It’s tough to find long ideas in retail today where the sheer force of company-specific initiatives can offset the cross currents of Macro and the Global Supply chain to take estimates above current expectations. LIZ is emerging as one of them.
Some points to consider. First off…look at the chart below. Former CEO Paul Charron saw what was coming down the pike. After having successfully rolled up a whole host of branded apparel companies and always looking like the good guy b/c he was perennially compared to Jones Apparel Group (JNY), Charron cashed out in 2006 with his stock in the low $40s. Enter Bill McComb – who arguably did not know what he was getting himself into.
We could dedicate a few thousand words alone to what allowed Charron to build his empire, and why the environment changed after McComb took the helm. But it won’t change one major factor – that the stock is sitting at six bucks.
It’s easy to see why given the earnings revision chart below.
The bottom line here is that we think that revisions are starting to turn positive again.
The Street’s 3Q number of break-even EPS seems about right. But in 4Q, the consensus numbers look low by about a third. For the next two years we’re commin’ in hot at $0.84 and $1.34. That compares to the Street at $0.30 and $0.80, respectively.
There are a few main drivers.
1) LIZ is finally coming off a 3-year period where it…
- First royally crossed its largest customer and the largest department store in the world (Macy’s for those that don’t cover the space).
- Prepared to ramp in an exclusive arrangement to sell into JC Penney with its core LIZ Claiborne Brand – which caused additional friction in the channel.
- Launched a new model to sell consumer-direct on QVC.
- These are great ideas, as they reduce margin volatility while taking working capital out of the business at a time when the market often reverts into a mode where it thinks LIZ is going away. This deal helps both the income statement and balance sheet. Mind you…while this transformation took place, it took away $500mm in revenue on a sales base that today stands at just $2.6bn. That’s about $3.90 per share after tax.
- This erosion is OVER. See earnings revision chart above once again.
2) Mexx is another business LIZ owns that has been just awful.
- Once upon a time, this was a $1.2bn brand. Now it is losing money at $750mm. One of the issues at Mexx is that the company in effect ‘fired’ their customer. They tightened the customer range, and went chic metrosexual (that’s the first and last time you’ll see that in a McGough note). They had all eggs in one basket with Li&Fung, who chinced on quality of materials. Overall, the consumer had very little reason to shop there.
- My Canadian friends and colleagues are gonna give me crap for bringing this up, but this got to a point where Mexx Canada asked for, and got permission to, stop sourcing from Mexx Europe. That fashion was simply too ‘out there’ for real people.
- Now what? New design team started early this year. Li&Fung accounts of 70% of biz – which is still big – but now there are others to keep them in check.
- AUR is coming down by 10%, but 2/3 of Mexx product has been selling at a discount, as opposed to peers of 1/3. The company can offer better product 10% lower in price and probably increase traffic and conversions.
- Will this happen overnight? No. But this has been a BIG problem for a long time, and most US investors don’t get it bc it is all about Europe and Canada. We could see as much as a $0.30 swing in EPS next year if this gets to a 2-3% EBIT margin.
3) There are other factors as well – such as the closure of LIZ’s perennially underperforming outlet stores – which will add another $0.12-$0.13 per share next year – and the additional cost costs at HQ.
4) Also, did we mention the balance sheet? We’re looking at a $200mm, or $2.15 per share swing, in operating cash flow at a time when the business is becoming less capital intensive. Interest expense should come down from $65mm last year to just under $30mm by 2012.
Are we concerned about cotton? Yes. But that’s not in the top 5 factors that matter here. We can’t say that for many other companies in retail.