5 November 2008
Hardline Retail
Liquidity analysis: mostly good
news, but some concerns
Mike Baker, CFA
Research Analyst
(+1) 617 217-6253
michael.baker@db.com
Dave Weiner
Research Analyst
(+1) 212 250-5577
david.weiner@db.com
Adam Sindler
Research Associate
(+1) 617 217-6263
adam.sindler@db.com
It's no longer about comps, it's about liquidity
As we head into what we believe will be the worst holiday for retail sales in
memory, we believe comp trends, which are generally assumed to be weak, have
taken a back seat to balance sheet issues in the minds of some investors.
Therefore, we have analyzed the liquidity of our hardline companies, comparing
expected cash obligations with resources to determine if any potential funding
problems may arise.
Deutsche Bank Securities Inc.
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208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
Industry Update
Top picks
Family Dollar Stores (FDO.N),USD26.94 Buy
99 Cents Only Stores (NDN.N),USD11.25 Buy
Staples (SPLS.OQ),USD18.74 Buy
O'Reilly Automotive Inc (ORLY.OQ),USD26.76 Buy
Dick's Sporting Goods (DKS.N),USD15.42 Buy
Companies featured
Family Dollar Stores (FDO.N),USD26.94 Buy
Dollar Tree Stores (DLTR.OQ),USD38.01 Hold
99 Cents Only Stores (NDN.N),USD11.25 Buy
Borders Group (BGP.N),USD3.27 Hold
Barnes & Noble (BKS.N),USD17.90 Hold
Cost Plus (CPWM.OQ),USD1.65 Hold
Tuesday Morning Corp. (TUES.OQ),USD2.27 Hold
Williams-Sonoma (WSM.N),USD9.21 Hold
Pier 1 Imports (PIR.N),USD1.31 Buy
AutoZone (AZO.N),USD120.73 Hold
O'Reilly Automotive Inc (ORLY.OQ),USD26.76 Buy
Best Buy (BBY.N),USD27.76 Hold
RadioShack (RSH.N),USD12.72 Hold
Home Depot (HD.N),USD22.22 Hold
Lowe's Companies (LOW.N),USD20.69 Hold
Bed Bath & Beyond (BBBY.OQ),USD25.19 Hold
Office Depot (ODP.N),USD2.88 Hold
Staples (SPLS.OQ),USD18.74 Buy
OfficeMax (OMX.N),USD6.51 Hold
PetSmart, Inc. (PETM.OQ),USD19.37 Buy
Dick's Sporting Goods (DKS.N),USD15.42 Buy
Big 5 Sporting Goods (BGFV.OQ),USD6.03 Hold
Global Markets Research Company
Most have ample liquidity to cover obligations
We believe that the majority of our names have ample resources to cover cash
obligations, even as we believe that holiday sales will disappoint and 2009
earnings will contract. This includes coming debt maturities. The ability to access
lines of credit certainly helps and we do expect some companies to utilize this
resource.
Some names are worth watching
While most of our universe will remain solvent through the current economic
crisis, there are some isolated causes for concern. In particular, it looks like Circuit
City may have a cash crunch problem. The weaker office products retailers, Office
Depot and OfficeMax, also have some balance sheet items worth watching, but
we do not believe the situation is as concerning as that of Circuit City and in fact
both should have enough resources to cover near-term obligations. For Cost Plus,
Borders Group, and Williams – Sonoma, relative weakness in their ranking in this
analysis raised red flags, but we believe that each has sufficient liquidity resources
to meet FY08 obligations.
Pension issue not a major concern for our group
We also conclude that exposure to defined benefit pension issues is relatively
minor for our group, with only about 25% of the hardine retailers that we cover
even having a plan. Of those, most appear to be adequately funded even
assuming down markets. Again, Office Depot and OfficeMax appear to be the
most under-funded, but the ability to access lines of credit as well as seek
extensions regarding needed cash infusions should preclude dire consequences,
in our view. Also, ODP’s pensions are backed by predecessor companies.
Group valuation: recent out-performance leads to above-average relative
valuation; risks
We remain defensive in our positioning for retail names, preferring hardliners with
product mixes that tend to be non-discretionary. With consensus 2009 estimates
still about 10% too high relative to our expectations, we’d expect the recent retail
rally to fade, particularly as disappointing 3Q results are reported. As the hardline
group valuation, which is currently at a 20% premium to the S&P 500, moves back
closer to its historic average of 100%, we’d look to be more constructive on “early
cycle” names. We made no changes to our ratings or estimates within this report.
Downside risks to our hardline group come primarily from weak housing and its
negative effect on consumerism, with upside possible if investors decide to shift
to ‘early cycle’ plays of higher-quality retailers.

As we head into what we believe will be the worst holiday for retail sales in memory, we
have analyzed the balance sheets of each of our hardline companies, comparing expected
cash obligations with sources of liquidity, to determine if any potential funding problems may
arise. Our work looks at approaching debt maturities, line of credit usage, off-balance sheet
obligations, and potential defined benefit pension exposure.
Conclusions: Most companies have ample liquidity, but some
names are worth watching
Most have ample liquidity to cover obligations
We believe that the majority of our names have ample resources to cover cash obligations,
even as we believe that holiday sales will disappoint and 2009 earnings will contract. This
includes coming debt maturities. The ability to access lines of credit certainly helps and we
do expect some companies to utilize this resource.
Some names are worth watching
While most of our universe will remain solvent through the current economic crisis, there are
some isolated causes for concern.
In particular, it looks like Circuit City may have cash crunch problems.
Also, the weaker office products retailers, Office Depot and OfficeMax, may have some
balance sheet items worth watching, but we do not believe that the situation is as
concerning as that for Circuit City, and in fact both should have enough resources to cover
cash obligations.
Finally, for Cost Plus, Borders Group, and Williams – Sonoma, while our analyses has each
company meeting all its FY08 cash obligations, each has cash ‘coverage ratios’ at the lowend
of our Hardlines universe. See Figure 1.
Figure 1: Current cash resources versus obligations
0.4x

Pension issue not a major concern for our group
We also conclude that exposure to defined benefit pension issues is relatively minor for our
group, with only about 25% of the hardine retailers that we cover even having a plan. Of
those, most appear to be adequately funded even assuming down markets. Again, Office
Depot and OfficeMax appear to be the most under-funded, but the ability to access lines of
credit as well as seek extensions regarding need cash infusions should preclude dire
consequences, in our view (see Figure 2). Also, ODP’s pensions are backed by predecessor
companies.