JNY: ‘They’re Baaaaack!’
JNY is morphing back to its old value destroying self again – both financially and behaviorally. JNY may have one quarter left of salvation, but then it’s gonna get ugly. The market is blissfully unaware of what lies ahead.
In case you weren’t counting, three of the seven analysts on the JNY call congratulated JNY on ‘a quarter well done.’ Am I the only one that hates when I hear someone being congratulated for doing their job – and a mediocre one at that? How’s that for a company that preannounced negatively a week ago, and put up a loss of $125mm thanks to yet another write down of its marginal assets.
I increasingly do not like this name. I’ve avoided being on the short side for the past three quarters as management simply had too many easy levers to pull to maintain momentum -- regardless of whether these levers should be pulled at all. Now we’re at a point where the incremental upside will be tougher to come by.
Let’s consider the facts…
1. Wholesale Better Apparel (29% of Revenue and 55% of cash flow): Just printed an 11.2% margin – up 128bps from a year-ago. This margin absolutely HAS TO hold, which is a stretch. With so-called ‘bad business’ already having been pruned (i.e. lost), the natural mix shift to a better book is not going to recur. JNY will get about a 3% top line boost due to its Rodriguez acquisition and from jump ball business created by LIZ hopping in the sack with JCP. But on the same token, with LIZ no longer at Macy’s whim, JNY will see added pressure for markdown dollars at quarters’ end by the 900lb gorilla – even if it is not JNY product that is not selling through. This also holds true for Jeanswear and Footwear.
2. Wholesale Jeanswear (24% of revenue and 35% of cash flow): Let’s face an ugly reality. This business just printed a +3.5% top line, but a 385bp improvement in segment margins, and it just highlighted a major roll over this quarter in top line due to anniversarying a big push last year with l.e.i., and increased competitive pressure. This was also the source of JNY’s asset write down. Margins in ’10 are not looking good here.
3. Wholesale Footwear (26% of Revenue and 30% of cash flow): This business is the poster child for a wholesale business that benefitted from the boot cycle. Could it last another quarter? Maybe. Another year (of sequential improvement in trajectory of boot sales)? Not likely – by a long shot. The company is guiding for 4-9% top line growth for ’10. This looks like a stretch without meaningful margin erosion.
4. Retail: (21% of revenue and -20% hit to cash flow): Here’s where I’m most concerned. JNY is in store closing mode, and 1Q alone should see a double digit revenue hit due to 50 fewer stores, and that should accelerate to 165 stores by end the of the year (it closed 96 in 2009). Also, retail has been a beneficiary of the boot cycle – something that’s not likely to recur in 2010. Management is on record as saying that it will break-even at retail this year. That might seem impressive in looking at the $41mm loss JNY just printed at retail. But read the fine print – that is ‘before corporate allocation.’ We estimate about $40mm in corporate expenses, or about $12mm at retail. So ‘breaking even’ actually equates to losing a double-digit number in what is reported to the Street. You can’t cut a business to profitability long-term. Ultimately you need to sell stuff that the consumer wants.
5. Balance Sheet: Lastly, let’s consider this thing called the balance sheet. On the plus side, JNY printed a commendable 18 point spread between sales growth and inventory growth. But how much longer is that sustainable for? Working capital should be helped by store closures, but keep in mind that in 2009 working capital was accretive to cash flow from operations to the tune of 29%. That’s the SAME year when capex as a percent of sales came down to 0.9%. Yes, boys and girls, that’s 0.9%. Can someone find me any company that touches this industry that can sustain a capex rate below 1%. Thanks in advance. In fact, JNY already guided that capex is going up to 1.5%, or about 55-60%.
6. Buy, Buy Buy. Another note on cash. JNY did not buy back stock this quarter, and in fact it issued a small amount. The company said flat-out that it is in full-on deal mode. No stock repo, no debt paydown. They’re gonna buy something. Let’s look back at JNY’s track record of acquisitions. Actually, let’s not. It’s too depressing. Just take a quick glimpse at long-term return on capital.
The bottom line here is that JNY is easing back into the ‘old Jones’ mindset. Cut when you should invest, and acquire when you can, not when you should. Let’s not forget that this is a company that historically traded as low as 3-4x EBITDA and 9-10x EPS, and had up to 35% short interest. Today it is at 6x EBITDA, 14.5x earnings, and has a paltry 6% short interest. Some might argue that 6x EBITDA is not expensive. And overall, it’s probably not – IF they believe in the stability of cash flow. I’ll go to the mat with them on that one!
-Brian McGough
