Valuing a struggling business can be a tough proposition for many investors. Although Warren Buffett was successful at this in his early days, buying what he called 'discarded cigar butts' for one 'final puff', it isn't a simple process.
Myer Ltd (ASX: MYR) is a sterling example; the company has lost more than three-quarters of its value since it debuted at $4.10, back in 2009. This was likely more than enough to scare off the vast majority of its initial shareholders.
More recently, however, the stock has put in a strong performance:
The stock has recovered from its 52-week low of $0.82 cents to rise 40% in the past 10 weeks, as investors put renewed hope in the company's turnaround.
Although Warren Buffett has sworn off 'cigar butt' investing, he is also famous for buying businesses facing transformation or restructure, saying 'we want to buy them when they're on the operating table'.
If there was ever a business undergoing transformation, it's Myer. Despite trading on a trailing Price to Earnings (P/E) ratio of 9, the company isn't necessarily cheap as many headwinds remain.
One key issue is low sales per square metre, which results in rent becoming a larger portion of revenue. Myer is rectifying this through store closures and also by introducing new store formats, although much work remains.
Another major headwind is competition, both domestic and international, online and bricks-and-mortar, as Myer struggles to compete both on price and product. This has lead to a major re-think of the brands on offer, with Myer simplifying its offer and also focusing on its Myer-exclusive labels (which now account for 20% of sales) in order to mitigate some of the competition and provide a unique selling point for Myer apparel. Again, much work is yet to be done.
A key area of focus for management right now is digital, with the company yet to make a successful full-scale entry into the online space. While online sales are growing, there have been some indications that they are cannibalising existing foot-traffic to a degree rather than opening Myer up to a whole new range of customers.
Curiously, one prominent fund manager wrote earlier this year that Myer shares could double in value by 2020, if the company's modest growth forecasts were met. With shares nearly halfway there already, I'd say there isn't much point sticking around until 2020 if your stake is only going to be worth $1.70. Of course, this is just a theoretical price and may not be at all accurate.
As a side note, Myer remains the second most shorted stock on the ASX, which means there is also a meaningful risk that recent gains could rapidly reverse.
Either way, it is hard to see Myer generating much wealth for shareholders over the next few years, and I believe investors could be better off selling their stake and investing it elsewhere.
