400 273,560 312,559 357,977 408,702
Operating EPS $0.23 $0.31 $0.35 $1.08 $1.95 $0.30 $0.37 $0.41 $1.18 $2.25 $0.34 $0.45 $0.49 $1.32 $2.60 $2.97 $3.41 $3.89
GAAP EPS $0.18 $0.28 $0.34 $1.05 $1.71 $0.29 $0.37 $0.41 $1.18 $2.23 $0.34 $0.45 $0.49 $1.32 $2.60 $2.97 $3.41 $3.89
Fully diluted shares outstanding 109,639 110,224 108,908 107,578 109,087 107,183 106,766 105,721 105,119 106,197 105,119 105,119 105,119 105,119 105,119 105,119 105,119 105,119
Dividend per share $0.13 $0.15 $0.15 $0.15 $0.58 $0.15 $0.17 $0.17 $0.17 $0.66 $0.17 $0.17 $0.17 $0.17 $0.68 $0.68 $0.68 $0.68
Payout ratio 55.6% 48.7% 43.3% 13.9% 29.7% 49.3% 46.2% 41.4% 14.5% 29.3% 49.7% 37.4% 34.7% 12.9% 26.1% 22.9% 20.0% 17.5%
Margins
Gross margin 37.8% 37.1% 38.2% 42.3% 39.3% 38.4% 37.9% 38.3% 42.2% 39.5% 38.4% 38.2% 38.7% 42.3% 39.8% 39.9% 40.1% 40.3%
SG&A expense 31.9% 29.8% 30.9% 26.6% 29.4% 31.5% 30.0% 30.4% 26.2% 29.1% 31.3% 29.5% 29.8% 25.9% 28.7% 28.3% 28.0% 27.6%
EBIT 5.8% 7.3% 7.3% 15.7% 9.9% 6.9% 7.9% 7.9% 15.9% 10.4% 7.1% 8.8% 8.9% 16.5% 11.1% 11.6% 12.1% 12.7%
EBITDA 11.3% 11.8% 11.5% 18.7% 14.0% 11.2% 11.9% 11.7% 18.6% 14.0% 11.4% 12.7% 12.7% 19.2% 14.6% 14.9% 15.2% 15.5%
Pre-tax margin 5.8% 7.3% 7.3% 15.7% 9.8% 6.9% 7.9% 7.9% 15.9% 10.4% 7.1% 8.8% 8.9% 16.5% 11.1% 11.6% 12.1% 12.7%
Tax rate 38.6% 39.9% 39.0% 39.0% 38.2% 38.7% 38.6% 36.8% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.1% 38.0% 38.1%
Net margin 3.6% 4.4% 4.6% 9.7% 6.1% 4.2% 4.8% 5.0% 9.9% 6.5% 4.4% 5.4% 5.5% 10.2% 6.9% 7.2% 7.5% 7.8%
Yr./yr. growth
Sales 17.3% 15.4% 11.8% 9.7% 12.9% 7.4% 5.1% 6.3% 4.6% 5.7% 6.1% 8.0% 7.7% 8.4% 7.7% 9.2% 9.3% 9.5%
Comparable brand growth 18.1% 16.5% 12.5% 10.9% 13.9% 9.0% 6.5% 7.3% 6.7% 6.5% 7.1% 8.4% 8.4% 7.6% 7.9% 8.1% 8.5% 8.7%
2-yr comp -6.2% -3.6% 7.9% 18.1% 4.6% 27.1% 23.0% 19.8% 17.6% 20.4% 16.1% 14.9% 15.7% 14.3% 14.4% 15.9% 16.5% 17.2%
SSS 17.0% 13.6% 8.1% 5.2% 9.8% 6.7% 1.4% 6.3% 4.0% 4.5% 3.0% 5.0% 5.0% 4.0% 4.2% 4.0% 4.0% 4.0%
2-yr comp -4.0% -1.7% 9.8% 12.8% 4.7% 23.7% 15.0% 14.4% 9.2% 14.3% 9.7% 6.4% 11.3% 8.0% 8.8% 8.2% 8.0% 8.0%
in gross margin (bps) 769 490 330 77 370 62 79 8 (10) 27 1 35 40 18 24 17 18 18
in sg&a expense (bps) (229) (109) (18) (131) (114) (45) 23 (55) (36) (28) (17) (55) (55) (36) (42) (36) (36) (36)
Gross profit 47.3% 32.9% 22.4% 11.7% 24.7% 9.2% 7.3% 6.6% 4.3% 6.4% 6.1% 9.0% 8.9% 8.8% 8.3% 9.7% 9.8% 10.0%
SG&A expense 9.5% 11.3% 11.2% 4.5% 8.7% 5.9% 5.9% 4.4% 3.6% 4.7% 5.0% 6.7% 6.5% 7.0% 6.1% 7.8% 7.8% 8.0%
SG&A/sq. ft. 13.1% 15.2% 15.1% 9.0% 13.3% 11.2% 11.3% 9.2% 5.5% 7.4% 7.4% 6.8% 7.1% 5.6% 4.8% 6.5% 6.4% 6.6%
EBITDA 636.4% 94.2% 40.9% 19.9% 57.4% 6.5% 6.1% 7.9% 4.0% 5.6% 7.9% 15.4% 16.9% 11.9% 12.9% 11.2% 11.4% 11.8%
Operating EPS NMF 574.1% 120.7% 25.2% 105.6% 30.1% 19.5% 18.6% 9.2% 15.1% 12.4% 23.5% 19.1% 12.0% 15.7% 14.3% 14.5% 14.2%
Free cash flow
Cash from operating activities (70,306) 61,195 51,564 313,536 355,989 (91,303) 43,572 45,848 196,840 194,957 45,478 179 109,281 225,506 380,443 413,299 442,689 516,829
Capital expenditures 17,431 13,458 15,533 15,484 61,906 22,236 40,289 39,730 48,136 150,391 35,624 26,703 36,878 47,837 147,042 152,378 156,974 161,445
FCF (87,737) 47,737 36,031 298,052 294,083 (113,539) 3,283 6,118 148,704 44,566 9,854 (26,524) 72,403 177,669 233,401 260,921 285,715 355,384
FCF/share ($0.80) $0.43 $0.33 $2.77 $2.70 ($1.06) $0.03 $0.06 $1.41 $0.42 $0.09 ($0.25) $0.69 $1.69 $2.22 $2.48 $2.72 $3.38
Source: Collins Stewart

Bed Bath & Beyond (BBBY): Buy

We are initiating coverage of BBBY with a Buy and DCF-
generated $69 PT, justified by the company's dominant
industry position and solid financial health. Despite BBBY's
22%+ market share in the fragmented home-furnishings
category, we believe the company still has significant room
to grow sales and EPS through both e-commerce and its
brick-and-mortar operations. The company's $7/share-plus
cash position is capable of supporting growth initiatives such
as building the e-commerce business, expanding the buybuy
Baby concept, and investing in its supply chain. BBBY could
also sustain an aggressive share repurchase program or
possibly initiate a dividend.
Industry leadership drives outsized returns. Behind a
vast assortment of non-discretionary household products
coupled with a growing inventory of specialty and seasonal
items, BBBY has built a dominant competitive position. The
company has steadily gained market share within the home-
furnishings industry over the last five years, with the rate of
growth accelerating following the bankruptcy and liquidation
of its main competitor Linens 'N Things in October 2008.
Based on total home-furnishings sales reported by the U.S.
Census Bureau, BBBY's market share has climbed 1,020bps
since FY05 to 21.6% in FY10. We believe this strong
competitive position leaves BBBY less dependent on
aggressive promotional activity than many other retailers
during a softer consumer climate and enabled the company
to post 20% ROIC in 2010.

E-commerce potential is vast. Management does not
disclose its total e-commerce sales, though Internet Retailer
magazine estimates that the company generated $88.7MM
in sales online in FY10, which would represent a mere 1% of
total sales. Even assuming a more-aggressive rate of e-
commerce penetration of three times nternet Retailer's
estimate, online sales would still represent a paltry 3% of
total sales. We believe BBBY has one of the lowest e-
commerce penetrations of all the retailers under our
coverage. In our view, the extremely low level of e-
commerce penetration presents a significant opportunity.
Home-related retailing peer Williams-Sonoma represents a
clear example of the growth potential online. WSM
generated sales of $1.2B, more-than one-third of its total
sales, online in FY10. Although BBBY may be hard-pressed
to achieve e-commerce penetration on par with WSM's 34%,
we believe the company is capable of increasing Internet
sales well above the current low-single-digit percentage of

FY Ends
Feb. FY10 FY11 FY12
Rev.
($MM)

Q1 1923 2110 2258E
Q2 2137 2314 2473E
Q3 2194 2368E 2531E
Q4 2505 2655E 2843E
FY 8759 9447E 10105E

Op. EPS

Q1 $0.52 $0.72 $0.83E
Q2 $0.70 $0.93 $1.07E
Q3 $0.74 $0.89E $1.02E
Q4 $1.12 $1.29E $1.47E
FY $3.07 $3.81 $4.38E

Key Data

52-week High $63.83
52-week Low $44.79
Short Interest 2.1%
Mkt. Cap. (MM) $15,093.1
Net Debt (MM) ($1,742.9)
Cash/share

$7.07
CY12E P/E

14.0x
CY12E P/FCF 17.0x
Price Target

$69

total sales. BBBY has taken some steps to build its online
business, including vendor-direct shipping and in-store
orders being shipped directly from an e-commerce
distribution center to a customer's home. Customers can
also return all items purchased online to any store. We
believe meaningful growth in the e-commerce business
would require infrastructure investments, specifically through
larger or additional DCs beyond the two e-commerce
fulfillment centers currently in operation. BBBY certainly has
the cash to finance such an investment, and the higher
margins of an e-commerce business with adequate scale
would drive high returns on the initial capital investment.

Organic square footage growth of the ancillary concepts
represents another potential catalyst. The core Bed Bath
& Beyond concept grew 29% yr./yr. to 311 locations in FY00.
The rate of unit growth has declined every year since then,
falling to +1.8% in FY10. The core concept appears on track
to open its 1,000
th
store in H2:12, and we expect units to
grow at an annual rate of 1.3% over the next five years. We
believe the smaller businesses, specifically buybuy Baby,
offer greater unit growth potential. buybuy Baby has been
BBBY's fastest-growing concept in recent years, increasing
55% yr./yr. to 45 stores in FY10. Despite this rapid unit
growth, buybuy Baby is still underpenetrated nationwide.
There were 54 locations open at the end of Q2:11 in only 24
states, with limited exposure on the West coast and in many
major metropolitan areas. In fact, there are no buybuy Baby
locations within a 50-mile radius of one-quarter of the top 20
most populated U.S. cities as recorded by the Census
Bureau. We think this indicates a significant opportunity for
BBBY to expand organic square footage through the buybuy
Baby concept. We look for unit growth of 50% in FY11 and
model for 174 locations by FY15, which still would not
represent a full, national footprint.

The Christmas Tree Shops concept is another potential
growth driver, though we expect it to grow slower than
buybuy Baby. CTS grew units by 8.2% in FY10 to 66
locations, with another 4 stores opening in H1:11. Similar to
buybuy Baby, the CTS concept remains underpenetrated
nationally. It operates in only 20 states, with no presence
west of Kentucky other than one store in Dallas, Texas. We
estimate annual unit growth of 8% for CTS over the next five
years. We believe that the concept should benefit from its
abundant, value-priced assortment of seasonal product.
Store branding remains our primary concern, as shoppers in
new markets may not recognize the year-round assortment
available at CTS locations.

Growth within the third ancillary concept, Harmon, is focused
on add-on sales through a shop-in-shop format. The average
Harmon shop-in-shop accounts for around 3,000-4,000 sq.
ft. within a standard 30,000-40,000 sq. ft. Bed Bath &
Beyond location. BBBY operated 45 Harmon stand-alone
locations at the end of Q2:11, and we project one new stand-
alone store per year.

An expanded DC network would likely benefit margins.
The majority of BBBY's merchandise is shipped directly to
stores from vendors. The company only operates three
distribution centers for a store base that exceeds 1,100
locations. Using DCs rather than shipping directly to stores
generally results in improved inventory management and
higher margins as the retailer better leverages its scale. As a
result, we believe that BBBY has the potential to expand
long-term margins if it invests in a network of DCs. We also
believe a lack of expertise in running DCs and a
decentralized management structure has been an
impediment to Bed Bath's e-commerce growth. We believe
management should eventually effect change as it realizes it
is leaving significant profits to its more agile on-line
competitors.
BBBY's supply chain brings to mind Home Depot's situation
before it revamped its distribution network. HD built 19 rapid
deployment centers (RDCs) to manage inventories for about
100 stores each. The RDCs differ from a traditional DC in
that there is no packing and storing, but there are more
processes that take place than in a cross-dock DC to ensure
that each store receives the appropriate merchandise. HD
has said that the greatest benefits from RDCs relative to its
previous direct-to-store system are shorter lead times
(allowing for faster reactions to demand trends) and the
elimination of vendor minimums, which often resulted in
items being either overstocked or completely out-of-stock.
HD says that it expects its new distribution network to have a
40bps benefit to margins. We believe it is being very
conservative, and that the benefit should be higher given the
dramatic improvements in efficiency HD is seeing. The cost
of building a network of DCs can be daunting, but we believe
it would be more than offset by the lift to margins longer-
term. Assuming BBBY could achieve 40bps of gross margin
improvement through greater supply-chain efficiency, this
would provide about a $0.10 lift to EPS relative to our
estimates.
A sizable cash balance and ample cash replenishment
should support the growth initiatives. BBBY had $1.7B in
cash and short-term securities, over $7 per share, at the end
of Q2. The company generated FCF of $810MM in FY10
following $750MM in FY09. We estimate FCF to average
about $900MM annually over the next five years. The sizable
cash position and abundant cash replenishment provide
BBBY with the financial flexibility needed for the
aforementioned growth initiatives.

BBBY may also utilize cash to return value to shareholders
through share buybacks. The company accelerated its buy-
back in FY10, following a two-year period when the company
bought less than $150MM in stock. BBBY spent $700MM on
repurchases in FY10, and another $530MM in H1:11.
Heading into the H2:11, there was another $1.6B remaining
on the current share repurchase authorization, which
management expects to complete in early FY13. We are
forecasting $1.1B in repurchases in FY11, which we
calculate adds $0.21 to EPS. Our projections call for another
$985MM in buybacks in FY12, followed by average annual
repurchases of $650MM out to FY15. Although BBBY does
not currently pay a dividend, and management has made no
indication that one is forthcoming, the company could do so
at any time.

Recent history implies upside to guidance. Management
has consistently guided conservatively in recent years.
BBBY reported Q2 EPS of $0.93, $0.11 above the high end
of management's guidance range, marking the 11
th

consecutive beat. Over this span, the company has recorded
an average earnings beat of 22% over the high end of
guidance and 26% relative to the midpoint of the range. EPS
has also exceeded consensus every quarter since Q2:08
(ended August 2008), when BBBY reported in-line results.
Since Q3:08, BBBY's EPS has beaten consensus by an
average of 16%. Our Q3 EPS estimate of $0.89 is slightly
above management's guidance of $0.82-$0.87 and the
consensus estimate of $0.88. For FY11, we are looking for
EPS growth of 24.4% yr./yr. to $3.81, which falls within
management's guidance range of +22% to +25% and
consensus at $3.82. The company's recent history of
outperforming guidance and the Street suggests our FY11
estimate may prove conservative. Our FY12 EPS estimate of
$4.38 is in-line with consensus. If BBBY continues to beat
guidance and consensus, we believe shares will move
meaningfully higher.

Valuation
Shares currently trade at 12x FY12 EV/NOPAT. Our
discounted NOPAT model suggests shares should trade at
14x, which represents potential upside of 12% over the
current price.
Risks
Amazon.com is a formidable competitor for many retailers,
and it has some overlap with BBBY's product categories
though Amazon's breadth is not as wide in home furnishings
as it is within other categories. We conducted a crosscheck
between the two retailers using a wide sample of products.
AMZN offers a relatively full inventory of small appliances,
and it carries the bulk of the dinnerware brands and products
in our check. In other categories, such as linens, towels, and
window treatments, AMZN's inventory appeared lighter. The
online retail giant did carry some of the same brands as
BBBY. On a sample of 50 overlapping products, AMZN
offered about a 5% discount, on average, to the listed BBBY
price. In many cases, shoppers are able to complete a
purchase on amazon.com for products that are to be
shipped and sold from an external seller. These items were
generally priced comparably to those listed at BBBY. There
were a small handful of items for which BBBY offered a
lower price, but Amazon.com generally offered better values.
Amazon.com offers free shipping on all items, whereas
BBBY offers free shipping on many, but not all, products.
Additional risks to our investment thesis include BBBY
limiting investments to expand the E-commerce channel and
ancillary concepts.

