What I like About Liz
(Guest Commentary - February 2, 2006)
Dear Subscribers and Readers,
For those who had wanted to learn more about picking stocks and evaluating companies, it is that time of the month again – the time when we bring in our regular guest commentator Mr. Bill Rempel for a quick discussion of his methods and thought processes. In this commentary, Bill is going to “get back to basics” and give us a quick analysis and opinions about Liz Claiborne – the famous retailer of women and men's apparel. First of all, following is biography of Bill:
Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see “A 2006 "Extravaganza" of Predictions” for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) in back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.
Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."
Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice. Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.
There is a lot I like about LIZ. Liz Claiborne, that is. LIZ closed the month of January at $34.72 a share, with a market capitalization of approximately $3.7 billion. Based in New York City and with an employment of about 14,000 people, the company designs and markets clothes, jewelry, accessories, and fragrances, etc. The "etc." includes furniture, games and toys, bath accessories, sheets, window treatments, DKNY and Kenneth Cole brands, flooring, “optic products,” jewelry, luggage, yada yada yada. A little bit of everything in the industry, really, and a trip to the mall will find her wares for sale in just about every department store, be it Foleys, Bealls, or Bed Bath and Beyond. That merchandise is characterized as “wholesale apparel” and “wholesale non-apparel” in her 10K. The company has over 250 specialty retail stores and over 600 concession stores that she calls her “retail” operating segment. At eight of their 15 websites, they offer direct to consumer sales, and I am guessing that ¾ of her sales are in the U.S. domestic market. She manufactures nothing but has about 88 licensed brands or trademarks under which the products she designs are manufactured by others and merchandised by her. But none of that brought her to my attention. What brought her to my attention were her physical measurements … as usual. The data below is from http://finance.yahoo.com, competitors per Reuters in the apparel/accessories industry.
From a first glance, she seems healthy enough. LIZ is inexpensive on both an absolute and a relative basis, although not extremely so. Note that VFC was on last month's list of large caps poised to outperform, so it seems to me there's some value to be found in this industry. Combined with the poor returns over the last year, this makes for an interesting look. When I look at some aspects of the long-term picture per data from MSN Money, this is what I see.
||Book / Share
While her next earnings announcement is due sometime around February 27th, the TTM (Trailing Twelve Months) earnings don't really show me why LIZ is cheap right now – the pattern seems to be continued growth. So I turn to the earnings history as compared to expectations, and I find what is turning into one of my favorite stories – the fairly-valued stock that gets unduly punished for missing expectations and/or guiding down. Combine this with the somewhat prevalent macro view of a “challenging retail environment” and Mister Market tends to place stocks like this at a negative 52-week return – and I positively start to salivate. Check the following monthly chart and you will see what I mean.
In terms of P/E ratio, this is the cheapest LIZ has been in years! This despite actually consistently turning a profit over the last decade! A two-stage model with 11.5% growth over the next five years, reverting to S&P 500 standard 6% growth thereafter, and using a 15% discount rate, generates a suggested PE of 14.3, which of course is higher than 11.8. Not a lot, but higher.
Downloading the recent financials, I checked for earnings quality, cash generating power, reliance on financing cash flow, free cash flow, and liabilities and interest payments as percentage of operating cash flow, and found all of the above to be free of red flags. I did note that the most recent TTM had upticks in inventories and accounts receivable as a percent of revenues, however, and these are typically red flags for me. Going back to the quarterly numbers, I note that 3Q 2004 had similarly high numbers which decreased after the 4Q – and I remember that this line of business is seasonal. So I decided to forgive LIZ for this indiscretion. LIZ does pay a dividend, but the modest yield is unimportant to me at the volume of shares that I would purchase. I do believe the dividend is safe, however, and there is certainly room for it to increase if management ever became so inclined.
Recent events include the retirement announcement of their CEO (for the end of 2006), the promotion of a lady who came over in 2001 from J. Crew Group to President, and an unsolicited all-cash offer for J. Jill Group that was made last November. Like most companies in this industry, acquisition plays a role in the risk of buying these stocks, because it's always possible for the company to eat something that disagrees with it, leading to a subsequent drop in market price. The last major acquisition carried through was the C&C California brand in January 2005. The executives of the company have mostly been in place for the entire time of which I reviewed financials.
LIZ grants stock options only at or above the current market price. I didn't find their dilution factor excessive. They do engage in currency hedging through derivative instruments and an interest rate swap, which makes sense given the proportion of business transacted in Euros, but I didn't see any signs of wholesale speculation in these markets. I found only one off-balance sheet financing arrangement (commonly referred to as a “synthetic lease”), associated with warehouse and distribution facilities in Ohio and Rhode Island. It seems to be an arms-length transaction to take advantage of the favorable financing rates such an arrangement afforded, and there's no visible relationship with directors, the company, etc. There are the usual legal statements about litigation, but nothing that at first glance seems outrageous for a company of this size.
The chart suggests very strong support at $34. This support is reinforced by the April and October lows. More recent and less robust support seems to be at $35, with several retests in the last few months. This is a fairly well traded stock to have been so range-bound for so long, but looking back at 2003-2004 one can see that it has precedence. The stock appears to be basing. There is probably little immediate need to buy in, unless one sees either a close or (preferably) a low above $36, which would indicate a breakout. Anything below $35, in the absence of news, is an opportunity to accumulate shares. Technically I don't find anything immediately appealing about LIZ – none of the indicators are really speaking to me. At this point, this looks like a “wait and see.”
The risks involved with LIZ seem confined to the macro risks associated with their industry. The price carries with it a margin of safety that, while not large, is attractive to me considering the company's history of profitable growth. Combined with the current price stability, this is not the most exciting value stock I've ever seen, but is definitely something I am going to keep an eye on. I will continue to keep track of this stock going forward and report what I find out.