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Just wanted to weigh in to support the recent views of Fool contributors Dave Marino-Nachison (2 Sept.) and Seth Jayson (23 Aug.) on The Bombay Company (BBA). I've responded with a fairly long blurb but one that I hope you will find well worth reading.

Of course, the opinions and views expressed below are solely mine and are not intended to act as a recommendation for long or short trading in BBA stock.

I think Dave and Seth's judgement in this case is pretty close to the mark. The one exception being Dave's comment that the current market value of BBA is "a good bit less than the value of its cash and inventory". I don't think that's right. From my reading of the 2Q accounts, as at July 31, inventory was $136.6M and net cash $7.8M for a total of $144.4M (I believe the "other current assets" refers to debtors). So $144.4M equates to about $4.05 per diluted share. If this is the support level, it's 30% below yesterday's close of $5.81!

I was also pretty bemused by the rise in the stock price yesterday. Looks like a case of a rising tide lifting all boats, despite the vast divergence in operating fortunes of retailers through August.
The operating performance of the business is clearly horrendous.
For those who have taken heart from the comments in the press release yesterday referring to (1) improving sales trends through yet another horror month in August and (2) September same store sales trends improving on July and August, beware because:

1. It shouldn't be a difficult target because July came in at –25% and August at –19%; but more importantly

2. The guidance for Q3 comp store sales (provided at the Q2 release on August 18) is for "low double-digit declines". It is this forecast that underpins the EPS guidance of Q3 of -$0.07 to -$0.11 per share. The simple math suggests the August performance (-19%) puts achievement of Q3 sales and EPS guidance into serious doubt.

There are also a number of other factors, in my view, as to why the operating performance and current market value of BBA don't stack up:
Likely 3Q Earnings Downgrade

I believe that BBA will issue a profit warning and downgrade its 3Q sales and eps targets, the reasons being:

- Continuing precipitous slide in same store sales (SSS) in September and October;

- Damage being done to BBA's margins due to the very heavy promotional activity that BBA is currently undertaking on its website. BBA is slashing up to 50%, 60% and 70% off selected big-ticket items across virtually all major product categories (furniture and wall décor, lighting, bedding/textiles);

- Adverse impact of Hurricane Francis on BBA's store network in Florida and Georgia. Gov. Jeb Bush estimated 2.5 million residents were under evacuation orders in 15 Florida counties based on the state's projections of people living in evacuated areas. Bush asked his brother President Bush to declare Florida a federal disaster area. Of its 415 stores (as at 31 Jan. 2004), BBA has 39 stores in Florida and 20 in Georgia, representing over 15% of its store network. BBA also has one of its five distribution centres located in McDonough, Georgia.

- The market underestimating the damage to BBA's brand when it suffers adverse PR and a massive sales slump and the cost and risks involved in BBA rehabilitating its brand and reconnecting with the consumer (i.e very heavy promotional spend, discounts, etc).

Hurricane Francis

A major risk point for BBA and a risk, which the market is not currently factoring into BBA's stockprice.

First, a little background:

- “…Adverse conditions in Florida with the hurricane” was specifically mentioned by BBA's Chairman and CEO as being a contributing factor to the 19% fall in BBA's August SSS result (1 Sept. press release on August sales).

Fast forward to the present:

- Florida and Georgia have declared States of Emergency in response to the build up of Hurricane Francis.
- BBA has exposure to these potential hurricane states.
- Of its 415 stores (as at 31 Jan. 2004), BBA has 39 stores in Florida and 20 in Georgia, representing over 15% of its store network.
- BBA has one of its five distribution centres located in Georgia.
- According to industry sources, evacuation is, predictably, affecting discretionary spending. For retailers, this is having a negative effect on foot traffic and average spend for capital goods.

Rising Short Interest Ratio

Up from 2% in May to 7.5% now, mirroring the deterioration in operating performance over the course of this year.

