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Sorry For Your Loss

Posted: Jan 09, 2008 08:26 AM by Glenn Curtis

Tickers in this Article: AM, DLTR

Shareholders of American Greetings (NYSE:AM) received a rude message from the market to start off 2008: during the first few days of trading in the new year, the stock dropped almost 10%.

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This recent fall compounds a steady decline that has persisted since October of 2007. That decline intensified on December 20, when the greeting card company release disappointing third-quarter earnings results. American Greetings' recent earnings, its valuation, and its bleak prospects for growth going forward all combine to write a pretty ominous message for 2008.

Q3 Down and Dirty Overview
On December 20, American Greetings reported a third quarter profit of roughly $29 million or 52 cents a share in the period. This was well below the $49.7 million or 83 cents a share it earned in the comparable period last year and also shy of the 57 cents a share the analyst community had been expecting.

These missed expectations are particularly significant, because the company had been blowing its earnings estimates out of the water up until now. Last quarter, American Greetings' EPS beat Wall Street's consensus estimate by 23 cents, while in the first quarter of this fiscal year it produced a positive earnings surprise of 21 cents per share. That's why this quarter's negative earnings surprise was a kick in the teeth for investors who bought shares in the middle of 2007, anticipating that the stellar earnings the company reported, and new highs the stock hit had been hitting, were going to be repeated as the year progressed. Going forward, this leads to several causes for concern:

1) Valuation Issues
At present the company trades at about 12.5 times the current year's earnings forecast of $1.50 a share. That's not terrible, given that it's expected to grow its earnings at a 16.7% pace during fiscal 2009; however, given that it is expected to grow at only about 10% per annum over the coming five years, the stock looks a bit expensive.

It's expensive when compared to a rival such as CSS Industries (NYSE:CSS), which also sells "social expression products" - aka greeting cards. For the record, CSS currently trades at about 13.5 times the current year's earnings forecast of $2.42 a share. While there are no five-year growth estimates published for the stock, it's expected to grow its bottom line by 25% in the upcoming fiscal year. In comparison, American Greetings' near-term expected growth rate is almost 9% less, making the stock's similar forward P/E valuation seem pricey. (For added insight, check out our tutorial on Investment Valuation Ratios.)

2) Insiders Getting Out
Another red flag to me is that, although the stock has been steadily trading lower over the past six months, insiders have been net sellers during this time. Over the last six months they've collectively sold more than 110,000 shares. As per the company's latest proxy statement, all officers and directors own a total of about 1.1 million shares. Ten percent is definitely a significant portion of their collective stake to be selling.

Now to be clear, it appears much of this activity was option related. In other words, the executives exercised stock options and then sold the underlying shares. And while I certainly can’t begrudge an officer or director from taking some profits off the table, to see execs selling the stock as its dropping is hardly a morale boost. (For related reading, see The "True" Cost Of Stock Options.)

3) Dollar Stores on The Rise
If you've been to a dollar store lately, you'll probably have noticed a whole rack full of lesser-known or "no-name" greeting cards, all selling for a dollar or, in some cases, even less. This commoditization of greeting cards is certainly a big concern for the stock going forward. With the prospect of an economic downturn looming on the horizon, American Greetings could lose even more sales as consumers opt for the less expensive greeting cards sold by dollar store chains.

The dollar stores are already doing well in this economic climate. As proof, just take a look at Dollar Tree's (Nasdaq:DLTR) third-quarter earnings press release from late last year. In its most recent quarter, it posted decent 9% revenue growth, 19% growth in earnings and a solid 1.9% increase in same store sales. Unfortunately, its cards business isn't broken out in Dollar Tree's earnings, but the fact that it's garnering such foot traffic is a warning for high-end card makers like American Greetings.

The Bottom Line
American Greetings is coming off a lousy third quarter. Based on the stiff competition, its apparently high valuation, and persistent insider selling despite continued share price declines, I have a hunch that fiscal 2009 might not greet the company's investors warmly.

By Glenn Curtis

Glenn Curtis started his career in the 1990s as an equity analyst for a regional firm in New Jersey. There, he covered companies in the technology, entertainment, and gaming industries. Curtis has since worked as a financial writer at a series of both web and print publications, including TheStreet.com and Registered Rep Magazine. He has held his series 6,7,24, and 63 securities licenses.

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