Bed Bath & Beyond (BBBY)
FY: February ($000s)
2010A 2011E 2012E 2013E 2014E 2015E
May-10 Aug-10 Nov-10 Feb-11 Feb-11 May-11 Aug-11 Nov-11 Feb-12 Feb-12 May-12 Aug-12 Nov-12 Feb-13 Feb-13 Feb-14 Feb-15 Feb-16
Q1 Q2 Q3 Q4 FY Q1A Q2A Q3 Q4 FY Q1 Q2 Q3 Q4 FY FY FY FY
Net sales 1,923,051 2,136,730 2,193,755 2,504,967 8,758,503 2,109,951 2,314,064 2,367,794 2,655,077 9,446,885 2,257,701 2,472,681 2,531,373 2,843,001 10,104,756 10,716,913 11,333,561 11,992,778
COGS 1,148,015 1,261,812 1,297,247 1,428,500 5,135,574 1,252,379 1,363,065 1,396,998 1,510,739 5,523,181 1,338,817 1,456,409 1,493,510 1,617,667 5,906,403 6,264,220 6,624,661 7,009,985
Gross profit 775,036 874,918 896,508 1,076,467 3,622,929 857,572 950,999 970,795 1,144,338 3,923,704 918,885 1,016,272 1,037,863 1,225,333 4,198,352 4,452,693 4,708,900 4,982,793
SG&A expense 549,642 578,016 591,398 615,415 2,334,471 568,624 579,363 620,362 645,184 2,413,533 605,064 615,697 661,954 690,849 2,573,565 2,722,096 2,867,391 3,022,180
EBITDA 270,407 341,771 350,445 509,655 1,472,278 333,169 415,525 398,416 550,008 1,697,118 361,587 451,335 427,621 587,160 1,827,704 1,945,229 2,068,844 2,203,249
EBIT 225,394 296,902 305,110 461,052 1,288,458 288,948 371,636 350,433 499,154 1,510,172 313,821 400,574 375,909 534,484 1,624,788 1,730,597 1,841,509 1,960,613
Interest income (expense), net 516 327 1,996 1,681 4,520 552 (1,872) 1,392 1,085 1,157 1,994 1,736 1,895 1,559 7,183 14,524 17,475 22,149
Pretax income 225,910 297,229 307,106 462,733 1,292,978 289,500 369,764 351,826 500,239 1,511,329 315,814 402,310 377,804 536,043 1,631,971 1,745,122 1,858,984 1,982,762
Income taxes 88,357 115,474 118,532 179,282 501,645 108,922 140,392 137,212 195,093 581,619 123,168 156,901 147,344 209,057 636,469 680,598 725,004 773,277
Net income 137,553 181,755 188,574 283,451 791,333 180,578 229,372 214,614 305,146 929,710 192,647 245,409 230,460 326,986 995,502 1,064,524 1,133,980 1,209,485
Diluted EPS $0.52 $0.70 $0.74 $1.12 $3.07 $0.72 $0.93 $0.89 $1.29 $3.81 $0.83 $1.07 $1.02 $1.47 $4.38 $4.94 $5.49 $6.13
GAAP EPS $0.52 $0.70 $0.74 $1.12 $3.07 $0.72 $0.93 $0.89 $1.29 $3.81 $0.83 $1.07 $1.02 $1.47 $4.38 $4.94 $5.49 $6.13
Fully diluted shares outstanding 263,638 259,928 255,936 252,816 258,079 249,799 246,539 241,494 237,144 243,744 233,069 229,319 225,569 221,819 227,444 215,444 206,444 197,444
Margins
Gross margin 40.3% 40.9% 40.9% 43.0% 41.4% 40.6% 41.1% 41.0% 43.1% 41.5% 40.7% 41.1% 41.0% 43.1% 41.5% 41.5% 41.5% 41.5%
SG&A expense 28.6% 27.1% 27.0% 24.6% 26.7% 26.9% 25.0% 26.2% 24.3% 25.5% 26.8% 24.9% 26.2% 24.3% 25.5% 25.4% 25.3% 25.2%
EBIT 11.7% 13.9% 13.9% 18.4% 14.7% 13.7% 16.1% 14.8% 18.8% 16.0% 13.9% 16.2% 14.9% 18.8% 16.1% 16.1% 16.2% 16.3%
EBITDA 14.1% 16.0% 16.0% 20.3% 16.8% 15.8% 18.0% 16.8% 20.7% 18.0% 16.0% 18.3% 16.9% 20.7% 18.1% 18.2% 18.3% 18.4%
Interest rate (income) 0.1% 0.1% 0.5% 0.4% 0.2% 0.1% -0.4% 0.3% 0.3% 0.1% 0.5% 0.5% 0.5% 0.5% 0.5% 1.0% 1.0% 1.0%
Tax rate 39.1% 38.9% 38.6% 38.7% 38.8% 37.6% 38.0% 39.0% 39.0% 38.5% 39.0% 39.0% 39.0% 39.0% 39.0% 39.0% 39.0% 39.0%
Net margin 7.2% 8.5% 8.6% 11.3% 9.0% 8.6% 9.9% 9.1% 11.5% 9.8% 8.5% 9.9% 9.1% 11.5% 9.9% 9.9% 10.0% 10.1%
Yr./yr. growth
Sales 13.5% 11.6% 11.1% 11.6% 11.9% 9.7% 8.3% 7.9% 6.0% 7.9% 7.0% 6.9% 6.9% 7.1% 7.0% 6.1% 5.8% 5.8%
SSS 8.4% 7.4% 7.0% 8.5% 7.8% 7.0% 5.6% 5.0% 3.0% 5.0% 4.0% 4.0% 4.0% 4.0% 4.0% 3.0% 3.0% 3.0%
2-year comp 6.8% 6.8% 14.3% 20.0% 12.2% 15.4% 13.0% 12.0% 11.5% 12.8% 11.0% 9.6% 9.0% 7.0% 9.0% 7.0% 6.0% 6.0%
Gross margin (bps) 95 56 (26) 39 39 34 15 13 13 17 6 0 0 0 1 0 0 0
SG&A expense (bps) (238) (174) (173) (149) (180) (163) (201) (76) (27) (111) (15) (14) (5) 0 (8) (7) (10) (10)
Gross profit 16.2% 13.1% 10.4% 12.7% 12.9% 10.6% 8.7% 8.3% 6.3% 8.3% 7.1% 6.9% 6.9% 7.1% 7.0% 6.1% 5.8% 5.8%
SG&A expense 4.8% 4.8% 4.3% 5.2% 4.8% 3.5% 0.2% 4.9% 4.8% 3.4% 6.4% 6.3% 6.7% 7.1% 6.6% 5.8% 5.3% 5.4%
SG&A/sq. ft. j -0.1% 0.4% 1.0% 1.2% -0.4% -4.0% 1.0% 1.4% -0.6% 2.6% 2.5% 2.9% 3.0% 2.6% 1.7% 1.7% 1.7%
EBITDA 44.5% 28.0% 19.6% 21.9% 26.4% 23.2% 21.6% 13.7% 7.9% 15.3% 8.5% 8.6% 7.3% 6.8% 7.7% 6.4% 6.4% 6.5%
Operating EPS 54.9% 34.1% 27.1% 29.9% 33.1% 38.6% 33.1% 20.6% 14.8% 24.4% 14.3% 15.0% 15.0% 14.6% 14.8% 12.9% 11.2% 11.5%
Free cash flow
Cash from operations 172,283 231,819 43,965 539,340 987,407 258,334 227,819 (60,289) 510,296 936,160 76,407 439,649 48,160 528,412 1,092,627 1,204,416 1,329,524 1,356,277
FCF 133,251 187,277 (14,647) 503,250 809,131 225,192 172,177 (141,636) 427,636 683,369 28,433 366,499 (26,216) 452,626 821,343 915,059 1,012,184 1,020,479
FCF per share $0.51 $0.72 ($0.06) $1.99 $3.14 $0.90 $0.70 ($0.59) $1.80 $2.80 $0.12 $1.60 ($0.12) $2.04 $3.61 $4.25 $4.90 $5.17
Big Lots (BIG): Buy

We are initiating coverage on BIG shares with a Buy rating
and a DCF-generated long-term PT of $58. Big Lots is the
nation's largest broadline closeout retailer, selling
merchandise in a variety of categories including
consumables, home, furniture, hardlines, and seasonal. The
company recently reported Q3 EPS below consensus, as
gross margin compression dragged the U.S. business below
expectations. Investors were clearly disappointed, and the
stock sold off sharply following the release. We believe
investors' concerns are overdone and view the recent
pullback as a buying opportunity. The gross margin pressure
stemmed primarily from lower initial mark-up (IMU), which is
largely the result of more aggressive pricing and a shift in
mix. SSS growth returned in Q3, and management
commented that yr./yr. sales growth accelerated at the end
of November. The company's fledgling venture into Canada
seems to be headed in the right direction, but the business is
still in the very early stages of a turnaround. We believe an
improving assortment and competitive pricing will help BIG
sustain the recent sales momentum through the remainder
of FY11 and into FY12. Based on our FY12 estimates, we
think the shares are attractively valued at 10.5x EPS and
5.5x EV/EBITDA.
Sales trends are improving. BIG reported SSS declines in
the first two quarters of FY11 as it faced difficult comps and
challenging weather which impacted outdoor seasonal
product. SSS turned positive in Q3, increasing 1.7% on top
of +0.7%. Consumable product BG's largest category at
around 30% of total sales - continues to improve with comps
increasing in the high-single-digits on top of a low-single-digit
decline. Sales of hardlines, electronics, furniture, and home
also trended higher in the quarter. More aggressive
promotions and pricing likely drove traffic. Sales of
Halloween and fall seasonal products lagged in the quarter,
but we believe BIG should benefit from a more-appealing
holiday assortment. Early indications are that Q4 has gotten
off to a solid start. Management said that comps were
modestly positive through the first three weeks of November
and improved notably over the Thanksgiving weekend. The
company noted that it expanded its December holiday
product, adding square footage for trees and trim. We
estimate SSS should increase 2% on top of a flat
performance in Q4. BIG faces easier comps in H1:12, and
we look for SSS growth of 7% on top of -3.7%. For FY12, we
look for SSS growth of 3.4% on top of -0.3%.

We expect a gross margin recovery in H2:12. BG's gross
margin contracted 150bps yr./yr. in Q3, and we estimate a

FY Ends
Jan. FY10 FY11 FY12
Rev.
($MM)

Q1 1235 1227 1352E
Q2 1142 1167 1276E
Q3 1056 1138 1200E
Q4 1519 1648E 1728E
FY 4952 5181E 5557E

Op. EPS

Q1 $0.68 $0.70 $0.83E
Q2 $0.48 $0.50 $0.58E
Q3 $0.23 $0.06 $0.18E
Q4 $1.46 $1.65E $1.91E
FY $2.83 $2.87E $3.51E

Key Data

52-week High $44.44
52-week Low $27.82
Short Interest 8.3%
Mkt. Cap. (MM) $2,414.4
Net Debt (MM) $225.2
Cash/share

$59.95
CY12E P/E

10.4x
CY12E P/FCF 18.2x
Price Target

$58

decline of 40bps in Q4. This is largely the result of lower
IMU. The company has become more aggressive with its
pricing against an increasingly competitive promotional
landscape. BIG has been shifting mix to lower-margin
product that tends to be in higher demand and turns faster in
stores. We expect these strategies to drive traffic and help
support the SSS gains we are projecting. As product
improves and sales gain momentum, we look for gross
margin expansion of 50bps in H2:12.

Our FY12 EPS estimate is above consensus. We believe
the Street underestimates BG's sales growth potential next
year. We are forecasting a 7.3% increase in net sales, 30bps
higher than consensus. The Street's gross margin forecast is
20bps below our call, and we expect 40bps of SG&A
expense leverage, compared with the consensus forecast of
a 10bps improvement. Our $3.51 EPS estimate is $0.16
above consensus.

BIG's recentIy acquired Canadian operations stiII need
work. In mid-July BIG completed the $20MM acquisition of
Liquidation World, an 89-store closeout franchise in Canada.
Our recent visit to three LW locations in Calgary revealed
obscure locations, dated buildings, and sparse inventory
excluding a solid furniture assortment. The transition to Big
Lots Canada is still in the early stages, and management
expects to invest $55MM to $60MM in the business in FY11.
These funds will primarily be devoted to building inventory,
hiring staff, and improving the stores. EPS guidance implies
LW will dilute earnings by $0.23 for the full year.

Shares currently trade at an EV/NOPAT multiple of 9.5x. Our
model suggests BIG should trade at a multiple of 15x.
Assuming shares approach their intrinsic value over the next
12 months, BIG offers potential upside of 60% over its
current price.
Risks
Risks to our investment thesis include a slowdown in sales
stemming from a product assortment that does not resonate
with shoppers. Macroeconomic factors and extreme weather
could also impact sales trends. Rising cost pressures could
impact margins. The LW acquisition could require a greater
capital investment to refurbish stores and replenish
inventories than management anticipates.

Big Lots (BIG)
FY: January ($MMs)
Income statement
2010A 2011E 2012E 2013E 2014E 2015E
Q1 Q2 Q3 Q4 FY Q1A Q2A Q3A Q4 FY Q1 Q2 Q3 Q4 FY FY FY FY
Sales 1,235 1,142 1,056 1,519 4,952 1,227 1,167 1,138 1,648 5,181 1,352 1,276 1,200 1,728 5,557 5,787 6,026 6,267
COGS 733 680 628 899 2,940 733 707 694 982 3,116 814 776 726 1,023 3,339 3,467 3,604 3,741
Gross profit 502 462 428 620 2,012 494 461 444 666 2,065 538 500 474 705 2,218 2,321 2,423 2,525
SG&A expense 412 399 401 443 1,655 408 401 435 479 1,723 445 435 453 494 1,826 1,886 1,948 2,008
EBIT 90 63 27 177 357 86 60 9 187 342 93 66 21 211 392 435 475 517
EBITDA 108 81 45 197 431 106 80 26 213 424 115 91 48 239 492 538 585 633
Interest expense 1 1 1 1 3 1 1 1 1 4 2 2 2 2 9 9 9 9
Interest income (0) (0) 0 (0) (1) (0) (0) 0 (1) (1) (1) (1) (1) (1) (2) (2) (2) (2)
Pre-tax income 90 63 26 176 355 86 58 8 187 340 92 64 20 210 385 428 468 511
Taxes 34 24 8 66 133 33 23 4 79 138 37 26 8 84 154 171 187 204
Net income from continuing operations 56 39 18 110 222 53 36 4 109 201 55 38 12 126 231 257 281 307
Net income from discontinued operations (0) (0) (0)
EPS from continuing operations $0.68 $0.48 $0.23 $1.46 $2.83 $0.70 $0.50 $0.06 $1.65 $2.87 $0.83 $0.58 $0.18 $1.91 $3.51 $3.93 $4.36 $4.83
EPS from discontinued operations ($0.00) ($0.00) ($0.00)
GAAP EPS $0.68 $0.48 $0.23 $1.46 $2.83 $0.70 $0.50 $0.06
Diluted shares outstanding 82 80 76 75 79 75 71 66 66 70 66 66 66 66 66 65 64 63
Margins
Gross margin 40.6% 40.5% 40.5% 40.8% 40.6% 40.3% 39.5% 39.0% 40.4% 39.9% 39.8% 39.2% 39.5% 40.8% 39.9% 40.1% 40.2% 40.3%
SG&A rate 33.3% 34.9% 38.0% 29.2% 33.4% 33.2% 34.3% 38.3% 29.0% 33.2% 32.9% 34.1% 37.7% 28.6% 32.9% 32.6% 32.3% 32.0%
EBIT 7.3% 5.5% 2.5% 11.7% 7.2% 7.0% 5.1% 0.8% 11.4% 6.6% 6.9% 5.1% 1.8% 12.2% 7.0% 7.5% 7.9% 8.3%
Tax rate 37.7% 38.3% 32.4% 37.6% 37.4% 38.9% 38.9% 45.4% 42.0% 40.8% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0%
Net margin 4.5% 3.4% 1.7% 7.2% 4.5% 4.3% 3.1% 0.4% 6.6% 3.9% 4.1% 3.0% 1.0% 7.3% 4.2% 4.4% 4.7% 4.9%
Yr./yr. growth
Sales 8.2% 5.1% 2.0% 3.8% 4.8% -0.6% 2.2% 7.8% 8.5% 4.6% 10.2% 9.4% 5.5% 4.9% 7.3% 4.1% 4.1% 4.0%
SSS 6.0% 3.8% 0.7% 0.0% 2.5% -3.6% -1.5% 1.7% 2.0% -0.3% 5.0% 5.0% 2.0% 2.0% 3.4% 2.0% 2.0% 2.0%
2-year SSS 5.5% 1.4% 0.5% 5.1% 3.2% 2.4% 2.3% 2.4% 2.0% 2.2% 1.4% 3.5% 3.7% 4.0% 3.1% 5.4% 4.0% 4.0%
Gross margin (bps) 16 50 17 (51) 3 (38) (102) (151) (42) (78) (46) (26) 46 40 5 19 10 10
SG&A (bps) (186) (64) 97 (32) (50) (12) (61) 26 (12) (17) (33) (29) (53) (46) (39) (27) (27) (27)
EBIT margin (bps) 201 115 (80) (19) 53 (26) (41) (177) (29) (61) (13) 3 99 86 44 46 37 37
Gross profit 8.6% 6.5% 2.4% 2.5% 4.9% -1.6% -0.4% 3.8% 7.4% 2.6% 8.9% 8.6% 6.7% 5.9% 7.4% 4.6% 4.4% 4.2%
SG&A expense 2.5% 3.2% 4.6% 2.7% 3.2% -1.0% 0.4% 8.5% 8.1% 4.1% 9.1% 8.4% 4.0% 3.2% 6.0% 3.3% 3.3% 3.1%
SG&A expense/sq. ft. 0.7% 1.7% 1.4% -0.8% -0.3% -4.4% -9.0% -1.8% -2.0% -5.6% -1.0% 4.5% 0.9% 0.3% 3.0% 0.4% 0.5% 0.4%
EBIT 49.4% 32.6% -22.3% 2.1% 13.1% -4.2% -5.4% -66.9% 5.8% -4.2% 8.2% 9.9% 138.7% 12.8% 14.4% 11.0% 9.3% 8.9%
EPS 54.1% 39.2% -13.5% 11.8% 19.6% 2.7% 4.1% -72.2% 12.9% 1.5% 19.6% 16.0% 177.6% 15.8% 22.0% 12.0% 11.1% 10.8%
Free cash flow
Cash flow from operations 108 30 (101) 279 315 126 (15) (91) 342 362 (58) 82 (141) 382 266 347 377 407
Capital expenditures 11 31 41 24 108 19 28 55 23 125 32 33 34 34 134 139 145 150
FCF 96 (1) (143) 255 208 106 (43) (146) 320 237 (90) 49 (175) 348 132 208 232 257
FCF/share $1.17 ($0.02) ($1.87) $3.39 $2.64 $1.41 ($0.61) ($2.21) $4.85 $3.38 ($1.37) $0.75 ($2.65) $5.28 $2.01 $3.18 $3.60 $4.05
Rent-A-Center (RCII): Buy

