Hedgeye - VFC For TRLG? Not a Chance

VFC For TRLG? Not a Chance

The rumor mill is saying that TRLG is exploring a sale – and it absolutely should before margins collapse. Any buyer with half a due diligence process should realize this. VFC has learned its lesson with 7.

The good ‘ol rumor mill is churning this fine Friday afternoon. An interesting one is that True Religion has hired Goldman to explore a sale, and that VFC could be interested. Now… the first part of that might very well be true. After all, this is the exact time TRLG should sell – before margins erode further as the company tries to establish itself as a lifestyle brand with more of a direct-to-consumer (i.e. Retail) strategy. This will fail. Any buyer with half a due diligence process should realize this. That brings us to the second part of the rumor – that VFC is interested. Not likely… Let’s YouTube VFC on its acquisition of 7 For All Mankind.

VFC’s PREMIUM DENIM SRATEGY

VFC’s tone is changing on its premium denim line, 7 For All Mankind, as it hits a critical juncture in the contemporary brands portfolio. The original business of 7, which was purchased at the top of M&A cycle in 2007 for $775 mm, is under pressure as premium denim is no longer selling at price points it once did. Average price has now fallen from a peak $180 to $150, down 17%. Despite oversupply and weakening prices in the premium denim space overall, VFC is following its original growth plan for the brand. Such strategies include opening retail locations, expanding internationally, and extending product line offerings beyond denim and into sportswear and accessories. The challenge however lies in the fact that the wholesale channel is suffering (primarily department store distribution), the retail stores aren’t performing as well as Vans and North Face stores, and overall contemporary coalition margins are being deluted by investment spend with no near-term incremental revenue return.

Most notably, management’s tone has changed on the company’s quarterly conference calls. What was once the trio of investment spending – North Face, Vans, and 7 For All Mankind – has now become the duo with a side of everything else - 7 included. It will likely be a long time before $200 jeans return on such a widespread scale. There’s no question that there will always be a niche market for premium denim, just not one that shares distribution and price points all the way from Macy’s to Barney’s. With that said, we’re more likely to hear about efforts to diversify the product assortment from 75% denim to 66% and ultimately lower as original expectations for the “lifestyle” denim brand are paired back. 7 stores will still be opened but this is not a needle moving strategy at this point or in the near future. If one thing was clear on yesterday’s call, it’s that the company’s growth drivers remain rooted in North Face, Vans, and in Asian (China) expansion.

The 7 For All Mankind YouTube:

Q3 09

7 For All Mankind should continue to enjoy mid-teen operating margins this year. The growth opportunities we identified at the time we purchased the brand – international expansion, retail store growth, and product line extensions – remain intact, and we continue to see excellent long-term potential for the brand.

Q4 09

7 For All Mankind’s international revenues grew by 23% in constant dollars.
This year we will step up our investments to drive future growth. These investments, totaling $50 million, will be very targeted and concentrated in those businesses with the strongest opportunities for growth, including The North Face, Vans and 7 For All Mankind brands, and our business in Asia.
Our Outdoor & Action Sports and our Contemporary and Sportswear businesses achieved growth in revenues on a constant currency business in the fourth quarter. The strongest growth was in our 7 For All Mankind, Eastpak, Vans and The North Face brands.
Our 7 For All Mankind brand has also gotten off to a fast start in Asia. We have 15 new freestanding partnership stores planned in ‘10, and we also be investing to support our distributors in both China and Korea to build market leadership in the premium jeans category.
Obviously, there’s mixed numbers in there with all the retail formats we have around the world. And as you’d expect, our retail formats in businesses like The North Face and Vans and 7 For All Mankind posted stronger comps.
The 2010 outlook, the best way I think to deal with that, we’re looking at 80 to 90 stores [globally]. Two-thirds of [of the store openings will be] between The North Face, Vans and 7 For All Mankind. We’re very focused this year in our marketing spending, and we’re very focused supporting strongest brand opportunities. And so, really, it’s 7 For All Mankind, The North Face and Vans will be where we’re focused in new stores. A lot of them internationally

Q1 10

Double-digit growth in the 7 For All Mankind direct-to-consumer business was driven by both new store openings, as well as very strong comp store increases. We’re looking forward to double-digit revenue growth for our 7 For All Mankind brand starting in the second quarter. Investments in new 7 For All Mankind retail stores reduced margins in this seasonally low period for revenues, these new stores are expected to contribute to significantly stronger margins throughout the remainder of the year. We are also expanding the direct-to-consumer business for 7 For All Mankind to the opening of a combined total of over 15 owned and partnership retail stores in key European cities this year.
The 7 wholesale business is getting better than it was last year for sure. Last year was a particularly tough year. But we still don’t have positive trend in our wholesale shipments business. Part of the reason for that is we lost a lot of customers to bankruptcy over the recession – small customers and specialty stores. And that’s part of the reason we’ve invested in some of our own specialty store business and that business is strong for us. Our comps are good and our overall global trend in opening 7 For All Mankind stores is strong.
Yeah, I can comment on what gives us confidence in our product direction being back on track and that is the performance of the products we have in our own stores where we get obviously instant feedback on whether or not we’re on trend. And our own stores are performing well. So that tells us that consumers are relating to the products we have in the stores. And our team out there has done a nice job of getting the brand back on – into the right product mix. Unfortunately, we have a lot less customers to sell those products to because of the massive amount of closures in the specialty store industry during the recession.
And what we can say is that later in the year is when we’ll see the most substantial improvement in terms of the retail side of things. So, as Eric said, we’re in the pretty early stages of our overall retail business within 7 For All Mankind and especially in a lower quarter of revenues which is, as you know, this is a low retail quarter for us and it picks up in the third and fourth quarters and that’s true for our 7 For All Mankind business as well. So we’ll see some substantial improvement in terms of the profitability of those stores beginning in the second half of this year.

