A Gloomy Tale for Borders

Shares of the bookseller dipped Wednesday after it posted a wider loss amid lackluster sales and heavy discounting

Where's Harry Potter when you need him? Bookseller Borders Group (BGP) could've used a dose of the boy wizard's sales magic as it suffered through another gloomy quarter, and the shares dipped on May 30 as a result. Alas, the next Potter book won't be released until July.

After the close of trading May 29, Ann Arbor (Mich.)-based Borders posted a loss for its fiscal first quarter ended May 5 of 51 cents per share before one-time items on consolidated sales of $876.8 million, a 2% increase from a year earlier. The company lost 31 cents in the year-earlier period.

While total sales at the company's U.S. Borders superstores increased 1.4%, same-store sales fell 1.9%. The culprits: Declines in book and music sales and flat DVD sales.

Adding to the company's woes: Gross margin shrank to 23.3% of sales from 22.4%, partly because of increased promotional discounts. Expenses climbed as the company spent more on strategic initiatives, and recorded non-operating charges, including an increase of $4.5 million in interest expense as a result of increased debt levels.

"Our first quarter results were generally in-line with our internal expectations, although the current sales environment was more challenging than we anticipated and that trend has continued," said Borders CEO George Jones in a May 29 press release. Jones said the company is focused on executing its strategic plan, which includes returning the company to EPS growth beginning in 2008.

But the company faces big obstacles to that goal. Profits have been squeezed by promotional pricing on books, DVDs, and music, and the company's rewards program for buyers has also pressured margins.

While the company has been expanding its flagship Borders superstores, opening four new units in the U.S. during the first quarter to bring its total to 502, it is retrenching elsewhere. The company is considering strategic alternatives for the majority of its international segment, and closed 11 underperforming stores at its Waldenbooks specialty division during the period.

Wall Street gave a negative review to Borders' downbeat tale. The shares fell 3.8% in afternoon NYSE trading May 30 to $22.44, below their 52-week high of $24.19 reached last Nov. 14 but above their low for the period of $16.20 on July 14. Shares of archrival Barnes & Noble (BKS) gained 0.3% on May 30 to $42.52.

Standard & Poor's Equity Research said in a recent report that it expects the final Harry Potter book to fuel sales growth for Borders in fiscal 2008, but it expects ongoing promotional activity to hinder profitability. In a May 30 note, analyst Michael Souers said "we still expect a highly competitive environment, along with a heavy amount of promotional activity near-term." The analyst slashed his fiscal 2008 EPS estimate to 15 cents from 30 cents and his fiscal 2009 forecast to 58 cents from 62 cents. The analyst kept his sell rating and $18 target price on the shares. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Cos. [MHP].)

Meanwhile, Goldman Sachs analyst Matthew Fassler said in a May 30 note that the company's first quarter loss was much wider than his 39 cents estimate, according to an S&P MarketScope report, noting a "surprising" profit decline in Borders' core domestic superstore business. Fassler believes the same-store sales drop at Borders superstores reflects the company's ongoing structural challenges as well as its high exposure to music sales. He has a neutral rating on the shares.

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