10/11/2002

No Sign of a Slowdown in Crafts Retail Sales

Although the overall retail sales picture appears to remain downbeat, Crafts Retailers continue to report solid sales increases. Once again, the strength of this segment clearly supports our positive view of The Leather Factory (AMEX:TLF).

Overall, retail sales are viewed negatively, although this weakness may be as much the result of continued warm weather across the U.S., which seems to have curtailed purchases of winter clothing. An October 10th New York Times headline read "Retail Sales Languished in September," with the underlying article stating that, "As the nation's merchants reported their sales Thursday, department stores and apparel stores again languished. But even companies like Wal-Mart Stores Inc., Target Corp., TJX Cos. and Kohl's Corp., which have been the industry's stars, also posted disappointing results."

However, this is clearly not true within the retail crafts stores segment:

• On October 10th, Michaels Stores, Inc. (NYSE:MIK) reported that same-store sales for the month of September increased 10%, four percentage points higher than previous expectations. Total sales for the month, from both old and new stores combined, increased 25%.
  
  To quote the company's press release "While we are sensitive to current concerns about consumer spending, we believe that the significant improvements we continue to make in our operations will continue to propel our same-store sales and profit growth. We expect same-stores sales for October to increase between 4% to 6% and third quarter same-store sales to increase 6% to 7%. We have also raised our earnings estimates per diluted share to $.40 for the third quarter and $2.10 for the full fiscal year." The company reiterated its high expectations for the fourth quarter and indicated that the West Coast dock strike was not tying up a significant amount of inventory and would not affect fourth quarter sales.
  
  
• On October 3rd, A.C. Moore Arts & Crafts, Inc. (Nasdaq:ACMR) reported an 18% increase in sales for the third quarter. Revenues reached $89.7 million for the quarter that ended on September 30, 2002, versus sales of $76.2 million during the third quarter of 2001. Much of this increase was the result of new store openings; comparable store sales increased 4%, which reportedly was at the upper end of the company's "guidance."
  
  
• On October 8th, Jo-Ann Stores (NYSE:JAS.A) reported that September net sales increased 2.6% to $159.6 million from $155.6 million for the same period last year. September same-store sales increased 5.0%, versus a 4.0% same-store sales increase last year. In its press release, Jo-Ann Stores stated that it "does not expect the work stoppage at the West Coast ports to have a significant impact on its fourth quarter holiday season."
  

However, at least one sell-side analyst believes that revenues for the retail crafts stores segment are likely to weaken slightly. For some time, Adams, Harkness & Hill, an investment banking firm, has provided solid and balanced coverage of several major participants in the retail crafts stores segment, including A.C. Moore, Michaels and Jo-Ann Stores. Until recently, this firm has seen the crafts industry in a very positive light.

• In late August, an Adams Harkness research report noted that "One of the things we like best about the craft and fabric industries is their sales stability in good and bad economies." The report also cited "a consumer environment that has been favorable for crafts and sewing, which we believe will continue throughout 2002." They also noted that "with the current economic and social climate favorable for inexpensive, home related leisure activities, such as crafts and sewing. In addition, we think the aging baby boom should be a long-term positive for crafts, sewing, and other age-friendly leisure activities, given the historical increases in leisure time associated with aging."
  
  
• As recently as September 26th, Adams, Harkness & Hill remained bullish toward the retail crafts segment, explaining that "long-term demographic drivers (aging baby boom, increasing leisure time) are strong for craft participation and other home-related leisure pursuits. Near term, we think the current consumer environment, influenced by an awful stock market, ongoing terrorist threats, and shaken confidence in many business and financial institutions, remains favorable for crafts which have a history of sales stability in good and bad times."

However, the first week in October opened with a hail of grim news from several of the major retail chain stores; several of the "biggies" such as Federated, J.C. Penney and Wal-Mart lowered their same-store sales projections for the coming months, while at least one "teen retailer" cited a slowdown in mall traffic. When combined with reports of weakening automobile sales, this could be seen as signaling a slowdown in consumer spending.

In response, on October 3rd, Adams, Harkness & Hill downgraded all three of the crafts retailers it follows. Their analyst stated that they "believe (the) retail environment is weakening even for value oriented retailers like craft stores," citing "recent results from a variety of retailers" to support this conclusion. On the other hand, Adams Harkness has not lowered their earnings estimates on these stocks, although "we are lowering P/E expectations and price targets on all three stocks, to reflect lower probability of sales and earnings blowouts."

We don't completely understand the underlying logic of this call, and we tend to suspect that it reflects the analyst's reaction to the current general economic uncertainty rather than to any specific signs of weakness in this subsegment. Instead, we continue to see strong sales reports from crafts retailers as a positive for The Leather Factory (AMEX:TLF). We maintain our Strong Buy recommendation on this stock for value-oriented portfolios, as it clearly remains undervalued at its current price levels.

J.M.Dutton & Associates, LLC. John M. Dutton, President and Supervisory Analyst, 1129 Manning Drive, Suite 310, El Dorado Hills, CA 95762 Phone (916) 941-4985, Fax (978) 418-6422 Email: JMDutton@JMDutton.com Web site: www.JMDutton.com

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