We are launching coverage of RCII with a Buy rating and
DCF-generated PT of $49. RCII is a leader in the rent-to-
own space, with an approximate 35% market share based
on store count as of the end of Q3. The company provides
customers with limited access to credit the ability to obtain
home furnishings, electronics, and appliances through
weekly-payment rental contracts. Customers have the option
to eventually purchase the product outright or return the
item. This business model has held up through most
economic cycles, especially as the current restrictive credit
environment has increased the appeal of the RTO option for
those unable to procure financing. The weekly contracts
require smaller payments per installment compared with the
monthly-pay structure of RTO counterpart AAN. RCII is
already dominant in the RTO industry with over 3,000
weekly-pay locations, and we believe the continued
expansion of the RAC Acceptance business, which places
RTO kiosks within third-party retail stores, will be an
important driver of organic growth. The company's
expansion into Canada and Mexico provides another
potential catalyst. SSS growth improved in Q3 as a sizable
number of RAC Acceptance kiosks have begun to enter the
comp base. RCII shares appear attractively valued, trading
at 11x our FY12 EPS estimate and 10x normalized FCF.
RAC Acceptance kiosks are an important lever to
growth. Customers that are denied the necessary credit to
make a purchase from a retailer can visit the RAC kiosk
located within the store to arrange financing. RCII purchases
the product from the store and arranges the RTO transaction
directly with the customer. The kiosks enable RCII to gain
exposure to a higher-credit shopper that would not ordinarily
visit an RTO location. According to management, the
average RAC kiosk transaction generates about 10% more
revenue per contract on a monthly basis than the typical
RTO agreement, products remain on rent longer, and default
rates are generally lower. The start-up cost for a kiosk is
significantly less than that of an RTO store, as the kiosk is
located within another retailer and requires minimal staffing.
According to management, the initial investment is around
$265,000, with the bulk of the capital allocated to purchase
inventory upon sale, compared with a $650,000 investment
for a typical RTO store. RAC Acceptance locations turn a
profit within 6 to 8 months and break even on a cumulative
basis within 12 to 15 months. By comparison, RTO stores
are typically profitable within 10 to 14 months and reach the
breakeven point at around 24 to 28 months.
We estimate another 45 kiosks will open in Q4 bringing the
total number of RAC Acceptance locations to 766 at
yearend, just about double the FY10 total. We believe RCII
will continue to aggressively expand RAC Acceptance, given
the attractive store-level economics. Our estimates call for
another 200 kiosks to open annually in FY12 through FY15.

FY Ends
Dec. FY10 FY11 FY12
Rev.
($MM)

Q1 718 742 821E
Q2 672 698 766E
Q3 665 704 780E
Q4 677 746E 807E
FY 2732 2891E 3174E

Op. EPS

Q1 $0.77 $0.79 $0.88E
Q2 $0.72 $0.68 $0.77E
Q3 $0.62 $0.60 $0.64E
Q4 $0.71 $0.82E $0.92E
FY $2.81 $2.89E $3.22E

Key Data

52-week High $37.37
52-week Low $21.30
Short Interest 10.8%
Mkt. Cap. (MM) $2,116.4
Cash/share

$1.26
CY12E P/E

10.9x
CY12E P/FCF 24.6x
Price Target

$49

An earlier Dow Jones report indicated RCII had begun a pilot
program to install RAC kiosks within a small number of Best
Buy stores. Management has not publicly addressed this
prospect, and our model does not reflect any potential
impact from expansion into BBY locations. We calculate that
a full rollout into all 1,105 U.S. Best Buy stores by the end of
FY12 would provide significant upside to our long-term
estimates. Based on existing kiosk economics, we project
BBY kiosks would generate incremental sales of 16% and an
EPS accretion of $2.24 over our published FY15 estimate.
SSS growth should improve as RAC kiosks enter the
comp base. In Q3, SSS increased 2% on top of +0.3%, with
about 100bps of that improvement generated by the 95 RAC
Acceptance kiosks in the comp base. Another 60 kiosks will
enter the comp base in Q4, which should support the 5%
SSS growth we project in the quarter on top of a flat showing
in Q4:10. A significant number of kiosks will enter the comp
base throughout FY12, which should help RCII sustain
positive SSS momentum. We look for comp sales to
increase 3.5% in FY12 and grow at the same rate annually
through FY15.

Mexico and Canada provide growth potential. RCII
opened its first five RTO stores in Mexico in Q4:10 and
added another 19 locations in the first three quarters of this
fiscal year. We expect a more aggressive expansion into the
country, with 20 stores opening in Q4, followed by another
60 new locations in FY12. At its investor day in November
2010, management highlighted the significant potential south
of the border, stating that over half of the Mexican population
of 111MM is part of RC's target demographic. Management
believes the Mexican market could support over 1,000 RTO
locations. This provides a sizable opportunity for RCII, given
that there are no major RTO operators in Mexico. We project
RCII can expand the store base from five locations at the
end of FY10 to nearly 300 by FY15.
In Canada, RCII has opened two new stores in Q1-Q3,
bringing the total to 20 locations. Our estimates call for a
slower rate of new store growth in the near term compared
with Mexico. We forecast five stores to open in Q4, followed
by another 10 in FY12. RCII appears on track to have 150
stores open in Canada by FY15, up from 18 at the end of
FY10.
We are setting a PT of $49 based on our DCF. The stock
currently trades at 13x our FY12 NOPAT estimate. Our DCF
model suggests RCII shares should trade at an 18x multiple,
which represents potential upside of 40% over the next 12
months.
Risks
RC's low-income customer base may be pressured by
elevated gas and food inflation. Despite the growth potential
we believe the international markets hold, there are risks that
the relatively new RTO concept will not reach a level of
acceptance comparable to the U.S. market. An additional
risk would be that costs related to ongoing growth initiatives
could dilute FY12 EPS by more than management's
guidance of $0.20.
Rent-A-Center, Inc. (RCII)
FY: December ($000s)
Consolidated Income Statement 2010A 2011E 2012E 2013E 2014E 2015E
Mar-09 Jun-09 Sep-09 Dec-10 Dec-10 Mar-10 Jun-10 Sep-10 Dec-11 Dec-11 Mar-11 Jun-11 Sep-11 Dec-12 Dec-12 Dec-13 Dec-14 Dec-05
Q1 Q2 Q3 Q4 FY Q1 Q2A Q3A Q4 FY Q1 Q2 Q3 Q4 FY FY FY FY
Total revenues 718,419 671,543 664,580 677,090 2,731,632 742,178 698,253 704,271 746,263 2,890,965 821,353 765,624 779,746 807,203 3,173,927 3,390,220 3,628,105 3,884,656
Cost of rentals and fees 130,114 129,818 127,573 131,777 519,282 135,649 139,295 142,796 152,760 570,500 158,494 159,637 162,612 166,277 647,020 695,452 748,802 806,357
Cost of merchandise sold 61,811 32,603 34,807 34,912 164,133 68,579 39,510 43,170 41,807 193,066 81,507 46,707 48,697 49,750 226,661 228,906 230,885 232,881
Cost of installment sales 5,426 5,003 5,507 7,367 23,303 6,048 5,898 5,655 7,377 24,978 6,645 6,416 6,168 8,021 27,250 29,899 32,889 36,178
Salaries and other expenses 391,471 381,121 389,295 381,504 1,543,391 397,198 395,091 405,633 412,181 1,610,103 429,603 423,698 447,233 438,271 1,738,806 1,852,718 1,980,048 2,117,171
Franchise cost of merchandise sold 8,068 6,454 6,680 8,040 29,242 8,754 7,195 6,926 8,437 31,312 9,024 7,397 7,053 8,536 32,010 32,970 33,917 34,933
Operating expenses 596,890 554,999 563,862 563,600 2,279,351 616,228 586,989 604,180 622,561 2,429,958 685,273 643,855 671,763 670,855 2,671,747 2,839,946 3,026,541 3,227,520
General and administrative expenses 31,775 32,173 30,796 31,575 126,319 34,553 32,047 33,448 34,328 134,376 37,782 35,219 35,868 37,131 146,001 155,950 166,893 178,694
Amortization of intangibles 1,051 1,540 529 134 3,254 858 1,132 1,261 1,032 4,283 735 735 735 735 2,938 571 568 568
Operating income (EBIT) 88,703 82,831 69,393 81,781 322,708 90,539 78,085 65,382 88,342 322,348 97,563 85,816 71,380 98,482 353,241 393,752 434,103 477,874
EBITDA 104,635 98,816 85,195 98,173 386,819 107,075 95,370 82,521 106,484 391,450 117,000 104,430 90,327 117,840 429,597 470,823 517,039 567,141
Finance charges from refinancing
Interest expense 6,083 6,051 6,085 8,547 26,766 9,760 9,613 8,811 8,867 37,051 8,786 8,786 8,786 8,458 34,815 33,194 31,894 30,594
Interest income (168) (156) (282) (248) (854) (154) (237) (91) (100) (582) (154) (237) (91) (100) (582) (611) (642) (674)
Pretax income 82,788 76,936 63,590 73,482 296,796 80,933 68,709 56,662 79,575 285,879 88,932 77,267 62,685 90,125 319,008 361,170 402,851 447,954
Taxes 31,327 29,106 23,093 27,338 112,498 30,382 25,736 20,612 29,761 106,491 34,239 29,748 24,134 34,698 122,818 139,050 155,098 172,462
Net Income 51,461 47,830 40,497 46,144 184,298 50,551 42,973 36,050 49,814 179,388 54,693 47,519 38,551 55,427 196,190 222,119 247,753 275,491
Extraordinary item, net of taxes
Net income from operations 51,461 47,830 40,497 46,144 184,298 50,551 42,973 36,050 49,814 179,388 54,693 47,519 38,551 55,427 196,190 222,119 247,753 275,491
Diluted EPS from operations $0.77 $0.72 $0.62 $0.71 $2.81 $0.79 $0.68 $0.60 $0.82 $2.89 $0.88 $0.77 $0.64 $0.92 $3.22 $3.79 $4.41 $5.14
GAAP EPS $0.77 $0.72 $0.62 $0.49 $2.60 $0.69 $0.63 $0.52 $0.82 $2.66 $0.88 $0.77 $0.64 $0.92 $3.22 $3.79 $4.41 $5.14
Dividends $0.06 $0.06 $0.12 $0.06 $0.06 $0.16 $0.16 $0.44 $0.16 $0.16 $0.18 $0.18 $0.67 $0.74 $0.81 $0.89
Payout ratio 9.7% 8.4% 4.3% 7.6% 8.8% 26.9% 19.5% 15.2% 18.2% 20.7% 27.6% 19.0% 20.9% 19.5% 18.4% 17.4%
Diluted weighted average shares outstanding 66,517 66,773 65,746 64,575 66,567 64,292 63,148 60,504 60,711 62,164 62,086 61,486 60,536 59,936 61,011 58,661 56,211 53,611
Free cash flow
Cash from operations 71,917 16,395 104,341 23,836 216,489 147,946 23,304 95,459 117,881 384,590 (54,885) 60,723 47,073 135,689 188,600 274,990 317,193 386,837
Capital expenditures (16,079) (13,663) (27,542) (35,520) (92,804) (27,065) (32,019) (32,736) (24,944) (116,923) (24,430) (28,223) (27,849) (21,202) (101,704) (111,874) (123,062) (135,368)
FCF 55,838 2,732 76,799 (11,684) 123,685 120,881 (8,715) 62,723 92,937 267,667 (79,315) 32,500 19,225 114,487 86,896 163,115 194,131 251,469
FCF per share $0.84 $0.04 $1.17 ($0.18) $1.86 $1.88 ($0.14) $1.04 $1.53 $4.31 ($1.28) $0.53 $0.32 $1.91 $1.42 $2.78 $3.45 $4.69
Yr./yr. growth
Total revenues -1.3% -1.2% -1.0% 0.6% -0.7% 3.3% 4.0% 6.0% 10.2% 5.8% 10.7% 9.6% 10.7% 8.2% 9.8% 6.8% 7.0% 7.1%
SSS growth -0.5% 0.1% 0.3% 0.0% -0.4% 0.1% -0.3% 2.0% 5.0% 1.7% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5%
2-year comp trend -3.0% -6.1% -5.8% -3.2% -3.9% -0.4% -0.2% 2.3% 5.0% 1.3% 3.6% 3.2% 5.5% 8.5% 5.2% 7.0% 7.0% 7.0%
Salaries & other -2.5% -1.0% -0.1% 0.4% -0.8% 1.5% 3.7% 4.2% 8.0% 4.3% 8.2% 7.2% 10.3% 6.3% 8.0% 6.6% 6.9% 6.9%
Salaries & other/store -1.2% -0.2% 0.0% 0.3% -0.8% 0.8% 2.8% 4.2% 6.8% 2.0% 5.8% 4.8% 6.6% 4.5% 4.4% 3.0% 3.1% 3.1%
General & administrative/store -6.0% -6.3% -5.8% -12.4% -8.2% 8.0% -1.2% 8.6% 7.5% 4.0% 7.0% 7.4% 3.6% 6.3% 5.1% 3.2% 3.3% 3.3%
Operating expenses/store -1.5% -1.9% -1.6% 0.3% -1.8% 2.5% 4.9% 7.1% 9.2% 4.2% 8.8% 7.2% 7.5% 5.9% 6.3% 2.7% 2.8% 2.9%
EBITDA 7.9% 9.5% 5.4% 8.6% 7.9% 2.3% -3.5% -3.1% 8.5% 1.2% 9.3% 9.5% 9.5% 10.7% 9.7% 9.6% 9.8% 9.7%
EPS 18.6% 17.4% 11.5% 8.6% 13.3% 1.6% -5.0% -3.3% 14.8% 2.7% 12.0% 13.6% 6.9% 12.7% 11.4% 17.8% 16.4% 16.6%
Margins
Rentals and fees COGS 22.3% 22.1% 22.1% 22.4% 22.2% 22.2% 22.5% 22.9% 23.4% 22.8% 23.7% 23.7% 23.7% 23.7% 23.7% 23.7% 23.7% 23.7%
Retail product COGS 69.1% 75.8% 78.5% 80.2% 74.5% 69.1% 77.5% 81.8% 80.0% 75.6% 69.0% 77.0% 77.5% 80.0% 74.6% 74.6% 74.5% 74.4%
Store gross margin 72.2% 74.8% 74.4% 73.9% 73.8% 71.3% 73.2% 72.5% 72.6% 72.4% 69.6% 71.9% 71.8% 71.9% 71.3% 71.5% 71.8% 72.0%
Salaries & other expenses/total store revenue 55.2% 57.4% 59.3% 57.2% 57.2% 54.3% 57.3% 58.3% 56.0% 56.4% 53.0% 56.0% 58.0% 55.0% 55.5% 55.3% 55.2% 55.1%
Franchise margin 83.2% 81.0% 81.5% 84.0% 82.5% 83.7% 82.0% 81.5% 82.5% 82.5% 83.7% 82.0% 81.5% 82.5% 82.5% 82.6% 82.6% 82.7%
Cost of installment sales 35.8% 34.5% 35.3% 39.6% 36.5% 36.2% 35.6% 34.6% 34.8% 35.3% 36.2% 35.2% 34.3% 34.4% 35.0% 34.9% 34.9% 34.9%
General and administrative 4.4% 4.8% 4.6% 4.7% 4.6% 4.7% 4.6% 4.7% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6%
Operating expenses 83.1% 82.6% 84.8% 83.2% 83.4% 83.0% 84.1% 85.8% 83.4% 84.1% 83.4% 84.1% 86.2% 83.1% 84.2% 83.8% 83.4% 83.1%
EBITDA 14.6% 14.7% 12.8% 14.5% 14.2% 14.4% 13.7% 11.7% 14.3% 13.5% 14.2% 13.6% 11.6% 14.6% 13.5% 13.9% 14.3% 14.6%
Operating margin (EBIT) 12.3% 12.3% 10.4% 12.1% 11.8% 12.2% 11.2% 9.3% 11.8% 11.2% 11.9% 11.2% 9.2% 12.2% 11.1% 11.6% 12.0% 12.3%
Taxes 37.8% 37.8% 36.3% 37.2% 37.9% 37.5% 37.5% 36.4% 37.4% 37.3% 38.5% 38.5% 38.5% 38.5% 38.5% 38.5% 38.5% 38.5%
Interest expense 3.6% 3.8% 4.0% 5.3% 4.2% 5.7% 5.8% 5.2% 5.2% 5.5% 5.2% 5.2% 5.2% 5.1% 5.2% 5.2% 5.2% 5.2%
Pretax margin 11.5% 11.5% 9.6% 10.9% 10.9% 10.9% 9.8% 8.0% 10.7% 9.9% 10.8% 10.1% 8.0% 11.2% 10.1% 10.7% 11.1% 11.5%
Net margin 7.2% 7.1% 6.1% 6.8% 6.7% 6.8% 6.2% 5.1% 6.7% 6.2% 6.7% 6.2% 4.9% 6.9% 6.2% 6.6% 6.8% 7.1%
Charge-offs 2.1% 2.2% 2.6% 2.3% 2.3% 2.2% 2.4% 2.9%
Aaron's Inc. (AAN): Buy

