Warnaco's Time Has Come

One company that has been on my short watch list for the better part of a year is Warnaco. I'm not the only one with that idea, as it has been a somewhat crowded sandbox. Much to short-sellers' dismay (and mine) this stock has done nothing but go up. But insiders are selling, inventory/sales spread is peaking, margin compares are getting tough, cotton costs are rising, and a cleaner P&L is making it tougher for WRC to sandbag. Not good.
  • Yes, the company has made some very good decisions over the past few years. No argument there. WRC cleaned its books after accounting irregularities (which were set in place in part by the ops folks under the former regime), as well as sold and closed down unprofitable divisions. There's no denying that this is a better company today than 2 years ago.
  • Now we're looking at a streamlined WRC, whose main profit engine is Calvin Klein Underwear. A great global business - and probably the best undergarment brand aside from Victoria's Secret. But with margins topping 20%, cotton costs up 30% vs. last year, and what I would argue is too much FX benefit flowing through to the EBIT margin line instead of being reinvested in the business (CKU as well as CK Jeans), this thing just smells off to me.
  • In addition, a key factor I like to track is the ratio of sales growth vs. inventory growth, and WRC's ratio has been defying gravity - leading the industry for 3 quarters. In fact, WRC's inventories have trended from 130 days to 110, partially due to divestitures. Though now inventories have ticked up, suggesting that perhaps they've found a near term bottom. When I layer that on top of WRC hitting very tough margin compares 2 quarters out, and a much cleaner P&L (making it difficult to sandbag with guidance) then I truly wonder how this multiple stays at a 20% premium to higher quality companies.


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