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A Fine Clothier that Bill Actually Likes: Hartmarx

(Guest Commentary - September 14, 2006)

Dear Subscribers and Readers,

For those who had wanted to learn more about picking stocks and evaluating companies, I have again invited our regular guest commentator Mr. Bill Rempel for a quick mid-week discussion of an individual stock that he likes.  As subscribers should know, Bill took the day off from writing his regular guest commentary last week, since he was in the midst of relocating his blog to:

Newsflash: I have always liked Lowry as a technical service since they have always been the most objective technical analysts and since their measurement of market indicators are timeless.  For subscribers who do not have a subscription to Lowry's Reports, the following 13-minute video provides a good introduction to their indicators as well as their current views of the market and various sectors and stocks:

In this commentary, Bill is going to discuss Hartmarx – a somewhat risky small cap stock (but potentially rewarding) in an out-of-consensus industry.  This is again a “value play” given that Bill is a value investor at heart.  Without further ado, 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 “An Out-of-Consensus Small Cap: Ennis, Inc.” for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) 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.

Silk suit, black tie, I don't need a reason why.  Nothing says "value" like old technology and a simple business model that's easily understood.  There are very few technologies older than textiles, and there are very business models that are easier to understand than "quality and excellence in clothing since 1887."  If you don't recognize that tag line, don't be alarmed.  It belongs to a very small company that might – might! – represent value. 

Hartmarx is a clothier with some of the more prestigious brands in fine apparel.  Keep in mind that I am typing this while wearing Rustler jeans, $15 shoes, and an oversized v-neck T-shirt that came in a 3-pack, and all of those items were purchased at Wal-Mart, so I don't know fine apparel from Jack.  However, the list of brands being sold by the company is impressive even to this neophyte. 

Moreover, Hartmarx also has a long and storied history.  The company dates back to Mrs. O'Leary's cow, and, in their own words, the company "went to war twice, turning over its plants for U.S. uniform production" – as if they had a choice.  Oh, bother. 

Regarding the clothing, Hartmarx (HMX) does manufacturing and marketing, primarily in the U.S. and Canada.  They do men's and women's, tailored clothing, career wardrobe, designer jeans and knitwear, blah blah blah, yada yada yada.  From looking at a couple of their shop online links, I'm convinced that I will only see their products in a browser, or on a movie screen.  That's OK, because I'm going to take a look at their company, and their stock.

HMX has a market capitalization of just over $200 million, and the following FundaTechnicals, courtesy of Yahoo!Finance:

Trailing P/E: 10.3

Forward P/E: 7.9

Price/Sales: 0.4

Price/Book : 0.9

Dividend Yield: n/a

Well, it certainly looks cheap so far! If you want to know why the stock is this cheap, you don't need to look any further than the last two quarters' earnings reports versus expectations.  Two large negative surprises in a row can impact your per-share numbers.  The P/E has been cut in half from not too long ago.  When you compare the P/E to the projected five-year growth, you get a PEG of well under 1.0, which is ... cheap.

The Fundamentals are mighty nice, again courtesy of Yahoo!Finance:

Return on Assets: 5.3%

Return on Equity: 8.4%

Debt/Equity Ratio: 0.4

Current Ratio: 3.3

Dividend Payout Rate: n/a

That is a mighty nice ROA, but the ROE is fairly low, probably because the company is not very leveraged.  The numbers are interesting enough so I decided to work up the metrics I like to see on my own spreadsheet. 

Per (Diluted) Share Measurements Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 TTM
Earnings Per (Diluted) Share (0.60) 0.03 0.25 0.44 0.63 0.54
Tangible Book Value Per (Diluted) Share 5.71 3.39 4.30 4.04 4.31 4.50
Operating Cash Flow Per (Diluted) Share (0.68) 1.72 0.43 1.02 0.20 0.16
Free Cash Flow* Per (Diluted) Share (1.01) 1.62 0.36 0.90 (0.17) 0.00
Dividends Paid Per (Diluted) Share - - - - - -
Growth Measurements Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 TTM
Revenue Growth n/a -5.0% -1.5% 4.4% 2.0% 1.2%
Net Income Growth n/a -104.9% 901.1% 82.2% 48.5% -13.4%
Total Assets Growth n/a 2.7% -7.5% 6.5% 10.3% -2.0%
Total Liabilities Growth n/a 7.6% -17.3% -0.9% 9.7% -6.7%
Equity Growth n/a -3.9% 7.8% 15.2% 10.8% 2.8%
Tangible Equity Growth n/a -33.5% 30.6% -1.5% 9.2% 5.2%
Profitability and Earnings Quality Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 TTM
Profit Margin [Net Income / Revenue] -3.0% 0.2% 1.6% 2.7% 3.9% 3.4%
ROA [Net Income / Average Total Assets] n/a 0.2% 2.0% 3.6% 5.0% 4.2%
ROE [Net Income / Average Shareholder Equity] n/a 0.5% 4.7% 7.7% 10.1% 8.2%
Earnings Quality [should exceed 1.00] 1.11 8.40 1.31 1.67 0.63 0.63
Cash Generating Power [should exceed 1.00] (0.80) 5.50 (3.23) 0.98 0.26 1.06
Reliance on Financing Cash [should be negative] n/a -10.6% -4.5% 0.1% 4.4% -0.1%
Inventory as Percent of Sales 24.9% 20.1% 22.0% 22.1% 25.5% 25.8%
Accounts Receivable as Percent of Sales 25.0% 23.7% 22.8% 21.4% 21.4% 18.5%
Accounts Payable as Percent of Sales 5.7% 6.5% 6.5% 7.3% 7.2% 0.0%
Related to Solvency Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 TTM
Total Liabilities / OCF (12.58) 4.77 15.19 6.15 33.53 37.61
Current Liabilities / OCF (5.41) 1.58 5.36 2.67 13.32 15.36
Interest / [OCF + Interest] 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Effective Interest Rate [InterestExp/LongTermDebt] 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Dividend Factor [DivPaid / OCF] 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Just Plain Interesting Stuff Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 TTM
Effective Tax Rate [IncomeTax/PreTaxIncome] 39.5% 39.4% 39.5% 38.7% 38.6% 37.9%
Dilution Factor 100.0% 99.8% 96.0% 96.3% 97.9% 98.1%
Intangibles as Percent of Assets 3.3% 14.2% 10.3% 16.7% 17.3% 17.4%