We are initiating coverage on AAN with a Buy rating and a
DCF-generated PT of $29. A leader in the rent-to-own
space, AAN's business model demonstrates resilience
through most economic cycles. The customer base has
limited access to credit, and the current restrictive credit
environment has increased the appeal of the RTO option.
Customers that cannot afford or obtain the necessary
financing to purchase home furnishings, electronics, and
small appliances are drawn to the rental contracts AAN
offers. Rentals are primarily offered on a monthly-contract
basis and include the option to return the item, purchase the
product outright, or pay through the full term of the lease.
This has translated to same-store revenue gains and
increased comparable-store customer counts for AAN in
FY11. We expect AAN to continue to expand its store base
in the MSD range on an annual basis out to FY15, and we
look for EPS to increase at a five-year CAGR of 11%. AAN
shares appear attractively valued given the company's
growth prospects. The stock currently trades at 13.5x our
FY12 EPS estimate and 7x FY12E EV/EBITDA.
We look for FY11 SSS growth of 5.1% on top of +4.1.
AAN generated total revenue growth of 7.3% on SSS up
5.3% on top of +3.2% in Q3. EPS of $0.36 came in near the
bottom of management's previous $0.35-$0.39 guidance
range. Margins were impacted by an elevated depreciation
expense related to a greater number of customers choosing
to payout their contracts early at a discounted price, as well
as higher costs related to the transition of recently acquired
stores to the HomeSmart concept. For FY11, AAN guided for
EPS of $1.73-$1.77, which is $0.04 lower on the top end.
We estimate total revenues will increase 7.7% yr./yr. to
$2.02B. Our estimates call for AAN to generate 120bps of
operating expense leverage in FY11. We are calling for EPS
of $1.76, one penny ahead of consensus.
Our model projects EPS will increase at a five-year
CAGR of 11%. Our estimates call for AAN to continue
expanding its store base in the mid-single-digit range in
FY12 and annually out to FY15. We believe a highly
restrictive credit environment will drive consumers to the
RTO option, which supports our projection of annual SSS
growth of 3.5% in FY12 through FY15.
The HomeSmart concept gives AAN an entree into the
weekly pay space. In Q3, AAN converted 37 stores it had
previously acquired to the HomeSmart concept. The
transition, coupled with the four new HomeSmart locations
that were opened in the quarter, brings the total number of
stores to 56. The HomeSmart model differs from Aaron's
stores in that it provides weekly-pay options, while product is
typically priced higher over the life of the contract to offset
increased cost of more frequent servicing of the lease.
Overhead expenses are less than at Aaron's concept, as the
locations are generally smaller than Aaron's 9,000 square

FY Ends
Dec. FY10 FY11 FY12
Rev.
($MM)

Q1 495 533 566E
Q2 445 483 508E
Q3 452 485 519E
Q4 484 520E 562E
FY 1877 2021E 2155E

Op. EPS

Q1 $0.45 $0.55 $0.61E
Q2 $0.35 $0.41 $0.41E
Q3 $0.31 $0.36 $0.42E
Q4 $0.37 $0.44E $0.50E
FY $1.37 $1.76E $1.95E

Key Data

52-week High $29.34
52-week Low $19.16
Short Interest 5.5%
Mkt. Cap. (MM) $2,052.5
Cash/share

$2.79
CY12E P/E

13.4x
CY12E P/FCF NMF
Price Target

$29

foot stores. Management said that it has yet to see material
cannibalization of the core concept in the small sample of
markets where HomeSmart operates. HomeSmart operates
locations in 10 states, and we estimate AAN's will open 14
more locations in Q4, bringing the total to 70 stores by YE11.
The HomeSmart concept is clearly still in the testing stages.
Following the Q4 ramp up to 70 stores, management said
that it plans to slow openings until it can better gauge the
success and business model of the concept compared with
Aaron's stores and other weekly pay businesses. Our model
does not reflect any further HomeSmart openings beyond
FY11. The 70 HomeSmart stores would give AAN a small
footing in the weekly-pay RTO business, but it poses very
little threat, at this point, to RCII. RCII operated over 3,000
locations at the end of Q3.
The company appears to be feeling out the European
market. In mid-October, AAN invested ten million British
pounds (about $15.4MM) to purchase an 11.5% interest in
Perfect Home Holdings Limited, a privately-held RTO
company in the United Kingdom. Perfect Home offers
contracts with weekly or monthly payments. According to
AAN management, the company primarily follows a weekly
pay model, as a significant portion of the customer base will
schedule payments to coincide with the receipt of weekly
government subsidies. BrightHouse is the industry leader in
the U.K. RTO market, with 240 retail locations nationwide
versus Perfect Home's 45 stores, but the latter company
plans to double its store count within the next few years. On
its Q3 conference call, management said Perfect Home
could open the door for European and international
expansion.
Interim CEO Ronald Allen brings a wealth of experience.
After more than three years at the helm, Robert C.
Loudermilk stepped down as CEO in early November.
Loudermilk, son of company founder and board Chairman R.
Charles Loudermilk, had served as President and COO for
eleven years prior to becoming CEO. AAN will conduct a
search to find a replacement, but it has named board
member Ronald W. Allen to serve as interim CEO until that
time. We believe the transition period will proceed smoothly
with Allen at the reins, given his experience, highlighted by a
decade-long stint as Chairman and CEO of Delta Airlines,
and his familiarity with AAN, having served on the board
since 1997. During Allen's tenure as CEO from 1987-1997,
Delta launched a major international expansion through the
near $2B purchase of assets from Pan Am, which included a
hub in Germany and a number of European routes, and the
airline completed a sizable restructuring that restored
profitability in FY95 coming out of the earlier economic
recession.
We have established a $29 PT based on our DCF. AAN's
current FY12E EV/NOPAT is 28x, but our model suggests it
should trade at a 31x EV/NOPAT multiple. Assuming AAN
shares converge to their intrinsic value over the next 12
months our model indicates the stock offers 12% upside
during that time frame.

Risks
AAN's customer base is pressured by high levels of
unemployment and persistent economic strain, the
continuation of which could pose risks to our top- and
bottom-line growth forecasts. Store growth within the core
concept could slow. HomeSmart's challenges include a
dominant competitor in the weekly space, and a volatile
economic climate in Europe may impact the company's
minority stake in Perfect Home.

Aaron's I nc. (AAN)
FY: December ($000s)
Consolidated income statement 2010A 2011E 2012E 2013E 2014E 2015E
Mar-10 Jun-10 Sep-10 Dec-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Dec-12 Dec-13 Dec-14 Dec-15
Lease revenues and fees 366,697 344,949 340,848 349,559 1,402,053 398,224 371,107 370,350 379,083 1,518,764 421,698 393,087 393,940 407,953 1,616,678 1,720,691 1,829,149 1,941,426
Retail sales 15,086 9,330 8,362 7,778 40,556 14,006 8,187 8,298 7,700 38,191 14,006 8,187 8,298 7,700 38,191 38,191 38,191 38,191
Non-retail sales 96,076 73,564 84,301 108,332 362,273 100,447 84,607 86,100 112,995 384,149 108,967 86,483 94,722 124,864 415,036 472,065 513,043 554,020
Franchise royalties and fees 14,927 14,147 14,537 15,501 59,112 16,343 15,176 15,889 16,668 64,076 17,552 16,380 17,305 18,235 69,472 78,318 84,265 90,086
Other 2,483 3,009 4,102 3,259 12,853 3,645 3,623 4,558 3,617 15,443 3,645 3,623 4,558 3,617 15,443 15,443 15,443 15,443
Total revenues 495,269 444,999 452,150 484,429 1,876,847 532,665 482,700 485,195 520,064 2,020,624 565,868 507,760 518,823 562,370 2,154,822 2,324,709 2,480,091 2,639,167
Retail cost of sales 8,962 5,651 4,415 3,985 23,013 8,480 4,805 4,872 4,466 22,623 8,194 4,806 4,813 4,466 22,278 22,151 22,151 22,151
Non-retail cost of sales 87,363 68,157 76,209 99,189 330,918 91,089 77,121 78,508 102,825 349,543 99,160 79,564 86,197 113,626 378,548 429,579 467,895 505,267
Operating expenses 206,459 206,210 206,021 206,239 824,929 216,410 211,390 218,319 217,387 863,506 229,743 229,507 232,433 235,071 926,754 999,625 1,066,439 1,134,842
Depreciation of rental merchandise 132,080 124,808 122,692 124,525 504,105 144,093 134,585 136,727 139,882 555,287 152,655 142,297 142,606 147,679 585,238 619,449 656,664 696,972
Operating income (EBI T) 60,405 40,173 42,813 50,491 193,882 72,593 54,799 46,769 55,504 229,665 76,117 51,585 52,774 61,528 242,004 253,905 266,942 279,936
EBI TDA 71,934 50,880 54,588 61,907 239,309 87,161 66,405 59,000 68,328 280,894 91,551 63,856 65,531 75,067 296,005 311,062 327,533 344,246
Interest expense 843 844 728 681 3,096 674 672 1,677 1,677 4,700 1,677 1,677 1,677 1,677 6,708 6,708 5,618 4,527
Pretax income 59,562 39,329 42,085 49,810 190,786 71,919 54,127 45,092 53,827 224,965 74,440 49,908 51,097 59,851 235,296 247,197 261,324 275,408
Taxes 22,587 14,894 15,906 19,023 72,410 27,530 20,834 17,047 20,024 85,435 27,692 18,566 19,008 22,265 87,530 91,957 97,213 102,452
Income before cumulative effect of accounting change 36,975 24,435 26,179 30,787 118,376 44,389 33,293 28,045 33,803 139,530 46,749 31,342 32,089 37,586 147,766 155,240 164,112 172,956
Cumulative effect of change
Net Income 36,975 24,435 26,179 30,787 118,376 44,389 33,293 28,045 33,803 139,530 46,749 31,342 32,089 37,586 147,766 155,240 164,112 172,956
Extraordinary item, net of taxes
Net income fromcontinuing ops. 36,975 24,435 26,179 30,787 118,376 44,389 33,293 28,045 33,803 139,530 46,749 31,342 32,089 37,586 147,766 155,240 164,112 172,956
Net income fromdiscontued ops.
Diluted EPS fromcont. operations $0.45 $0.35 $0.31 $0.37 $1.37 $0.55 $0.41 $0.36 $0.44 $1.76 $0.61 $0.41 $0.42 $0.50 $1.95 $2.07 $2.21 $2.35
Discontinued operations/nonrecurring items $0.00 $0.05 $0.01 $0.01 $0.07 $0.00 ($0.28) $0.00 ($0.28)
GAAP EPS $0.45 $0.30 $0.32 $0.38 $1.44 $0.55 $0.13 $0.36 $0.44 $1.48 $0.61 $0.41 $0.42 $0.50 $1.95 $2.07 $2.21 $2.35
Diluted weighted average shares outstanding 82,148 82,309 81,695 81,836 82,102 81,096 80,899 78,340 76,402 79,184 76,057 75,810 75,563 75,316 75,686 74,874 74,237 73,599
Dividend per share $0.01 $0.01 $0.01 $0.01 $0.05 $0.01 $0.01 $0.01 $0.01 $0.05 $0.02 $0.02 $0.02 $0.02 $0.05 $0.05 $0.05 $0.05
Dividend payout ratio 2.7% 3.4% 3.9% 3.3% 3.5% 2.4% 3.2% 3.6% 2.9% 3.0% 2.4% 3.6% 3.5% 3.0% 2.7% 2.5% 2.4% 2.2%
Free cash flow
Cash fromoperations (3,173) (3,746) 56,233 (53) 49,261 144,365 79,260 94,443 1,164 209,363 (20,280) 14,780 57,662 (20,916) 31,246 168,502 207,344 216,460
FCF (19,389) (30,920) 35,609 (23,675) (38,375) 128,590 58,097 75,430 (24,111) 128,137 (36,844) (7,442) 37,699 (47,455) (54,042) 78,950 113,315 117,729
FCF/share ($0.24) ($0.38) $0.44 ($0.29) ($0.47) $1.59 $0.72 $0.96 ($0.32) $1.62 ($0.48) ($0.10) $0.50 ($0.63) ($0.71) $1.05 $1.53 $1.60
Yr/yr. growth
Total revenues 4.5% 6.5% 8.9% 8.6% 7.1% 7.6% 8.5% 7.3% 7.4% 7.7% 6.2% 5.2% 6.9% 8.1% 6.6% 7.9% 6.7% 6.4%
SSS growth 4.4% 2.4% 3.2% 6.2% 4.1% 6.0% 5.0% 5.3% 4.0% 5.1% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5%
Customer count 840,000 859,000 872,000 912,000 912,000 914,000 935,000 961,000
Sequential change 1.3% 2.3% 1.5% 4.6% 0.0% 0.2% 2.3% 2.8%
Rentals and fees 6.4% 6.4% 6.3% 8.7% 7.0% 8.6% 7.6% 8.7% 8.4% 8.3% 5.9% 5.9% 6.4% 7.6% 6.4% 6.4% 6.3% 6.1%
Retail sales -5.0% -1.7% -5.5% -15.3% -6.5% -7.2% -12.3% -0.8% -1.0% -5.8% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Non-retail sales 3.3% 8.4% 21.3% 10.9% 10.4% 4.5% 15.0% 2.1% 4.3% 6.0% 8.5% 2.2% 10.0% 10.5% 8.0% 13.7% 8.7% 8.0%
Franchise royalties and fees 13.9% 9.5% 12.9% 10.5% 11.7% 9.5% 7.3% 9.3% 7.5% 8.4% 7.4% 7.9% 8.9% 9.4% 8.4% 12.7% 7.6% 6.9%
Other -66.9% -12.2% 19.7% -15.6% -27.6% 46.8% 20.4% 11.1% 11.0% 20.2% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Operating expense margin (bps) 22 192 (49) (137) 6 (106) (255) (57) (77) (122) (3) 141 (20) 0 27 (1) 0 0
Depreciation margin (bps) (32) (20) (51) (9) (28) 17 8 92 128 61 2 (7) (72) (70) (36) (20) (10) 0
Depreciation of rental merchandise 5.5% 5.8% 4.8% 8.5% 6.1% 9.1% 7.8% 11.4% 12.3% 10.2% 5.9% 5.7% 4.3% 5.6% 5.4% 5.8% 6.0% 6.1%
Operating expenditures 5.1% 11.1% 7.7% 5.2% 7.2% 4.8% 2.5% 6.0% 5.4% 4.7% 6.2% 8.6% 6.5% 8.1% 7.3% 7.9% 6.7% 6.4%
EPS 3.8% 1.5% 7.2% 20.0% -0.6% 21.6% 17.6% 15.3% 20.8% 28.4% 12.3% 0.5% 18.6% 12.8% 10.8% 6.2% 6.6% 6.3%
%of total revenues
Rentals and fees 74.0% 77.5% 75.4% 72.2% 74.7% 74.8% 76.9% 76.3% 72.9% 75.2% 74.5% 77.4% 75.9% 72.5% 75.0% 74.0% 73.8% 73.6%
Retail sales 3.0% 2.1% 1.8% 1.6% 2.2% 2.6% 1.7% 1.7% 1.5% 1.9% 2.5% 1.6% 1.6% 1.4% 1.8% 1.6% 1.5% 1.4%
Non-retail sales 19.4% 16.5% 18.6% 22.4% 19.3% 18.9% 17.5% 17.7% 21.7% 19.0% 19.3% 17.0% 18.3% 22.2% 19.3% 20.3% 20.7% 21.0%
Franchise royalties and fees 3.0% 3.2% 3.2% 3.2% 3.1% 3.1% 3.1% 3.3% 3.2% 3.2% 3.1% 3.2% 3.3% 3.2% 3.2% 3.4% 3.4% 3.4%
Other 0.5% 0.7% 0.9% 0.7% 0.7% 0.7% 0.8% 0.9% 0.7% 0.8% 0.6% 0.7% 0.9% 0.6% 0.7% 0.7% 0.6% 0.6%
Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Margins
Retail cost of sales 59.4% 60.6% 52.8% 51.2% 56.7% 60.5% 58.7% 58.7% 58.0% 59.2% 58.5% 58.7% 58.0% 58.0% 58.3% 58.0% 58.0% 58.0%
Non-retail cost of sales 90.9% 92.6% 90.4% 91.6% 91.3% 90.7% 91.2% 91.2% 91.0% 91.0% 91.0% 92.0% 91.0% 91.0% 91.2% 91.0% 91.2% 91.2%
Operating expenses 41.7% 46.3% 45.6% 42.6% 44.0% 40.6% 43.8% 45.0% 41.8% 42.7% 40.6% 45.2% 44.8% 41.8% 43.0% 43.0% 43.0% 43.0%
Depreciation of rental merchandise 36.0% 36.2% 36.0% 35.6% 36.0% 36.2% 36.3% 36.9% 36.9% 36.6% 36.2% 36.2% 36.2% 36.2% 36.2% 36.0% 35.9% 35.9%
Operating margin (EBI T) 12.2% 9.0% 9.5% 10.4% 10.3% 13.6% 11.4% 9.6% 10.7% 11.4% 13.5% 10.2% 10.2% 10.9% 11.2% 10.9% 10.8% 10.6%
Taxes 37.9% 37.9% 37.8% 38.2% 38.0% 38.3% 38.5% 37.8% 37.2% 38.0% 37.2% 37.2% 37.2% 37.2% 37.2% 37.2% 37.2% 37.2%
Pretax margin 12.0% 8.8% 9.3% 10.3% 10.2% 13.5% 11.2% 9.3% 10.4% 11.1% 13.2% 9.8% 9.8% 10.6% 10.9% 10.6% 10.5% 10.4%
Net margin 7.5% 5.5% 5.8% 6.4% 6.3% 8.3% 6.9% 5.8% 6.5% 6.9% 8.3% 6.2% 6.2% 6.7% 6.9% 6.7% 6.6% 6.6%
Charge-off rate 2.6% 3.4% 3.1% 2.5% 2.7% 3.3%
Lumber Liquidators (LL): Buy

