Not many public companies have gotten into the action, and some of the ones in business have been struggling. But there is one tiny furniture chain that has done well recently, while other companies have hit rough waters.

But despite its recent strong performance, you should avoid this furniture chain for the time being. I’ll explain in a minute…

The name of the company is Jennifer Convertibles (JEN: AMEX). It is a $41 million furniture chain that operates 175 Jennifer Convertibles stores and 16 Jennifer Leather stores. The Jennifer Convertibles stores sell sofa beds, along with other furniture such as chairs, loveseats and recliners.

But even though this is still a small company, Jennifer Convertibles is the largest sofa bed specialty retailer and the largest Sealy and Simmons sofa bed dealer in the United States. Unlike many furniture stores that cater to a particular demographic, Jennifer Convertibles carries both high and low-end pieces in an effort to appeal to a broader customer base.

Jennifer Convertibles has worked to turn around its fortunes recently. This past quarter was their fifth in a row that was profitable, and the company closed 20 unsuccessful stores last year and improved profit margins. One store was closed during the most recent quarter, and no new stores were opened.

The company’s operating margins increased during the current three- and nine-month periods to 32.5% and 31.4%, respectively, up from 29.2% and 27.2% during the same periods last year.

All of this has been accomplished as other furniture chains have lost business to big discount stores like Target (TGT: NYSE).

The following small-cap furniture stores have faltered recently: Pier 1 Imports (PIR: NYSE), the furniture store that caught shoppers’ eyes with unique items at reasonable prices, hasn’t turned a profit in five quarters. And vintage-inspired items from the more upscale Restoration Hardware (RSTO: NASDAQ) haven’t helped the company make a dime in profits for five quarters as well.

But to truly judge the performance of a retail chain, there are two more factors that need to be strongly considered.

Same-Store Sales and Low Debt

One of the most important things to look at when it comes to retail is same store sales performance. This shows how sales at stores that have been open for at least a year have faired. While overall sales growth is important, growing same-store sales is a better indicator of a chain’s success because it shows the company is doing something right by attracting more buyers to its existing locations.

Growing same-store sales also proves that a company isn’t relying on rapid expansion to line its coffers. Chains that grow too quickly can spin out of control just as fast. And when the rapid expansion stops and competition starts chipping away at their market share, disaster could be just around the corner.

Jennifer Convertibles has improved same-store sales drastically. The most recent quarter saw same-store sales jump 15.9%, added to an even more impressive 31% same-store sales growth. The same-store sales growth adds up to more than 20% year-to-date.

The other factor is debt. Famed former Magellan Fund manager Peter Lynch said he likes to invest in retail that carries very little debt, since these are the companies that are better prepared to ride out a recession. Heavily indebted retail stores usually go out of business when the economy takes a turn for the worst, Lynch said.

Jennifer Convertibles has $100,000 in long-term debt, and $9.8 million in cash. So the company’s current debt is obviously not a factor that would affect the business.

While Jennifer Convertibles looks good on paper, I have two major concerns with this company that make me want to steer clear…

First, as much as I like how the folks at Jennifer Convertibles have worked to turn a profit again, it is important to note that the strength of the economy will play a strong role in Jennifer’s success. Generally, sofa beds and other furniture are big-ticket items — purchases that families will put off if money is tight. And I have a feeling that higher gas prices will not only have an affect on the company’s operational expenses, but also on the number of customers who cross furniture off their “buy now” lists.

Second, the housing market is another concern. As the number of houses being built slows, fewer families will be moving into brand new, empty homes that need furniture.

These factors — while totally out of the company’s control — could affect Jennifer’s ability to grow and prosper as much as management would like. The P/E ratio of 7 makes this stock look tempting, but now is not the time to pull the trigger.

Best,

Gunner
July 17, 2006

Avoid This Retail Play was originally featured in the Penny Sleuth.