Q2 10

Our 7 For All Mankind brand continues to expand in Europe, with 24% revenue growth in the second quarter. Strong bookings and additional new stores should drive double-digit growth in the second half of the year as well. New stores opened in the quarter include in Milan, Berlin, and Antwerp, and we are looking forward to opening our second store in Paris this quarter. We remain on plan to open a combined total of about 15 owned and partnership retail stores in key European cities this year.
7 For All Mankind shifted on us a little bit here in the second quarter. You know, we had a really strong first quarter with 7. We had a strong second quarter with 7 as well. We have seen a slowdown in the premium denim space in the last few weeks – the last eight weeks, really, since May. That segment in particular has been a soft spot. So our stores are still working for us and we are continuing to invest in our stores, but there clearly has been sort of ‘how long does that last?’ I wish I knew the answer to that. The answer for us is to make sure we create compelling product, which obviously we’re working on that. And we are increasing our investment in the brand. In fact, we are just about doubling our marketing spend behind 7 For All Mankind right now because we think it’s a great brand. And even though it’s under pressure right now, we are going to spend on it to make sure that we connect with consumers in the right way. We underspent on it a bit in the last few years. So we are going to reinvest in it and hope we have the right products at the time and the fall gets better than the last eight weeks have been.
In the contemporary space in terms of price points, there was a significant reduction in price points during the course of the recession over a two-year period. The average price point for a pair of premium jeans regardless of brand came down. It didn’t mean that we didn’t still offer the high end of the range, but the consumers bought more at the lower end of the range. So we saw a reduction in AURs. That stabilized in the first four months of this year. And I think it’s under question right now because there’s been a change that really has just happened. And as you know, we’re also in a period of year, it’s been a very warm June and July across the United States. And I’m not sure if people are waking up thinking I am going to buy a pair of long jeans – long-bottom jeans right now because that’s what I want to wear today. In fact, I’m pretty sure they aren’t. The question will be during back to school, does that come back and what does that mean to the average unit retails?

Q3 10

We’re investing over half of our incremental marketing spend in outdoor and action sports initiatives, the balance of the spending increase is strategically allocated to important growth initiatives in our U.S. and our Asian jeanswear business and in our Nautica, 7 For All Mankind and other brands.
Relative to our 7 For All Mankind brand, the premium denim business is softening from the strength we experienced in the first half when we were up 8% globally. In tough economic times, consumers are more value conscious than ever, more focused on savings and spending and looking for something new as a trigger to spend. Fortunately, while 7 For All Mankind continues to be the brand leader in the category it’s more than a denim brand. In fact, a quarter of the brand’s volume in our own stores is nondenim currently and that’s going to be increasing to a third of the business next spring.
Also our retail partners are adding more sportswear into their premium denim departments which will add variety to the current offerings and help spark consumer interest. The 7 For All Mankind continues to resonate strongly with consumers and we’re capitalizing on this by adding new retail stores and we’re investing heavily in marketing, expanding into Europe and Asia and building our sportswear and accessories business. This brand still has a lot of room to grow but faces some short-term challenges.
There’s no question that the premium denim category is soft which resulted in a slight decline for 7 For All Mankind revenues in the first third quarter. There are, however, a number of bright spots. European revenues for the brand increased 8% on a constant currency basis and we are on track to open 19 stores this year. As mentioned in the release we are investing in the 7 For All Mankind brand and will continue to do so in the upcoming quarter.
Let me give you color on 7 For All Mankind for us globally. The domestic business year to date is up low single digits due mostly to the success we’re having with our own retail stores. The international business is up high single digits in constant dollars. And around the world we’re seeing that driven by the stores that we’re opening are working for us and some softness in the wholesale business in general.
The reason I’m confident in our future is we expect to continue the rollout of our own retail stores. We’re just really getting started in Asia and Europe. We have a lot of runway ahead of us there and we continue to build the brand into new product categories, into the sportswear and accessories business where it’s very early days for those initiatives. We do expect pressure on the core denim business at least in the short-term. But, and I don’t know what that will look like in five years, nor does anyone else. So that’s, when you look at total model, we think that we can weather through this because of the strength of the brand and the success we’re having on the initiatives I mentioned. The total premium denim business is soft. That’s really a U.S. comment. That’s why you’re seeing many of the brands expand their businesses into sportswear.