We are launching coverage on LL with a Buy rating and
DCF-generated $26 PT. The company began lapping last
year's botched implementation of SAP technology systems
in Q3, and it faces easier comps in the coming quarters. We
think benefits from recent sourcing improvements, including
the completion of multiple line reviews and the acquisition of
its major sourcing partner in China, should start to flow
through in Q4 with the bulk of the margin impact coming in
FY12. LL plans to utilize some of the cost savings from its
sourcing initiatives to beef up promotional marketing and
shore up opening price points. We are modeling for EPS
growth of 61% in H2:11 following a 32% decline in H1:11.
Our forecast calls for EPS growth of 38% in FY12, and we
are currently the high estimate on the Street. Based on our
expectation of an EPS recovery gaining momentum in FY12,
we believe LL shares are attractively valued at 12x our FY12
EPS estimate and 6x FY12E EV/EBITDA. Longer term, we
estimate five-year sales and EPS CAGRs of 11% and 18%,
respectively. Five-year projected annual store growth of 15%
is the highest of all the retail names in our coverage.
Comparisons have started to ease. LL reported SSS
growth of 3% in Q3 on top of -5.7%, having lapped last
year's bungled implementation of a new SAP system. The
prolonged system integration resulted in sales shortfalls,
margin erosion, and inventory-management issues, the
impacts of which were prevalent through H1:11. LL is
beginning to reap the benefits from a fully-functioning
system, including automatic inventory replenishment,
improved planning and allocation processes, and enhanced
point-of-sale systems. Our forecast calls for Q4 SSS growth
of 1% on top of +1.2%. LL also began lapping easy margin
comparisons in Q3. Gross margin expanded 45bps yr./yr. in
Q3 following a 126bps decline a year ago. The company
generated 125bps of SG&A expense leverage in the recent
quarter, compared with an increase of 295bps in Q3:10. LL
is up against easy margin comparisons in Q4. In Q4:10, LL
suffered 132bps of yr./yr. gross margin compression, and the
SG&A expense rate increased 101bps. We are modeling for
gross margin expansion of 205bps in Q4 and for SG&A
expense leverage of 80bps. We are calling for FY11 EPS of
$0.97, in-line with consensus.

Our FY12 EPS estimate is the highest on the Street. LL
will face easy sales comparisons in FY12. H1:11 SSS
declined 6.2%, and FY11 SSS guidance is for a flat showing
to a low-single-digit decline. We estimate 13% sales growth
in FY12 on SSS up 4% on top of -2.2%. The consensus
forecast calls for an 11% increase in sales. The ongoing

FY Ends
Dec. FY10 FY11 FY12
Rev.
($MM)

Q1 151 160 184E
Q2 169 176 204E
Q3 147 172 187E
Q4 153 173E 193E
FY 620 680E 768E

Op. EPS

Q1 $0.25 $0.20 $0.25E
Q2 $0.32 $0.19 $0.32E
Q3 $0.15 $0.24 $0.31E
Q4 $0.21 $0.34E $0.45E
FY $0.93 $0.97E $1.33E

Key Data

52-week High $28.96
52-week Low $13.43
Short Interest 22.5%
Mkt. Cap. (MM) $444.2
Cash/share

$1.33
CY12E P/E

11.8x
CY12E P/FCF 19.2x
Price Target

$26

sourcing initiatives, coupled with the double-digit top-line
growth we project, should drive margin expansion of 69bps
in FY12 to 36.1%. Consensus gross margin expectations are
slightly higher at 36.3%. We are forecasting 59bps of SG&A
rate improvement to 28.3% of sales, which is 30bps better
than consensus. Our FY12 EPS estimate of $1.33 is $0.13
above consensus and the highest on the Street.
The marketing message focuses on a heightened level
of consumer price sensitivity. Amid the ongoing economic
turbulence, consumers remain extremely cautious and very
promotionally driven in purchasing big-ticket discretionary
items. Although LL's average sale increased 4.7% yr./yr. in
Q3, as purchases were geared more toward premium
products across multiple categories, total customers invoiced
declined 1.5% on top of a 5.2% decline in Q3:10.
Management indicated that customer interest was there in
Q3, but similar to Q2 when increased samples did not lead
to sales, caution prevailed. LL credits the overall reluctance
to spend on big-ticket discretionary items for the traffic
decline rather than a fiercer competitive environment. The
company's marketing strategy emphasizes promotions and
more aggressive opening price points in an effort to close
sales. LL plans to utilize some of the cost savings from its
sourcing initiatives to support the marketing message.
Sourcing initiatives should generate significant cost
savings. LL has begun a multi-phase sourcing initiative in
an effort to reduce costs and improve the productivity and
quality of its vendor base. The initial efforts of the program
have led to greater vendor reimbursements for sample costs,
promotional programs, and volume allowances. Earlier in the
year, management began the company's first-ever category-
by-category line review. LL completed initial line reviews of
the laminates business in Q2 and finished the engineered
hardwood category in Q3. The laminates and engineered
hardwood categories account for about 30% of total sales.
Both current and new vendors, including a number of mills in
China, were asked to submit competitive bids for products
within the merchandise category. Through the process, the
company broadened its vendor base and garnered sizable
cost concessions. The reviews should have a noticeable
impact on margins as the lower-cost product rolls out to
stores through the end of FY11 and into FY12. Management
indicated that the benefits may not flow through for six
months following the reviews. As a result, we think LL should
start to see some margin benefit, specifically from the
laminates review, by YE11, but it now looks for a greater
portion of the impact to come in FY12. Management
estimates that the total impact from all sourcing initiatives,
primarily volume-based discounts, vendor reimbursements,
and promotional programs, added 80bps to gross margin in
Q3, and it expects a greater lift to margins in Q4. We look for
205bps of gross margin expansion in Q4. LL plans to
conduct line reviews across every product category over the
next 12 months. In the second year of the line reviews, LL
will reevaluate and consolidate vendors. Management has
said a portion of the overall savings will be utilized to
sharpen opening price points and increase promotions, but it
expects the bulk of the margin improvement from the line
reviews to flow through to the bottom line.
The acquisition in China removes the company's key
middle-man. This quarter, LL is acquiring assets of its
supply chain partner Sequoia Floorings in China. The
acquisition essentially removes the middle man, allowing LL
to directly manage around 90% of its purchases from vendor
mills in Asia. Sequoia was the trading company for 42% of
the company's total merchandise purchases for FY11. By
assuming control over its sourcing in Asia, LL should
materially lower product costs, while shoring up its direct
relationships with vendor mills, which have proven to be a
significant competitive advantage. In addition to lower costs,
the direct vendor-mill relationship leads to greater visibility
and a broader product assortment. The acquisition included
an initial cash payment of around $5MM, with additional
considerations likely to reach about $3MM. Management
believes the reduced unit costs resulting from its direct
control of sourcing in Asia will start to be reflected in Q4,
having a greater impact on margins in FY12.
LL has the highest unit growth potential in our
coverage. The company has expanded its store base from
91 locations in 39 states at the end of 2006 to 251 locations
in 46 states and another five stores in the greater Toronto
region at the end of Q3:11. We estimate LL will open another
eight locations in Q4, with FY11 unit growth topping 18%
yr./yr. The company is not hamstrung by sizable investments
in new store development. Occupancy costs are extremely
low, typically less 4% of sales, and stores generally employ
a limited staff of one manager and two to three associates.
In the first three quarters of FY11, occupancy costs were
slightly higher at 4% of sales ($20.1MM) as a result of both a
greater number of store openings than in years past and
investments in expanding warehousing and distribution in
Canada. We are projecting unit growth of 16% in FY12 to
306 total locations. Management's long-term target is to
build a domestic footprint of 400 locations with another 40-50
in Canada. Our model calls for stores to increase at a five-
year CAGR of 15%, which represents the highest pace of
growth and is well above the average of all the retailers
under our coverage.
Cannibalization is less of a factor as LL expands in
current markets. Since its IPO filings in 2007, management
has said it expects 300bps-500bps of SSS cannibalization
from new store openings. LL usually experiences a
significant amount of cannibalization when it opens the
second store in a market, but it benefits from a sizable
increase in total net sales within the market. In addition, the
cannibalization impact on the comparable store within a
market lessens with each subsequent opening. Given the
greater number of store openings in existing markets in
FY11 compared with FY10, management indicated
cannibalization was higher than it had anticipated in Q3. We
believe LL will operate toward the lower end of its
cannibalization guidance range of 300bps-500bps as its
markets become more fully-served. We are not particularly
troubled by LL's SSS cannibalization, given the low
occupancy costs and limited in-store staffing needs. The
incremental sales from each new store opening allows for
better leverage of LL's national advertising spend (at 8% of
sales, LL's ad spend is much higher than for most retailers).
As a result, we believe that each incremental store opening
is beneficial to EBIT margin, even if SSS is cannibalized.
We expect EPS to increase at a five-year CAGR of 18%.
We believe sales will grow at a five-year CAGR of 11%, and
the sourcing initiatives and a fully-implemented SAP system
should help drive annual gross margin expansion of about
10bps annually over the FY13-FY15 time frame. LL's
technology investments are also largely completed, in our
view, which should result in a reduction in capital spending
requirements from FY10's peak $20MM level. We estimate
FCF per share to increase from $0.20 in FY10 to $1.70 in
FY15.
The management transition should be smooth. At the
start of FY12, CEO Jeffrey Griffiths plans to step down as
CEO, handing the reins over to current President and COO
Robert Lynch. Lynch has served in this role since January
2011, and he has been the driver of the company's new
sourcing initiatives. We believe this will be a seamless
transition, given Lynch's experience in the home-
improvement segment. He served as President and CEO of
Orchard Supply Hardware (a subsidiary of Sears Holdings at
the time) and worked in various positions in store operations
and business development at Home Depot.
We are establishing a $26 PT based on our discounted
NOPAT model. Our DCF indicates a multiple of 22x FY12E
EV/NOPAT is warranted for LL shares, well above the
stock's current 10x multiple. This suggests shares offer
potential upside of 65%.
Risks
Without a significant improvement in the current economic
and consumer climates, customers are likely to remain
extremely cautious when purchasing big-ticket discretionary
items. Additional risks to our projections include more
aggressive pricing from competitors such as Home Depot,
which could pressure LL to further reduce price points on
entry-level product, and a higher level of cannibalization as
LL expands in its existing markets.
Lumber Liquidators (LL)
FY: Dec. ($MMs)
Income Statement
2010A 2011E 2012E 2013E 2014E 2015E
Mar-10 Jun-10 Sep-10 Dec-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Dec-11 Mar-12 Jun-12 Sep-12 FY Dec-12 Dec-13 Jan-14 Dec-15
Sales 151.2 168.7 147.2 153.2 620.3 159.7 175.5 172.0 173.2 680.4 184.1 203.7 187.4 192.5 767.7 854.7 943.5 1,033.7
COGS 97.7 110.1 95.4 101.2 404.5 101.9 115.7 110.7 110.9 439.2 117.8 132.4 118.8 121.2 490.3 544.9 600.6 656.8
Gross profit 53.5 58.5 51.8 52.0 215.8 57.8 59.7 61.2 62.4 241.1 66.3 71.3 68.6 71.2 277.4 309.8 343.0 376.9
SG&A expense 42.2 43.9 44.9 42.7 173.7 48.5 51.1 50.3 46.9 196.7 55.0 57.0 54.6 50.8 217.4 237.5 257.9 278.3
Advertising 12.7 13.2 13.3 10.6 49.8 13.3 15.0 13.3 12.1 53.7 14.9 16.3 14.2 12.1 57.6 60.7 63.2 65.1
Payroll 17.1 17.6 17.4 17.4 69.6 19.6 19.9 19.5 19.8 78.8 22.1 22.4 21.6 21.9 88.0 98.3 108.5 118.9
Equity compensation 0.7 0.8 0.8 0.8 3.1 0.9 1.1 1.0 0.9 3.9 1.1 1.0 0.9 1.0 4.0 4.3 4.7 5.2
Occupancy costs 5.3 5.4 5.6 5.9 22.2 6.4 6.4 7.2 6.2 26.2 7.4 7.3 7.9 6.9 29.5 32.5 35.9 39.3
Depreciation 1.2 1.3 1.4 1.7 5.6 1.9 2.1 2.1 2.2 8.3 2.2 2.4 2.3 2.4 9.3 9.3 9.7 10.5
Other expenses 5.4 5.5 6.4 6.3 23.6 6.3 6.6 7.1 5.7 25.7 7.4 7.5 7.7 6.4 28.9 32.5 35.9 39.3
EBIT 11.3 14.7 6.9 9.3 42.2 9.3 8.7 10.9 15.5 44.4 11.3 14.3 14.0 20.5 60.0 72.4 85.1 98.6
EBITDA 12.5 16.0 8.3 11.1 47.8 11.3 10.8 13.1 17.7 52.7 13.4 16.7 16.3 22.9 69.4 81.6 94.8 109.2
Interest expense (income)
Other expense (income) (0.1) (0.1) (0.1) (0.2) (0.6) (0.1) (0.1) (0.1) (0.4) (1.5) (0.5) (0.5) (0.5) (0.5) (2.0) (2.0) (2.0) (2.0)
Pretax income 11.4 14.8 7.0 9.6 42.7 9.4 8.7 11.1 15.9 45.1 11.8 14.8 14.5 21.0 62.0 74.4 87.1 100.6
Taxes 4.4 5.7 2.7 3.6 16.5 3.7 3.5 4.3 6.2 17.6 4.6 5.7 5.6 8.1 24.1 28.8 33.8 39.0
Net income 7.0 9.1 4.3 5.9 26.3 5.8 5.3 6.7 9.7 27.5 7.2 9.1 8.9 12.8 37.9 45.5 53.3 61.6
Diluted operating EPS $0.25 $0.32 $0.15 $0.21 $0.93 $0.20 $0.19 $0.24 $0.34 $0.97 $0.25 $0.32 $0.31 $0.45 $1.33 $1.60 $1.87 $2.16
Fully diluted shares 28.2 28.3 28.2 28.3 28.2 28.4 28.4 28.3 28.5 28.5 28.5 28.5 28.5 28.5 28.5 28.5 28.5 28.5
Margins
Gross margin 35.4% 34.7% 35.2% 34.0% 34.8% 36.2% 34.0% 35.6% 36.0% 35.4% 36.0% 35.0% 36.6% 37.0% 36.1% 36.3% 36.4% 36.5%
SG&A expense 27.9% 26.0% 30.5% 27.9% 28.0% 30.3% 29.1% 29.3% 27.1% 28.9% 29.9% 28.0% 29.1% 26.4% 28.3% 27.8% 27.3% 26.9%
EBIT 7.5% 8.7% 4.7% 6.1% 6.8% 5.8% 4.9% 6.3% 8.9% 6.5% 6.1% 7.0% 7.5% 10.6% 7.8% 8.5% 9.0% 9.5%
EBITDA 8.3% 9.5% 5.6% 7.2% 7.7% 7.0% 6.1% 7.6% 10.2% 7.8% 7.3% 8.2% 8.7% 11.9% 9.0% 9.6% 10.1% 10.6%
Tax rate 38.8% 38.6% 38.8% 38.0% 38.5% 38.7% 39.5% 39.2% 38.8% 39.0% 38.8% 38.8% 38.8% 38.8% 38.8% 38.8% 38.8% 38.8%
Net margin 4.6% 5.4% 2.9% 3.9% 4.2% 3.6% 3.0% 3.9% 5.6% 4.0% 3.9% 4.4% 4.7% 6.7% 4.9% 5.3% 5.6% 6.0%
Yr./yr. growth
Sales 22.1% 17.9% 4.7% 11.8% 13.9% 5.6% 4.0% 16.8% 13.1% 9.7% 15.3% 16.1% 9.0% 11.1% 12.8% 11.3% 10.4% 9.6%
SSS 8.0% 5.5% -5.7% 1.2% 2.1% -4.3% -7.9% 3.0% 1.0% -2.2% 7.0% 7.0% 0.0% 2.0% 4.0% 3.0% 3.0% 3.0%
2-year SSS 2.2% 3.7% -3.8% 6.7% 2.1% 3.7% -2.4% -2.7% 2.2% -0.1% 2.7% -0.9% 3.0% 3.0% 1.7% 7.0% 6.0% 6.0%
Gross margin (bps) (59) (63) (126) (132) (95) 81 (67) 45 205 65 (19) 96 99 100 69 12 10 11
SG&A expense (bps) (139) (142) 295 101 26 242 309 (125) (80) 91 (47) (111) (12) (68) (59) (53) (45) (41)
Gross profit 20.1% 15.7% 1.1% 7.6% 10.9% 8.0% 2.0% 18.3% 19.9% 11.7% 14.7% 19.4% 12.0% 14.2% 15.0% 11.7% 10.7% 9.9%
SG&A expense 16.3% 11.8% 16.0% 16.0% 15.0% 14.8% 16.4% 12.1% 9.8% 13.3% 13.5% 11.7% 8.5% 8.3% 10.5% 9.2% 8.6% 7.9%
EBITDA 31.9% 27.5% -39.1% -13.4% -1.1% -9.9% -32.7% 58.2% 59.8% 10.4% 19.5% 55.3% 24.9% 29.6% 31.5% 17.7% 16.2% 15.1%
Operating EPS 31.9% 27.5% -45.5% -17.4% -4.4% -17.7% -42.1% 56.7% 63.1% 3.9% 24.2% 70.8% 30.8% 31.8% 37.8% 19.9% 17.1% 15.5%
Yr./yr. growth/square foot
SG&A expense/sq. ft. -5.5% -7.5% -3.6% -3.3% -4.1% -5.4% -5.5% -6.8% -7.2% -4.3% -1.0% -3.1% -6.5% -6.6% -4.7% -4.8% -3.7% -3.1%
Occupancy expense/sq. ft. -0.0% 1.6% -3.1% 0.6% 0.6% -0.4% -3.8% 7.0% -10.8% -0.2% 0.5% -0.5% -5.8% -4.2% -3.0% -4.0% -2.1% -1.6%
Payroll expense/sq. ft. 3.6% 0.4% -5.6% -6.4% -1.3% -5.4% -8.2% -6.8% -4.4% -4.3% -1.7% -2.5% -4.7% -4.2% -3.7% -2.6% -2.2% -1.6%
Free cash flow
Cash from operating activities 17.9 (5.3) (9.6) 9.7 26.3 11.1 (7.6) 12.6 9.9 27.5 19.2 (28.3) 37.4 4.6 37.9 45.5 53.3 61.6
Capital expenditures (3.6) (4.8) (5.7) (6.4) (20.5) (4.2) (4.1) (3.3) (4.2) (15.9) (2.6) (2.7) (4.7) (4.7) (14.7) (14.5) (14.2) (13.4)
FCF 14.3 (10.1) (15.4) 3.3 5.7 6.9 (11.7) 9.2 5.7 11.7 16.6 (31.0) 32.8 (0.1) 23.2 31.0 39.2 48.2
FCF/share $0.51 ($0.36) ($0.54) $0.12 $0.20 $0.24 ($0.41) $0.33 $0.20 $0.41 $0.58 ($1.09) $1.15 ($0.00) $0.81 $1.09 $1.37 $1.69
Home Depot (HD): Neutral

