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We reaffirm our Neutral recommendation on Kirkland’s Inc. (KIRK - Analyst Report) following its first-quarter fiscal 2013 results, wherein modest revenue growth was offset by higher cost of sales and operating expenses.

Why the Reiteration?

On May 23, Kirkland’s Inc. delivered first-quarter fiscal 2013 results where earnings remained flat year over year. However, earnings exceeded both the Zacks Consensus Estimate and management’s expectation on the back of the company’s strategic initiatives to improve sales.

Kirkland’s managed to post modest net sales gains of 3.5% backed by its growing e-commerce business and increased marketing spend. Although comparable store sales at brick and mortar stores declined by 3.1% year over year, due to lower transaction, e-commerce sales shot up by 19.1% year over year during the quarter.

However, higher cost of sales pressurized margins and led to a gross margin contraction of 41 basis points in the quarter. In fact, Kirkland’s is facing higher operating expense due to rising inbound freight cost and store occupancy cost for several past quarters. The higher outbound freight cost reflects an increase in shipping and packaging costs associated with the company’s e-commerce business.

Moreover, the company has been experiencing a decline in comparable store sales for the past three years. The recent trends show that although customer traffic has increased, comparative sales and transactions have declined as customers leave the store without purchasing anything.

However, management has taken several initiatives to improve its comps for the coming quarters. Kirkland’s has recently ramped up its marketing and promotional activity (advertising campaigns and loyalty credit card programs) to boost sales. Although such promotional campaigns have decreased merchandise margins, it is expected to drive earnings over the long term.

Kirkland’s has recently started closing its smaller underperforming stores in the malls and is opening bigger off-mall stores in popular places. This strategy of shifting the stores toward more prominent regions is expected to boost sales in the coming quarters.

Overall, we remain impressed with the company’s initiatives to improve its top line. Management narrowed its fiscal 2013 earnings guidance range, which reflects the strategic initiatives taken up by the company.

Other Stock to Consider

Kirkland’s currently carries a Zacks Rank #3 (Hold). Other consumer staples stocks worth considering are Nash Finch Company , United Natural Foods Inc. (UNFI - Analyst Report) and Fairway Group Holdings Corporation (FWM - Snapshot Report). While Nash Finch carries a Zacks Rank #1 (Strong Buy), United Natural and Fairway Group carry a Zacks Rank #2 (Buy).

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