If you want to see a beautiful ten-year history of consistent profits and growth in earnings and book value, you need to look somewhere else.  This company is certainly managing through some rough times, and the risk shows.  There are weaknesses in the cash flow from operations and in the earnings quality, as well as a nip up in inventories.   This is not a play for the faint-hearted.

The most-often-overlooked area of Fundamentals is the review of the Q's, K's, and proxy.  What I like to do is look for related-party transactions, special purpose entities, excessive compensation to executives or directors, the company's investment policies, outstanding legal risks, excessive use of options, sweet deals for takeovers, accounting policy changes, and etc., in about that order of importance.  Basically I am trying to be an amateur 10Q Detective or a less-experienced Footnoted.  It is something that helps me decide my personal comfort level with holding the stock, say, through a vacation.  I think of it as a "sniff test." 

The proxy shows only one class of stock, with one share equaling one vote. Share dilution looks to be around one percent.  There are no special controlling shares and no shares that get dividends while others do not.  Board meetings are frequent and well attended, and Board compensation looks reasonable to me.  The management salaries and golden parachutes also look reasonable to me in light of the company's size.  Executives have bonus potential based upon the company's achievement of goals.  The compensation stuff looks fairly tame, which is good.  The biggest single owner shown in the proxy is Abdullah Taha Bakhsh of Saudi Arabia at 15% of the common, but I do not see a direct connection to any Board member or executive.  Other than the election of Directors and replacing their old, much-amended 1995 compensation plan, it's a pretty empty proxy, which is nice.

Hey, speaking of big owners, good ol' Abdullah has been buying lots of shares recently.  Note that Emerson Investments and Traco International are both owned by Taha Bakhsh – and so are about 400,000 more shares recently.

The Q shows evidence of their acquisitiveness, which is good and bad, but typical of this business model in this day and age.  Acquisitiveness is often a bad sign when it leads to "integration issues" and an artificially inflated book value filled with intangibles.  What I am looking at with Hartmarx is how the acquisitions have positioned the company for the future, since most of the acquisitions are more casual lines, non-tailored clothing, sportswear, and high-end women's clothes (no pun intended).  In the annual report, their focus is clearly on building share in the non-tailored divisions and reducing debt while providing moderate gains in sales and earnings.  This seems like a smart thing to me.

Some interesting Technicals courtesy of Yahoo!Finance:

Insider Holdings: 14.9%

Institutional Holdings: 58.7%

Short Days to Cover: 6.3

Short Shares Change, Month over Month:  -18%

Keep in mind that Yahoo!Finance calculates "short days to cover" based on the last three months of volume, and the shares short data is usually a month old by the time I see it.  It certainly looks like the shorts were onto something here, as they had ridden this stock down 38% over the last 52 weeks before it squeezed up, and it trades closer to its 52-week low than its 52-week high.

I think "short percent of float" is a meaningless number, so I do not include it.  What is important is the amount of shares shorted compared to recent volume, in light of recent price action.  I can think of many day-trading stocks with high short percent of float, but when they turn over 100% of ownership in two months, does a high short percent of float tell you anything?  HMX actually has a pretty high turnover, once per six months, which may be a good thing if we can see the volume calm down and a bottom set in.

The short interest probably is not high enough to generate long-term technical support, but it seems to have been high enough to generate a squeeze.  I do really like two things about the technicals.  First is the high insider holdings, high enough for skin in the game but not high enough to control the game.  Second is the institutional interest that has room to grow.

What initially attracted me to Hartmarx (HMX) was my standard scan for value stocks, which I will eventually cover in the scans section of my blog.  Generally speaking, it is a scan for cheap, profitable, downtrodden, and not too leveraged.

The technical action that encouraged me to write about Hartmarx (HMX) was the violent bottoming of the stock over the last couple of months.  At one point I though it was entirely possible this stock could get cut in half from its highs of mid-2005 – and it still could!  There has been some explosiveness and volatility recently, which to me says "short squeeze" more than it says "bottom."  The time to enter may be when the volume calms down to more historic levels.

Hartmarx (HMX) is another small-cap value stock that could represent significant gains versus the overall market, given a tolerance for the high volatility and a long holding period.  I am looking for a calming of the volatility and some stability in the volume before considering it a serious buy.  This stock is on my watch list, and I will consider a position in Hartmarx if the technicals present themselves.

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