Prices Are Being Slashed on BBA's website; Margin and Earnings Fears

It is little wonder that BBA is reporting improving web traffic and web sales, given the massive price cuts the company has and continues to promote on its website.

Given the massive price cuts, I am concerned about prospect of further deterioration in BBA's earnings and margins. Ironically, greater sales over BBA's website are likely to be at expense of its retail store channel, raising the fear of cannibalisation of BBA's not insignificant physical store network.

Analyst Research- In the aggregate, very poor quality.

In my opinion, the analysts who follow this company seem to be (a) unwilling to diverge from company guidance when preparing their own forecasts; (b) wildly optimistic about the pace and magnitude of "turn-around" at BBA in terms of their own earnings estimates and valuations; and (c) underestimating the execution risk involved in the shift in company strategy.

In my opinion, there seems to very little “analysis” being done by the analysts. Several analysts appear to be toeing the company line and underestimating the degree of difficulty the business is currently in and the risks involved in achieving a successful turnaround.

Most of the analysts have been slow to pick up on the impact of negative momentum in the sales line. BBA has really suffered from operating de-leverage as the business was previously geared-up in anticipation of higher volumes this year. Consequently, consensus earnings estimates have fallen consistently since January.

As mentioned above, I think the company guidance and analyst estimates are due for yet another downgrade shortly. But the analyst estimates for the Q4 look high to me as well. The 4Q is very important to BBA as it typically more than offsets all the losses accumulated in Q1-Q3. The analysts are expecting $235M in sales in the Q4, which is a rise from their estimate of $138M in the 3Q. Even if they are right on both cases, Q4 equates to 1.70x Q3. This statistic compares to 1.56x last year and 1.66x the year before.

On the EPS front, analysts are expecting $0.373 for Q4. This compares to $0.33 the same time last year. Their assumption is that BBA will achieve an operating profit margin of 9.7% on the above mentioned sales. This is actually higher than Q4 last year at 9.5%!! This would be a massive turnaround in operating efficiency given the sharp sequential deterioration over the last few quarters.
Presumably downgrades to Q3 and Q4 would lead to re-basing down of 2005 estimates.

Current Market Price Unsupportable

Even if I am wrong about potential for downgrades to analysts' estimates, current metrics suggest all the upside is already more than captured in the current market price.
For the year ending 31 Jan 2006, analysts estimate BBA EPS at $0.20. (Forget trying to value BBA on 31 Jan 2005 because EPS will be -$0.06 according to the analysts). That equates to a P/E of 29x!
Even if you assume that BBA earns what it did in 2003 ($0.28), the P/E is still 21x—pretty solid indeed.
That compares with Pier 1 trading on 13.5x 06 EPS.
I think the case for using book value ($5.06 per share) as a “valuation floor” in times of extreme distress is flawed due to the likely impairment of inventory and property / equipment values.
Other observations I have made include:

- Analysts are basing their valuations of BBA off a significant improvement in BBA-specific and retail industry conditions in FY06 and FY07- conditions which are totally at odds with the current retailing environment. Furthermore, select analysts expect investors to pay for this rebound, while at the same time downplaying the risks of involved in achieving this hoped for 'rebound'.

- There has been no analysis of the effect of the sales slump on BBA's brand and the risks, going forward, involved in rehabilitating the company's brand in the eyes of consumers. There appears to be a 'build it and they will come' view taken by BBA and the analysts when factoring in a massive 4Q rebound in sales and hoped for return to more normal conditions in FY06.

- There has been little discussion by analysts about the 'inertia' or the economics of de-leveraging BBA and retailers in general when retailers are confronted with massive slumps in SSS. BBA's Chairman and CEO referred in recent press releases to this damaging and prolonged de-leveraging effect- it is still occurring as evidenced by the continuing losses.

Cash Drain; Balance Sheet Working Harder
Cash outflow has been a feature of the last few quarters, as one would expect with the BBA's cumulative operating losses this year. The risk that Q4 does not offset the losses of Q1-Q3 is substantial and is not reflected in the current stock price.
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