We are launching coverage of HD with a Neutral rating and
PT of $44 (based on 16x our 2012 EPS estimate of $2.74).
Sales trends appear to be improving for Home Depot, as
SSS have increased on a 2-year basis for four consecutive
quarters following 17 straight declines. We believe the
company's recent infrastructure investments will improve its
supply chain and technology systems, enhancing gross
margin expansion potential. Management raised its FY11
EPS guidance following Q3 results, and we expect HD's
recovery to continue with double-digit earnings growth in
FY12. Based on our FY12 estimates, shares currently trade
at 15x EPS and 9x EV/EBITDA. We view this as a fair
valuation, given the limited visibility surrounding the housing
market and home-related spending.
HD appears to be gaining some sales momentum.
Spending on home-related items and home-improvement
projects dwindled through the recent recession and
persistent sluggish housing market. Beginning in H2:06, HD
reported 17 consecutive SSS declines on a stacked 2-year
basis through Q4:10. Two-year SSS trends have improved in
FY11, with HD reporting SSS growth of 4.2% on top of
+1.4% in Q3. Transactions rose 1.2% yr./yr. in the October
quarter, and average ticket grew 3%. Storm-related repairs
following Hurricane Irene provided a boost to sales, but
demand has improved in a number of core categories. HD
reported positive comps in categories such as tools,
electrical, plumbing, and hardware. This indicates to us that
after a few years of postponing home-improvement projects,
consumers are now willing to address smaller home repairs.
Consumers do not yet appear ready to spend on larger,
more-discretionary projects, as HD's sales in categories
such as lumber, bath, and millwork all trended lower in Q3.
Without a significant and sustainable improvement in
housing and home prices, we believe purchases of big-ticket
discretionary items will be slow to recover. We estimate HD
will generate SSS growth of 2.3% on top of +2.9% in FY11,
followed by an increase of 2.8% in FY12.
Recent infrastructure improvements should support top-
line execution. HD completed a new network of 19 rapid
deployment centers (RDCs), which differ from a traditional
DC in that there is no packing and storing, but there are
more processes that take place than in a cross-dock DC to
ensure that each store gets the appropriate merchandise.
HD has said that the greatest benefits from RDCs relative to
its previous direct-to-store system are shorter lead times
(allowing for faster reactions to demand trends) and the
elimination of vendor minimums, which often resulted in
items being either overstocked or completely out-of-stock.
The company had been adding mechanization to the RDCs
and expects all but one facility to be completed by the end of
FY12. By FY15, HD plans to have 75% of COGS handled
through its centralized distribution system, up from 65% in
Q1-Q3 and 25% in FY07 prior to the RDC strategy's

FY Ends
Jan. FY10 FY11 FY12
Rev. ($MM)

Q1 16863 16823 17734E
Q2 19410 20232 20494E
Q3 16598 17326 17748E
Q4 15126 15294E 15822E
FY 67997 69675E 71799E

Op. EPS

Q1 $0.45 $0.50 $0.61E
Q2 $0.72 $0.86 $0.97E
Q3 $0.51 $0.60 $0.68E
Q4 $0.36 $0.41E $0.48E
FY $2.03 $2.38E $2.74E

Key Data

52-week High $40.72
52-week Low $28.13
Short Interest 1.9%
Mkt. Cap. (MM) $62,570.2
Net Debt (MM) $14,218.0
Cash/share

$1.44
CY12E P/E

14.7x
CY12E P/FCF 12.9x
Price Target

$44

implementation. Management says that it expects its new
distribution network to have a 40bps benefit to margins, but
this may prove to be conservative given the efficiency
improvements HD is seeing. Technology upgrades included
the implementation of software designed to more accurately
forecast inventory demand based on SKU sales history and
seasonal patterns, as well as the potential impact from
promotions. This should enable HD to better manage
inventories through more-effective stocking and
replenishment processes.
Our FY11 EPS estimate is in-line with consensus. We
estimate FY11 EPS of $2.38, reflecting management's $0.04
increase to its previous $2.34 guidance following Q3 results.
HD has beaten consensus EPS estimates every quarter
since Q4:07. For FY12, we look for EPS of $2.74, $0.01
above consensus.
Our discounted NOPAT model suggests HD shares are fully
valued. The stock currently trades at a FY12E EV/NOPAT
multiple of 16x. Our model implies that a multiple of 15x is
more representative of its intrinsic value, representing
potential downside risk of 13%. We believe this would
represent an overly conservative price target given the
company's strong recent performance and continued margin
drivers. We believe a 16x multiple on our 2012 EPS estimate
of $2.74, or $44, is a more reasonable target. 16x is the
historical 10-year average multiple for HD, which we believe
is still appropriate as weaker industry trends are currently
being offset by improved execution. This implies that HD's
prospects are already reasonably well-priced by investors in
today's market.
The Home Depot, Inc. (HD)
FY: January ($MMs)
Income statement 2010A 2011E 2012E 2013E 2014E 2015E
Net sales 16,863 19,410 16,598 15,126 67,997 16,823 20,232 17,326 15,294 69,675 17,734 20,494 17,748 15,822 71,799 74,869 77,790 80,819
Cost of merchandise sold 11,069 12,828 10,913 9,883 44,693 10,995 13,356 11,365 9,987 45,703 11,580 13,510 11,625 10,316 47,031 48,953 50,696 52,508
Gross profit 5,794 6,582 5,685 5,243 23,304 5,828 6,876 5,961 5,307 23,972 6,154 6,984 6,123 5,506 24,767 25,916 27,094 28,311
SG&A expense 4,078 4,127 3,837 3,807 15,849 4,009 4,186 3,956 3,770 15,921 4,150 4,140 3,993 3,861 16,144 16,696 17,192 17,780
Depreciation 411 406 400 399 1,616 397 396 390 393 1,576 393 397 389 389 1,569 1,553 1,540 1,531
EBITDA 1,716 2,455 1,848 1,436 7,455 1,819 2,690 2,005 1,537 8,051 2,004 2,845 2,130 1,646 8,624 9,221 9,903 10,531
EBIT 1,305 2,049 1,448 1,037 5,839 1,422 2,294 1,615 1,145 6,476 1,611 2,447 1,740 1,257 7,055 7,667 8,363 9,000
Interest income 4 3 4 4 15 2 3 4 4 13 5 5 5 5 20 25 30 30
Interest expense (142) (151) (146) (91) (530) (141) (149) (162) (162) (614) (154) (154) (154) (154) (614) (586) (557) (529)
Pretax income 1,167 1,901 1,306 950 5,324 1,283 2,148 1,457 986 5,874 1,462 2,299 1,592 1,108 6,461 7,106 7,835 8,501
Income taxes 409 709 472 363 1,953 471 785 523 369 2,148 535 840 582 405 2,362 2,598 2,865 3,108
Net income from continuing ops 758 1,192 834 587 3,371 812 1,363 934 617 3,726 928 1,458 1,010 703 4,099 4,508 4,970 5,392
Net income from discontinued ops
Operating EPS $0.45 $0.72 $0.51 $0.36 $2.03 $0.50 $0.86 $0.60 $0.41 $2.38 $0.61 $0.97 $0.68 $0.48 $2.74 $3.16 $3.62 $4.07
Discontinued operation
Dividends per share $0.24 $0.24 $0.24 $0.24 $0.95 $0.25 $0.25 $0.25 $0.29 $1.04 $0.29 $0.29 $0.29 $0.29 $1.16 $1.40 $1.60 $1.90
Payout ratio 52.6% 33.0% 46.6% 65.4% 46.5% 49.6% 28.9% 41.4% 71.5% 43.8% 47.3% 29.9% 42.6% 60.4% 42.3% 44.3% 44.2% 46.7%
Fully diluted shares 1,688 1,663 1,646 1,626 1,658 1,611 1,577 1,548 1,523 1,568 1,514 1,504 1,484 1,464 1,494 1,427 1,374 1,324
Margins
Gross margin 34.4% 33.9% 34.3% 34.7% 34.3% 34.6% 34.0% 34.4% 34.7% 34.4% 34.7% 34.1% 34.5% 34.8% 34.5% 34.6% 34.8% 35.0%
SG&A expense 24.2% 21.3% 23.1% 25.2% 23.3% 23.8% 20.7% 22.8% 24.7% 22.9% 23.4% 20.2% 22.5% 24.4% 22.5% 22.3% 22.1% 22.0%
Depreciation 2.4% 2.1% 2.4% 2.6% 2.4% 2.4% 2.0% 2.3% 2.6% 2.3% 2.2% 1.9% 2.2% 2.5% 2.2% 2.1% 2.0% 1.9%
EBIT 7.7% 10.6% 8.7% 6.9% 8.6% 8.5% 11.3% 9.3% 7.5% 9.3% 9.1% 11.9% 9.8% 7.9% 9.8% 10.2% 10.8% 11.1%
EBITDA 10.2% 12.6% 11.1% 9.5% 11.0% 10.8% 13.3% 11.6% 10.1% 11.6% 11.3% 13.9% 12.0% 10.4% 12.0% 12.3% 12.7% 13.0%
Interest rate 5.9% 6.2% 6.0% 3.7% 5.4% 5.2% 5.5% 6.0% 6.0% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% 5.7%
Tax rate 35.0% 37.3% 36.1% 38.2% 36.7% 36.7% 36.5% 35.9% 37.4% 36.6% 36.6% 36.6% 36.6% 36.6% 36.6% 36.6% 36.6% 36.6%
Net margin 4.5% 6.1% 5.0% 3.9% 5.0% 4.8% 6.7% 5.4% 4.0% 5.3% 5.2% 7.1% 5.7% 4.4% 5.7% 6.0% 6.4% 6.7%
Yr./yr. change
Sales 5.7% 1.8% 1.4% 3.8% 3.1% -0.2% 4.2% 4.4% 1.1% 2.5% 5.4% 1.3% 2.4% 3.5% 3.0% 4.3% 3.9% 3.9%
SSS 4.8% 1.7% 1.4% 3.9% 2.9% -0.6% 4.3% 4.2% 1.0% 2.3% 5.0% 1.5% 2.0% 3.0% 2.8% 3.0% 3.0% 3.0%
2-yr. comp -5.4% -6.8% -5.5% 5.1% -3.7% 4.2% 6.0% 5.6% 4.9% 5.2% 4.4% 5.8% 6.2% 4.0% 5.1% 5.8% 6.0% 6.0%
in gross margin (bps) 38 41 26 25 33 28 8 15 4 13 6 9 10 10 9 12 21 20
in sg&a expenses (bps) (26) (25) (48) (139) (54) (35) (57) (28) (52) (46) (43) (49) (33) (25) (37) (18) (20) (10)
Square ft. 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.2% 0.2% 0.4% 0.6% 0.7% 0.6% 0.6% 0.9% 0.9% 0.9%
Gross profit 6.9% 3.0% 2.2% 4.6% 4.1% 0.6% 4.5% 4.9% 1.2% 2.9% 5.6% 1.6% 2.7% 3.8% 3.3% 4.6% 4.5% 4.5%
SG&A expense 4.6% 0.6% -0.6% -1.6% 0.8% -1.7% 1.4% 3.1% -1.0% 0.5% 3.5% -1.1% 0.9% 2.4% 1.4% 3.4% 3.0% 3.4%
Depreciation -3.3% -6.5% -6.5% -4.3% -5.2% -3.4% -2.5% -2.5% -1.6% -2.5% -1.0% 0.3% -0.2% -0.9% -0.4% -1.0% -0.8% -0.6%
EBITDA 11.5% 5.7% 7.1% 22.8% 10.4% 6.0% 9.6% 8.5% 7.0% 8.0% 10.2% 5.7% 6.2% 7.1% 7.1% 6.9% 7.4% 6.3%
EPS 29.2% 7.5% 23.4% 51.9% 22.4% 12.2% 20.6% 19.1% 12.3% 16.9% 21.5% 12.2% 12.8% 18.4% 15.4% 15.2% 14.5% 12.6%
Free cash flow
Cash from operating activities 2,039 1,324 623 599 4,585 2,098 2,389 1,204 1,293 6,984 655 2,932 1,250 1,119 5,957 6,118 6,344 6,751
Depreciation and amortization 438 428 426 426 1,718 424 425 416 393 1,658 393 397 389 389 1,569 1,553 1,540 1,531
Capital expenditures 167 240 282 407 1,096 199 270 351 435 1,255 265 283 356 359 1,263 1,348 1,400 1,455
FCF 1,872 1,084 341 192 3,489 1,899 2,119 853 858 5,729 390 2,649 894 760 4,693 4,770 4,944 5,296
FCF per share $1.11 $0.65 $0.21 $0.12 $2.10 $1.18 $1.34 $0.55 $0.56 $3.65 $0.26 $1.76 $0.60 $0.52 $3.14 $3.34 $3.60 $4.00
Lowe's (LOW): NeutraI

We are launching coverage on LOW with a Neutral rating
and a DCF-generated PT of $26. After nearly five years of
negative SSS results on a 2-year basis, Lowe's reported
consecutive increases in Q2 and Q3; however, Q3 marked
the tenth straight quarter LOW's SSS growth trailed HD.
Sales in some core categories have improved, but big-ticket
items continued to trend lower. Traffic increased at LOW in
Q3, but the average ticket was flat. Transactions greater
than $500 declined 0.8% on a comparable basis, suggesting
consumers remain cautious when making costly home-
improvement purchases. LOW has begun a company-wide
revamp, which includes the closure of 27 underperforming
stores, a merchandising reorganization, a shift from
promotional pricing and costing to EDLP, and in-store and
online upgrades in an effort to win back shoppers. We will be
slow to judge these initiatives, as HD's execution
improvements create a difficult competitive dynamic. We
look for an anemic sales recovery in FY12. Based on our
FY12 estimates, LOW trades at a slight discount to HD,
which we view as justified by the continued SSS
underperformance and the margin expansion potential we
believe HD's recent infrastructure investments present.
We expect HD's SSS outperformance to continue in the
near term. We look for LOW's to report a SSS decline of
0.8% on top of +1.3% in FY11. In FY12, our estimate calls
for SSS growth of 1.7%. By comparison, we are projecting
SSS gains of 2.3% on top of +2.9% for HD in FY11, followed
by 2.8% growth in FY12. We believe more convenient
locations and greater operational efficiencies should help HD
sustain its advantage in the near term.

