Message part 1/3: (vertical integration + earnings power)
jtmaimi, Thanks for your response!
“jtmaimi: …they will design and produce the majority of their products. This means that they will have to use American workers to produce all the products. The main disadvantage is labor costs. American textile factories can’t compete with overseas factories”
I don’t know am I missing something, but you know, we see this ongoing transition to vertically integrated company very differently. I understand your concern about cost of American worker and the fact that you cannot compete with Asian or other countries in NOT too sophisticated works like apparel manufacturing.
But if I understand correctly, they have hired new talent to their designing and merchandise management side to NYC. All apparels are manufactured in more cost efficient countries somewhere in Asia or South-America. I think its quite common strategy if you look their competitors.
I would liquidate my position if they would try to do something so desperate (as manufacture textiles in USA). I don’t know is there possibility that even bigger retailers could compete that way?
Of course this kind of transition when they are starting to produce own merchandise will take time; before everything is running smoothly. I think, this transition to vertically integrated retailer started three years ago, when they acquired AVD. But, I understand your concern; it start to be time to show some results.
“jtmaimi: Sure they got a 7% increase in gross margins for one quarter, but how long can that last?”
I think this 39.5% gross margin is still depressed and it will bounce back more normal levels quite soon.
“jtmaimi: They may be in the black on strictly a cash flow basis and that is fine but in reality they are in the red. If things remain stable for the next three years they will have a stock holders equity loss of 12 million a year totalling around 36 million. “
Don’t worry about these kinds of scenarios. My calculations say that they will do just fine in next years; I see in this case $ 36 million is big number, but not much more. I think those cost take outs are running somewhere $ +1.2/share and that’s just sick when you compare their EPS history. Of course its hard to say, how they will tick up when sales levels rise, but one would think some part of those are permanent (not variable).
If you take hard look what $ 36 million losses consisted, I would say, it is much better when all that crap is swiped out of books, and some of those off-balance sheet items (severance costs etc) are also behind. They could do this kind of “cleaning” over longer period of time and shamble forward, but as investor I like, when everything what former CEO had left behind Is cleaned away, so quickly as possible. Often short term pain is inevitable, when trying to achieve maximum long term gain.
“jtmaimi: That would only leave about 25 million in net tangible assets. It might even be hard to keep their doors open.“
And that’s true there is not much tangible assets left, but that’s one reason why I like this business. It’s not too capital-intensive that means they should be are able to earn nice return for invested capital and market place should give some credit for that. When we consider what is going on when tangible equity is shrinking I would say, most critical question is, is this unintentionally or meant to happen. And when you reduce outstanding share count ~22% above book value (and inventories too), it is clear you shrink your tangible equity at same time. We cannot muddle this kind of development with companies which are really bleeding cash, because their of distress situation.