LOW's structuraI changes are a step in the right
direction. The company closed 17 underperforming stores
in Q3, and it plans to shutter an additional 10 locations in
Q4. LOW has also slowed its new-store growth initiative. The
company now plans to increase its store base by 10-15
stores annually from FY12 forward, down from 30 locations.
In addition, the reorganization of store operations into three
divisions and merchandising into two product divisions
should improve efficiency. Lowe's new one cost quote line
review process should improve the value proposition and
increase speed to market for the company's merchants. We
believe LOW will need to reduce sourcing costs through its
line reviews to avoid gross margin erosion. The shift to
EDLP reduced the Q3 gross margin by 10bps. Management
expects a similar margin impact in Q4 and negative pressure
through H1:12.

E-commerce is a focus, but currently represents only
1% of sales. We expect the company to benefit from an
expanded product assortment online. The company plans to
have 260,000 SKUs available on its site by YE. The
personalization of the myLowe's website, where shoppers
can create a home profile, provides a relatively low-cost
marketing tool that should make the customer experience

FY Ends
Jan. FY10 FY11 FY12
Rev.
($MM)

Q1 12388 12185 12672E
Q2 14361 14543 14696E
Q3 11587 11852 12059E
Q4 10480 11318E 10620E
FY 48815 49898E 50048E

Op. EPS

Q1 $0.34 $0.34 $0.38E
Q2 $0.58 $0.68 $0.74E
Q3 $0.31 $0.35 $0.40E
Q4 $0.21 $0.22E $0.26E
FY $1.44 $1.60E $1.78E

Key Data

52-week High $27.45
52-week Low $18.07
Short Interest 1.5%
Mkt. Cap. (MM) $31,325.0
Net Debt (MM) $5,646.0
Cash/share

$0.77
CY12E P/E

14.1x
CY12E P/FCF 12.7x
Price
Target

$26

easier and stickier. The company has added 2MM myLowe's
accounts less than two months after program launch.

We don't see any immediate cataIysts to drive upside to
consensus. LOW's guided for full-year EPS of $1.57-$1.60
excluding $0.20 in charges related to store closings and
discontinued projects. Our estimate of $1.60 is $0.01 below
consensus. For FY12, we look for EPS of $1.78, in-line with
consensus.

We are establishing a PT of $26 based on our discounted
NOPAT model. Based on our FY12 estimates, shares
currently trade at 14x NOPAT. Our DCF model suggests
shares should trade at a FY12 EV/NOPAT multiple of 15x,
which is still basically in line with today's share price.
Lowe's Companies Inc. (LOW)
FY: January ($MMs)
2010A 2011E 2012E 2013E 2014E 2015E
Net sales 12,388 14,361 11,587 10,480 48,815 12,185 14,543 11,852 11,318 49,898 12,672 14,696 12,059 10,620 50,048 51,448 52,885 54,358
Cost of sales 8,030 9,355 7,526 6,754 31,663 7,866 9,527 7,803 7,414 32,610 8,275 9,685 7,874 6,850 32,684 33,544 34,375 35,169
Gross profit 4,358 5,006 4,061 3,726 17,152 4,319 5,016 4,049 3,905 17,289 4,397 5,011 4,184 3,770 17,363 17,904 18,510 19,188
SG&A expense 3,093 3,189 2,931 2,792 12,006 3,120 3,149 2,909 2,988 12,166 3,168 3,160 2,942 2,793 12,063 12,296 12,534 12,774
Depreciation 397 398 399 392 1,586 371 365 361 374 1,471 380 353 374 361 1,468 1,492 1,375 1,305
EBITDA 1,265 1,817 1,130 934 5,146 1,199 1,867 1,140 917 5,123 1,229 1,852 1,242 977 5,300 5,608 5,976 6,414
EBIT 868 1,419 731 542 3,560 828 1,502 779 543 3,652 849 1,499 868 616 3,832 4,116 4,601 5,110
Interest expense, net 82 84 80 86 332 88 90 91 103 372 105 106 120 129 459 556 621 670
Pretax income 786 1,335 651 456 3,228 740 1,412 688 441 3,281 744 1,393 749 487 3,373 3,560 3,980 4,440
Income taxes 297 503 247 171 1,218 279 549 248 166 1,242 280 524 282 183 1,268 1,338 1,496 1,669
Operating net income 489 832 404 285 2,010 461 863 440 275 2,039 464 870 467 304 2,105 2,221 2,483 2,771
Extraordinary items, net of tax
Net income, as reported 489 832 404 285 2,010 461 863 440 275 2,039 464 870 467 304 2,105 2,221 2,483 2,771
Diluted operating EPS $0.34 $0.58 $0.31 $0.21 $1.44 $0.34 $0.68 $0.35 $0.22 $1.60 $0.38 $0.74 $0.40 $0.26 $1.78 $2.11 $2.61 $3.26
Per share impact of extraordinary item ($0.02) ($0.02) ($0.04) ($0.17) ($0.01) ($0.22)
GAAP EPS $0.34 $0.58 $0.29 $0.21 $1.43 $0.34 $0.64 $0.18 $0.21 $1.38 $0.38 $0.74 $0.40 $0.26 $1.78 $2.11 $2.61 $3.26
Dividends per share $0.09 $0.09 $0.11 $0.11 $0.42 $0.11 $0.14 $0.14 $0.14 $0.53 $0.14 $0.14 $0.16 $0.16 $0.60 $0.72 $0.86 $1.04
Payout ratio 27.1% 16.2% 37.9% 54.1% 29.3% 31.9% 21.9% 77.8% 66.7% 38.4% 37.1% 19.0% 40.0% 60.5% 33.7% 34.1% 33.1% 31.8%
Fully diluted shares 1,441 1,419 1,392 1,361 1,403 1,328 1,278 1,252 1,251 1,277 1,231 1,181 1,169 1,151 1,183 1,051 951 851
Margins
Gross margin 35.2% 34.9% 35.0% 35.6% 35.1% 35.4% 34.5% 34.2% 34.5% 34.6% 34.7% 34.1% 34.7% 35.5% 34.7% 34.8% 35.0% 35.3%
SG&A expense 25.0% 22.2% 25.3% 26.6% 24.6% 25.6% 21.7% 24.5% 26.4% 24.4% 25.0% 21.5% 24.4% 26.3% 24.1% 23.9% 23.7% 23.5%
Depreciation 3.2% 2.8% 3.4% 3.7% 3.2% 3.0% 2.5% 3.0% 3.3% 2.9% 3.0% 2.4% 3.1% 3.4% 2.9% 2.9% 2.6% 2.4%
EBIT 7.0% 9.9% 6.3% 5.2% 7.3% 6.8% 10.3% 6.6% 4.8% 7.3% 6.7% 10.2% 7.2% 5.8% 7.7% 8.0% 8.7% 9.4%
EBITDA 10.2% 12.7% 9.8% 8.9% 10.5% 9.8% 12.8% 9.6% 8.1% 10.3% 9.7% 12.6% 10.3% 9.2% 10.6% 10.9% 11.3% 11.8%
Interest rate 7.4% 9.9% 7.3% 7.6% 7.3% 5.9% 7.1% 6.0% 6.9% 6.2% 6.2% 8.2% 8.2% 7.1% 7.0% 7.1% 7.7% 7.4%
Tax rate 37.8% 37.7% 37.9% 37.5% 37.7% 37.7% 38.9% 36.0% 37.6% 37.8% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6%
Net margin 3.9% 5.8% 3.5% 2.7% 4.1% 3.8% 5.9% 3.7% 2.4% 4.1% 3.7% 5.9% 3.9% 2.9% 4.2% 4.3% 4.7% 5.1%
Yr./yr. change
Sales 4.7% 3.7% 1.9% 3.1% 3.4% -1.6% 1.3% 2.3% 8.0% 2.2% 4.0% 1.1% 1.7% -6.2% 0.3% 2.8% 2.8% 2.8%
SSS 2.4% 1.6% 0.2% 1.1% 1.3% -3.3% -0.3% 0.7% 0.0% -0.8% 4.0% 1.0% 1.0% 1.0% 1.7% 2.0% 2.0% 2.0%
2-year SSS -4.2% -7.9% -7.3% -0.5% -5.4% -0.9% 1.3% 0.9% 1.1% 0.5% 0.7% 0.7% 1.7% 1.0% 1.0% 3.7% 4.0% 4.0%
in gross margin (bps) (28) 2 85 60 27 27 (37) (88) (105) (49) (75) (39) 54 100 5 11 20 30
in SG&A expenses (bps) (2) (35) (4) (65) (26) 64 (55) (75) (24) (21) (61) (15) (14) (10) (28) (20) (20) (20)
Gross profit 3.9% 3.8% 4.4% 4.8% 4.2% -0.9% 0.2% -0.3% 4.8% 0.8% 1.8% -0.1% 3.3% -3.4% 0.4% 3.1% 3.4% 3.7%
SG&A expense 4.6% 2.1% 1.7% 0.6% 2.3% 0.9% -1.3% -0.8% 7.0% 1.3% 1.5% 0.3% 1.1% -6.5% -0.8% 1.9% 1.9% 1.9%
SG&A expense/sq. ft. 1.6% 0.1% -0.2% -1.4% 0.3% -0.7% -2.8% -1.2% 7.5% 1.7% 1.9% 0.7% 0.7% -7.3% -1.6% 1.3% 1.3% 1.1%
Depreciation -1.0% -2.5% -1.0% -2.2% -1.7% -6.5% -8.3% -9.5% -4.7% -7.3% 2.5% -3.4% 3.6% -3.3% -0.2% 1.6% -7.8% -5.1%
EBITDA 2.1% 6.9% 12.1% 19.9% 8.9% -5.2% 2.8% 0.9% -1.8% -0.5% 2.5% -0.8% 9.0% 6.6% 3.5% 5.8% 6.6% 7.3%
EPS 6.0% 13.7% 32.4% 48.9% 18.9% 1.6% 16.4% 13.4% 5.0% 11.0% 9.4% 9.0% 13.7% 20.2% 11.5% 18.8% 23.6% 24.7%
Free cash flow
Cash from operating activities 2,736 46 1,051 19 3,852 2,423 870 599 18 3,910 2,555 1,172 (583) 426 3,570 4,761 4,236 4,438
Capital expenditures 283 329 400 317 1,329 313 467 484 611 1,875 253 382 314 297 1,246 1,235 1,269 1,250
FCF 2,453 (283) 651 (298) 2,523 2,110 403 115 (593) 2,035 2,301 789 (896) 129 2,323 3,526 2,967 3,188
FCF/share $1.70 ($0.20) $0.47 ($0.22) $1.80 $1.59 $0.32 $0.09 ($0.47) $1.59 $1.87 $0.67 ($0.77) $0.11 $1.96 $3.36 $3.12 $3.75
Dollar Tree (DLTR): Neutral

We are initiating coverage of DLTR with a Neutral rating and
an $82 DCF-generated PT. DLTR has benefited from
customers trading down against a challenging economic
backdrop. Shoppers continue to be lured by the value
proposition of the stores' fun, largely discretionary product
assortment and expanding consumables selection. The
expansion of non-core concepts provides DLTR with a
broader pricing platform in the U.S. and exposure to a new
geographic market in Canada, but the ancillary brands
represent a minor portion of the total store base. The
company has increased its focus on enhancing stockholder
returns through a more-aggressive share repurchase
program. DLTR shares have appreciated over 45% YTD,
significantly outperforming the S&P 500 index, which has
declined 3% and the RLX index up 2%. The stock appears
fully valued, in our view, trading at 17.5x our FY12 EPS
estimate and 22x FY12E FCF.
DLTR's vaIue proposition and vast seasonaI inventory
should drive traffic. SSS increased 4.8% on top of +8.7%
in Q3, with traffic up 3.4% on top of a difficult +6.7% comp.
The company celebrated its 25th anniversary in the quarter
with promotional, bonus-sized merchandise packaging,
which drove traffic. Our estimate calls for SSS growth of 5%
on top of +3.9% in Q4, largely driven by an expanded
inventory of seasonal merchandise that should be well
received by budget-conscious holiday shoppers. The
company should continue to benefit from its flexible
purchasing strategy, which allows it to broaden the
merchandise assortment without sacrificing opening price
points. We believe the continued expansion of consumables
will remain a top draw, especially in an inflationary food
environment. This includes the installation of refrigerators
and freezers in a greater number of locations. By the end of
FY11, DLTR plans to offer frozen and refrigerated product in
over 2,200 Dollar Tree stores (around 55% of total), up from
1,850 stores (48%) in the year prior. With these drivers in
place, we project SSS will increase 3.2% on top of 5.4% in
FY12.

Non-core concepts provide significant unit growth
potential, but remain small in scale. The Deal$ concept
enables DLTR to broaden its product range beyond the
single $1 price point. Deal$ sells merchandise in categories
similar to Dollar Tree stores, but at a variety of prices. With
multiple price points, Deal$ can offer a greater variety of
brands and more complete assortments than can be found in
the Dollar Tree format, including items like backpacks, sheet
sets, and cookware. DLTR opened four Deal$ locations in
Q3 and, although we are not forecasting any openings in Q4,
the 181 stores currently in operation represents unit growth
of 10.4% from the end of FY10. We estimate Deal$ to grow
from 164 units in FY10 to 327 by FY15.DLTR is also building
its Dollar Giant chain in Canada at an ambitious pace. We
estimate units will increase in the Canadian segment at a
five-year CAGR of 24% to 250 locations. DLTR recently

FY Ends
Jan. FY10 FY11 FY12
Rev.
($MM)

Q1 1353 1546 1667E
Q2 1378 1542 1696E
Q3 1427 1597 1747E
Q4 1725 1921E 2102E
FY 5882 6606E 7212E

Op. EPS

Q1 $0.61 $0.82 $0.96E
Q2 $0.61 $0.77 $0.93E
Q3 $0.73 $0.87 $1.02E
Q4 $1.29 $1.57E $1.78E
FY $3.23 $4.00E $4.69E

Key Data

52-week High $83.99
52-week Low $48.51
Short Interest 3.1%
Mkt. Cap. (MM) $9,996.4
Cash/share

$2.32
CY12E P/E

17.6x
CY12E P/FCF 21.9x
Price Target

$82

completed investments in store-level POS and enterprise-
level merchandising, and it is now supplying product to
stores from DCs located in British Columbia and Ontario.
Despite double-digit unit growth, we believe the non-core
businesses will still only represent around 10% of the total
store base, combined, by FY15. We look for core Dollar Tree
brand stores to add units at a slower five-year CAGR of 5%
to just under 5,000 stores.

Accelerated share repurchases should lift EPS. The
company bought back 3.3MM shares in Q3 for a total of
$250MM, including a $200MM accelerated share
repurchase. DLTR announced an additional accelerated
share repurchase program of $300MM in November. We
estimate the accelerated repurchases will add a combined
$0.07 to FY11 EPS.

Though we expect continued solid growth, our FY12
estimates are below consensus. We believe the Street's
top-line estimate is slightly aggressive absent a significant
improvement in the job market. Our estimate of sales growth
of 9.2% is 110bps below consensus. We forecast EPS of
$4.69 in FY12, which is $0.06 lower than the Street.
We have established a PT of $82 based on our DCF. Shares
of DLTR currently trade at a 16x FY12E EV/NOPAT multiple,
about in-line with its intrinsic value. Our model now suggests
there is neither considerable upside nor downside to DLTR,
warranting a Neutral rating.
Dollar Tree (DLTR)
FY: January ($MMs)
Income statement
2010A 2011E 2012E 2013E 2014E 2015E
Apr-10 Jul-10 Oct-10 Jan-11 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Jan-13 Jan-14 Apr-15 Apr-16
Net sales 1,353 1,378 1,427 1,725 5,882 1,546 1,542 1,597 1,921 6,606 1,667 1,696 1,747 2,102 7,212 7,886 8,623 9,414
COGS 876 894 921 1,077 3,769 1,005 1,000 1,036 1,200 4,241 1,082 1,098 1,128 1,307 4,615 5,043 5,510 6,013
Gross profit 477 484 506 648 2,114 541 542 561 721 2,365 585 598 619 795 2,596 2,843 3,112 3,402
SG&A expense 348 356 365 389 1,458 379 389 396 425 1,588 402 421 424 456 1,703 1,814 1,975 2,156
EBIT 129 128 141 259 656 162 154 165 297 777 183 178 194 338 893 1,029 1,138 1,246
EBITDA 168 167 180 301 816 201 193 206 342 942 224 220 243 382 1,069 1,207 1,331 1,458
Interest expense (1) (2) (2) (1) (6) (1) (1) (1) (2) (4) (2) (2) (2) (2) (6) (2) 3 14
Other income (expense) 0 (1) 5 0 1 (1) 0
Pretax income 128 125 145 258 655 162 152 164 295 774 182 176 193 337 887 1,027 1,140 1,260
Taxes 49 47 52 96 243 61 57 60 111 289 68 66 73 127 334 387 430 475
Net income 79 78 93 162 412 101 95 105 184 485 113 110 120 210 553 640 711 785
Operating EPS $0.61 $0.61 $0.73 $1.29 $3.23 $0.82 $0.77 $0.87 $1.57 $4.00 $0.96 $0.93 $1.02 $1.78 $4.69 $5.51 $6.19 $6.93
GAAP EPS $0.48 $0.61 $0.73 $1.29 $3.10 $0.82 $0.77 $0.87
Diluted shares outstanding 130.2 128.1 127.8 125.8 128.0 123.5 123.0 120.7 117.1 121.1 117.4 117.6 117.9 118.1 117.7 116.2 114.7 113.2
Margins
Gross margin 35.2% 35.1% 35.5% 37.6% 35.9% 35.0% 35.2% 35.1% 37.6% 35.8% 35.1% 35.3% 35.4% 37.8% 36.0% 36.1% 36.1% 36.1%
SG&A expense 25.7% 25.8% 25.6% 22.6% 24.8% 24.5% 25.2% 24.8% 22.1% 24.0% 24.1% 24.8% 24.3% 21.7% 23.6% 23.0% 22.9% 22.9%
EBIT 9.5% 9.3% 9.9% 15.0% 11.2% 10.5% 10.0% 10.3% 15.5% 11.8% 11.0% 10.5% 11.1% 16.1% 12.4% 13.1% 13.2% 13.2%
EBITDA 12.4% 12.1% 12.6% 17.4% 13.9% 13.0% 12.5% 12.9% 17.8% 14.3% 13.5% 12.9% 13.9% 18.2% 14.8% 15.3% 15.4% 15.5%
Interest expense 2.1% 2.4% 2.4% 1.5% 2.1% 1.4% 1.1% 0.9% 2.3% 1.4% 2.3% 2.4% 2.3% 2.4% 2.4% -0.6% 0.4% 1.2%
Tax rate 38.0% 37.6% 35.6% 37.1% 37.0% 37.5% 37.7% 36.3% 37.7% 37.4% 37.7% 37.7% 37.7% 37.7% 37.7% 37.7% 37.7% 37.7%
Net margin 5.8% 5.7% 6.5% 9.4% 7.0% 6.5% 6.2% 6.6% 9.6% 7.3% 6.8% 6.5% 6.9% 10.0% 7.7% 8.1% 8.2% 8.3%
Yr./yr.change
Sales 12.6% 12.7% 14.2% 10.7% 12.4% 14.3% 11.9% 11.9% 11.4% 12.3% 7.8% 10.0% 9.4% 9.4% 9.2% 9.4% 9.3% 9.2%
SSS 6.5% 6.7% 8.7% 3.9% 6.3% 7.1% 4.7% 4.8% 5.0% 5.4% 2.0% 4.0% 4.0% 3.0% 3.2% 3.0% 3.0% 3.0%
2-year SSS 15.7% 13.5% 15.2% 10.5% 13.5% 13.6% 11.4% 13.5% 8.9% 11.7% 9.1% 8.7% 8.8% 8.0% 8.6% 6.2% 6.0% 6.0%
in gross margin (bps) 64 60 14 44 44 (25) 8 (36) 0 (13) 10 12 30 25 20 5 4 4
in SG&A expense (bps) (76) (139) (112) (54) (91) (118) (60) (81) (46) (74) (42) (41) (48) (40) (43) (61) (10) 0
Gross profit 14.7% 14.6% 14.7% 12.0% 13.8% 13.5% 12.2% 10.8% 11.4% 11.9% 8.1% 10.3% 10.3% 10.1% 9.8% 9.5% 9.5% 9.3%
SG&A expense 9.4% 6.9% 9.4% 8.1% 8.5% 9.1% 9.3% 8.4% 9.1% 9.0% 6.0% 8.2% 7.3% 7.4% 7.2% 6.5% 8.9% 9.2%
EBITDA 23.3% 30.3% 23.0% 15.8% 21.7% 19.4% 15.5% 14.6% 13.6% 15.4% 11.7% 13.7% 18.0% 11.6% 13.5% 12.9% 10.3% 9.5%
Operating EPS 37.3% 44.8% 44.2% 27.0% 36.2% 34.8% 26.7% 18.9% 21.9% 23.8% 17.9% 21.0% 17.3% 13.1% 17.2% 17.4% 12.5% 11.9%
Free cash flow
Cash from operations 36 118 21 344 519 156 103 60 303 579 177 160 (83) 427 681 740 844 931
FCF (9) 73 (36) 312 340 98 40 (16) 249 328 127 99 (141) 360 446 479 559 621
FCF/share ($0.07) $0.57 ($0.28) $2.48 $2.66 $0.79 $0.32 ($0.13) $2.12 $2.71 $1.08 $0.84 ($1.20) $3.05 $3.78 $4.13 $4.87 $5.48
Family Dollar (FDO): Neutral

We are initiating coverage of FDO with a Neutral rating and
a DCF-generated PT of $63. Family Dollar operates a
discount chain of over 7,000 stores located throughout the
continental U.S., with the majority of items priced under $10.
Higher customer traffic and average ticket have driven SSS
growth, as shoppers have shown a greater penchant for
value in the current economic climate. We believe an
expanded consumables selection will drive traffic, especially
in an inflationary environment for food and other household
necessities. The company is in the midst of an aggressive
store opening and remodeling initiative, one that will require
a significant investment of capital. We believe that an
expanded U.S. footprint should support the high-single-digit
net annual sales growth we project through FY15. Takeover
speculation subsided in late September, when Trian Group,
which had been pursuing FDO since February, pulled its bid
in exchange for a seat on the board. Shares have
appreciated approximately 17% YTD, versus a 3% decline
for the S&P 500 index and a 2% advance for the RLX index.
FDO shares appear fairly valued, in our view, trading at
15.5x our CY12 EPS estimate and 7.5x CY12E EV/EBITDA.
An improved consumables assortment should drive
traffic. FDO continues to expand its assortment in an effort
to attract a broader base of value-oriented customers, with
consumables being a primary area of focus. Sales of
consumables increased 11% yr./yr. in FY11, to $5.7B
(66.5% of total sales), and we believe the category will
remain a significant driver of traffic, especially in a continued
period of food inflation. Management noted that average
inventory per store increased 9% in Q4:11 as a result of the
planned buildup in consumable shelf space. FDO also plans
to increase penetration of private label brands within the
consumables category, stating that its near-term goal is to
increase private brands from 16% of sales in FY11 to 20%.
Supported by an expanded consumables selection, we
estimate SSS will increase 4.2% on top of +5.5% in FY12,
followed by growth of 3% annually out to FY16. We expect
the focus on consumables will limit margin expansion, given
the low-margin nature of the product.

We estimate FDO's ambitious store expansion wiII
increase total square footage by 28% from FY11 to FY16.
The store base increased 3.5% in FY11 to 7,023 locations,
and we estimate another 375 net openings in FY12,
including the company's recent initial entry into California.
Our projections call for annual net openings of around 410
from FY13-FY16. In addition, FDO plans to renovate over
1,000 stores in FY12 as part of its efforts to remodel every
location within the next four years. The remodeled locations
generally have brighter lights, new signage both inside and
outside the store, wider aisles, and increased SKUs in the
food and health/beauty sections. At a competitor's
conference in mid-November, management commented that
post-renovation comparable sales are up double digits.
Following our earlier visits to nine New York City locations,

FY Ends
Aug. FY11 FY12 FY13
Rev.
($MM)

Q1 1997 2171E 2330E
Q2 2263 2443E 2629E
Q3 2153 2325E 2510E
Q4 2134 2315E 2488E
FY 8548 9254E 9958E

Op. EPS

Q1 $0.58 $0.69E $0.78E
Q2 $0.98 $1.15E $1.27E
Q3 $0.91 $1.06E $1.19E
Q4 $0.66 $0.76E $0.87E
FY $3.12 $3.66E $4.11E

Key Data

52-week High $60.53
52-week Low $41.31
Short Interest 3.2%
Mkt. Cap. (MM) $6,976.1
Cash/share

$1.97
CY12E P/E

15.4x
CY12E P/FCF 53.8x
Price Target

$63

we believe the shopping experience has improved, but still
saw a considerable amount of empty space near the
entryway that we believe could be used for additional traffic-
driving SKUs.

Takeover speculation has been silenced for now. In late
September, Nelson Peltz's Trian Group withdrew its
purported $55-$60 bid for the discount chain after Trian's
Edward Garden was added to FDO's board. Trian agreed
not to increase its stake in FDO stock beyond 9.9% without
board approval and to support management's board
nominees.
Valuation & PT
Our DCF model suggests the stock is fairly valued, and we
have set a PT of $63. FDO shares currently trade at 14x
FY12 EV/NOPAT. Our model indicates shares should trade
at a slightly higher multiple of 15x.

Family Dollar (FDO)
FY: August ($MMs)
Income statement
2011A 2012E 2013E 2014E 2015E 2016E
Nov-10 Feb-11 May-11 Aug-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Aug-13 Aug-14 Aug-15 Aug-16
Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 Q4 FY FY FY FY
Net sales 1,997 2,263 2,153 2,134 8,548 2,171 2,443 2,325 2,315 9,254 2,330 2,629 2,510 2,488 9,958 10,700 11,478 12,294
COGS 1,277 1,456 1,374 1,409 5,516 1,398 1,578 1,477 1,521 5,974 1,496 1,696 1,591 1,632 6,416 6,880 7,369 7,892
Gross profit 720 807 780 726 3,032 773 865 849 794 3,280 834 933 919 856 3,542 3,820 4,109 4,401
SG&A expense 598 607 595 594 2,394 637 642 642 644 2,564 682 689 690 688 2,750 2,935 3,141 3,357
EBIT 122 200 184 132 638 136 223 207 150 716 153 244 228 168 793 885 969 1,044
EBITDA 166 245 230 179 821 187 276 263 211 936 217 310 296 239 1,062 1,166 1,286 1,377
Interest income 0 0 0 0 2 1 0 1 0 2 1 1 1 1 3 1 2 1
Interest expense 4 5 7 7 22 7 7 7 7 28 7 7 7 7 28 29 28 28
Pretax income 118 196 178 125 617 130 216 201 143 690 147 237 222 161 768 858 942 1,018
Taxes 44 73 67 45 229 48 81 75 54 258 55 89 83 60 287 321 352 381
Net income 74 123 111 80 388 81 136 126 90 432 92 149 139 101 481 537 590 637
Operating EPS $0.58 $0.98 $0.91 $0.66 $3.12 $0.69 $1.15 $1.06 $0.76 $3.66 $0.78 $1.27 $1.19 $0.87 $4.11 $4.65 $5.24 $5.87
GAAP EPS $0.58 $0.98 $0.91 $0.66 $3.12
Dividends $0.16 $0.18 $0.18 $0.18 $0.70 $0.18 $0.18 $0.19 $0.19 $0.74 $0.18 $0.18 $0.20 $0.20 $0.76 $0.78 $0.81 $0.83
Diluted shares outstanding 129.1 125.7 122.7 120.4 124.5 118.3 118.0 118.1 118.3 118.1 117.9 117.0 116.6 116.8 117.1 115.6 112.6 108.6
Margins
Gross margin 36.0% 35.7% 36.2% 34.0% 35.5% 35.6% 35.4% 36.5% 34.3% 35.4% 35.8% 35.5% 36.6% 34.4% 35.6% 35.7% 35.8% 35.8%
SG&A expense 29.9% 26.8% 27.6% 27.8% 28.0% 29.3% 26.3% 27.6% 27.8% 27.7% 29.3% 26.2% 27.5% 27.7% 27.6% 27.4% 27.4% 27.3%
EBITDA 8.3% 10.8% 10.7% 8.4% 9.6% 8.6% 11.3% 11.3% 9.1% 10.1% 9.3% 11.8% 11.8% 9.6% 10.7% 10.9% 11.2% 11.2%
EBIT 6.1% 8.9% 8.6% 6.2% 7.5% 6.3% 9.1% 8.9% 6.5% 7.7% 6.5% 9.3% 9.1% 6.7% 8.0% 8.3% 8.4% 8.5%
Interest income 1.1% 0.4% 0.5% 0.5% 0.5% 1.0% 1.0% 1.0% 1.0% 1.0% 2.0% 2.0% 2.0% 2.0% 1.7% 2.0% 2.0% 2.0%
Tax rate 37.3% 37.2% 37.5% 36.0% 37.1% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4% 37.4%
Net margin 3.7% 5.4% 5.2% 3.7% 4.5% 3.7% 5.5% 5.4% 3.9% 4.7% 3.9% 5.7% 5.5% 4.1% 4.8% 5.0% 5.1% 5.2%
Yr./yr.change
Sales 9.5% 8.3% 7.8% 9.1% 8.7% 8.7% 7.9% 8.0% 8.4% 8.3% 7.3% 7.6% 7.9% 7.5% 7.6% 7.5% 7.3% 7.1%
SSS 6.9% 5.1% 4.7% 5.6% 5.5% 5.0% 4.0% 4.0% 4.0% 4.2% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
2-year SSS 9.3% 8.7% 11.7% 11.7% 10.3% 11.9% 9.1% 8.7% 9.6% 9.8% 8.0% 7.0% 7.0% 7.0% 7.2% 6.0% 6.0% 6.0%
in gross margin (bps) (8) 23 (36) (69) (22) (43) (27) 29 30 (3) 20 10 10 10 12 13 10 0
in SG&A expense (bps) (15) 5 (40) (101) (37) (62) (56) (5) (1) (30) (8) (4) (9) (16) (9) (18) (7) (6)
Gross profit 9.3% 9.0% 6.8% 6.9% 8.0% 7.4% 7.1% 8.8% 9.4% 8.2% 7.9% 7.9% 8.2% 7.8% 8.0% 7.8% 7.6% 7.1%
SG&A expense 9.0% 8.5% 6.3% 5.3% 7.2% 6.5% 5.7% 7.8% 8.4% 7.1% 7.0% 7.4% 7.6% 6.9% 7.2% 6.7% 7.0% 6.9%
SG&A/sq. ft. 5.7% 5.2% 2.7% 1.5% 3.4% 2.0% 0.9% 2.9% 2.9% 1.7% 1.7% 1.7% 1.5% 1.3% 1.7% 1.4% 1.9% 2.0%
EBITDA 9.2% 9.7% 7.8% 13.1% 9.7% 12.8% 12.5% 14.0% 17.5% 14.1% 16.1% 12.4% 12.7% 13.4% 13.4% 9.8% 10.2% 7.1%
Operating EPS 18.5% 20.6% 17.9% 19.4% 19.2% 19.3% 17.2% 17.4% 14.5% 17.1% 13.4% 10.6% 12.0% 14.1% 12.3% 13.1% 12.8% 12.0%
Free cash flow
Cash from operations (40) 265 83 221 528 86 274 88 272 720 64 269 96 312 740 795 886 963
FCF (79) 165 (8) 106 183 (23) 141 (70) 110 157 (53) 149 (27) 187 256 281 346 398
FCF/share ($0.61) $1.31 ($0.07) $0.88 $1.47 ($0.20) $1.19 ($0.60) $0.93 $1.33 ($0.45) $1.27 ($0.23) $1.60 $2.18 $2.43 $3.08 $3.66
Important Disclosure / Disclaimer Information
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Price Recommendation Change Price Target Coverage Transfer
Created By BlueMatrix
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Williams-Sonoma
Collins Stewart LLC Ratings
Valuation and Risks
The recommendation and price target contained within this report are based on a time horizon of 12 months but there is no guarantee the objective will be achieved within the specified
time horizon. Price targets are determined by a subjective review of fundamental and/or quantitative factors of the issuer, its industry, and the security type. A variety of methods may be
used to determine the value of a security including, but not limited to, discounted cash flow, earnings multiples, enterprise value, book value, peer group comparisons, and the sum of the
parts. Overall market risk, interest rate risk, and general economic risks impact all securities. Specific information regarding the price target and recommendation is provided in the text
herein or in our most recent full research report on the subject company.
BUY: Improving fundamentals and/or identifiable catalysts in place expected to cause stock to outperform its industry
NEUTRAL: Companys fundamental backdrop suggest stock should perform in line with industry
SELL: Deteriorating fundamentals and/or identifiable catalysts in place expected to cause stock to underperform its industry
This report is for informational purposes only, and the information herein is obtained from sources that we believe to be reliable, but its accuracy and completeness, and that of the
opinions based thereon, are not guaranteed. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Further, this report is not
intended as an offer or solicitation to buy or sell any securities or related instruments. The investments discussed or recommended in this report may not be suitable for the specific
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From time to time, Collins Stewart LLC or its employees may have a long or short position in the securities of company (ies) discussed herein and, at any time, may make purchases
and/or sales as principal or agent.
% of CSTI Universe with
this rating
% of rating tier for which CSTI
provided IB services
Buy 54% 0%
Hold 43% 0%
Sell 3% 0%
The research analyst who is primarily responsible for the research contained in this research report and whose name is listed first on this report: (1) attests that all of the views expressed
in this research report accurately reflect that research analyst's personal views about any and all of the securities and issuers that are the subject of this research report; and (2) attests
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