No Ordinary Joe - Followup

On March 20 we wrote a blog post about $JOEZ and the recent runup in the stock price. Yesterday the company reported another blowout quarter, with top line numbers up 23% q/q.   We continue to be bullish on the company's long-term prospects, with a 2-3 year price target around $3.  

The sales increase is encouraging because it shows the product is resonating with customers.  The direct retail business is growing dramatically, and wholesale business has stabilized at the end of F2011, with an increase in this Q1 number relative to the prior year Q.  Margins were slightly better (both gross and net).

If the company can achieve 10% sales growth y/y on a consistent basis and keep costs reasonable, the stock would be worth about $3.  The current price of just below $1.50 is fair assuming 5% growth for the near-term.  If 20+% growth were sustainable (unlikely), the stock could be worth $6 or more.

From a risk perspective, the company has little long-term debt.  The recent expansion into the direct retail business means they have taken on operating lease obligations which would be costly to terminate if they are unsuccessful in retail.  Also, if sales growth turns negative the stock could go back to below $1.

Based on this, JOEZ represents a reasonable risk/reward.  I am long the stock (since before the earnings announcement) and I would consider buying more on a dip.

Written by:  Jennifer Galperin. Follow me on Twitter and StockTwits.

American Apparel +21% Gave Us the Green Light

American Apparel just reported fantastic sales numbers for the quarter ended March 31.  Total sales were up 14% Q/Q and comparable store sales for March were up +21% and 15% for the quarter.  They reiterated EBITDA guidance for 2012, with a commitment to reducing high-cost debt within 12 months.  This affirms our view that the probability a favorable outcome here is high.  

The company provided EBITDA guidance in March for $32mm to $40mm based on a very small sales growth (less than 1%).  Given the first quarter growth of 15%, we think this number is extremely conservative.  

If the company successfully cuts SG&A costs to $300mm, which is a 4.5% reduction from 2011's costs, the numbers speak for themselves.  Here is a scenario analysis for our estimate of EBITDA based on different levels of sales growth:

Sales Growth (% Y/Y) -> Our Estimated 2012 EBITDA

5% -> $35mm

10%-> $50mm

15%-> $60mm

As you can see, with sales growth strong there is significant cash available for debt reduction.  Inventory reductions to generate cash are icing on the debt reducing cake in this scenario. We believe the company will reduce inventory by $40mm in 2012.

On April 2012, the Board awarded 7,500,000 shares to Dov Charney, CEO of the company, vesting over the next three years as long as the company meets or exceeds the following annual EBITDA targets (one third of the award vesting annually):

2012: If EBITDA is greater than $32,253,000 he gets 2.5mm shares

2013: If EBITDA is greater than $53,251,000 he gets 2.5mm shares

2014: If EBITDA is greater than $68,212,000 he gets 2.5mm shares

Charney also owns 22.5mm warrants struck at increasing levels starting with the first struck at $3.50 maturing in March of 2014. There is a big incentive for the CEO to do everything in his power to achieve the EBITDA targets and to move the stock to above $3.50.

Charney discusses APP's business model in this video. He believes there is about $100mm to $140mm of EBITDA capacity in the current business without adding new stores.  

But.....

There are a few hurdles to overcome here.  First, if sales growth is slower than forecast, debt reduction will be slowed significantly.  With the current high-interest debt burden, it will be difficult for APP to achieve profitability.  Second, in order to secure financing over the last 3 years, the company has issued 21.6mm warrants to a creditor, Lion Capital, with a strike price of $1.00 expiring 2/18/2022.  These warrants are subject to a $0.25 strike price reduction if the company fails to meet aggressive EBITDA targets, the first of which is $37.5mm for the 12 months ending March 31, 2012.  EBITDA for 2011 was $20mm.  Based on that it is likely Lion will have 21.6mm warrants struck at $0.75.  This represents 20% of the 105.5mm shares outstanding as of 12/31/2011.  

Overall, we reiterate our view that the situation here is binary.  Either the company is able to generate a sustainable profit, in which case it is worth several dollars per share, or it declares bankruptcy and is worthless.  After monitoring the company for more than one year, we have determined for ourselves that APP is a good risk/reward tradeoff at the current price, and we think the Q1 sales numbers give us more conviction that the outcome will be favorable. We increased our long position significantly last week after the March sales were reported.

Written by:

Jennifer Galperin. Follow me on Twitter and StockTwits.

Michael Bigger. Follow me on Twitter and StockTwits.

No Ordinary Joe

We are researching a new opportunity in Joe’s Jeans ($JOEZ).  The stock has run up this year from around $0.50 per share to the current level of $1.30.  Following the extremely favorable earnings report from February 28, the stock has been on a huge run-up, nearly doubling in price.  Here is a recent chart:

 

We think the company may be worth a look.  First, the company has very little debt.  The company has been profitable since 2007.  In 2011 inventory reductions resulted in a significant ($5mm) increase in cash.  This indicated an ability to move product off the shelves and into the hands of customers. 

With the share price trading above $1, the stock is no longer at risk of being delisted from the Nasdaq. 

We will keep monitoring the company.  We think there may be a pull-back in the stock which could be seen as a buying opportunity, closer to the $1 level.  

Written by Jennifer Galperin. Follow me on Twitter and StockTwits.

Is Ebay on its Way to an All Time High?

Last week while reading the Wall Street Journal, I came across an interesting statement and I tweeted this:

Multiple catalysts on name... WSJ: 11-year-old Xander Gansman, who sold his iPad 2 on eBay $EBAY +2.85% to raise money for the new device 

It got me thinking. There will be more than 100,000,000 Ipads in circulation in 2013. That is many devices and I believe that the trading in these devices is about to explode on $EBAY and $AMZN as Ipad fanatics trade their old devices for the new new shiny. There is money in these devices and Ipad users will monetize it.

This weekend I decided to sell my son's DSi and my own Galaxy Tab (7 inches, original version) on Amazon.com to figure out how liquid the market is for these devices. We have four Kindle Fires in the family and the DSi and the Galaxy were gathering dust. We sold them in less than 24 hours.

The liquidity in the iPads must be significantly better. This will be big business for the marketplaces.

And now back to $EBAY, here is what I think will push the company towards an all time high within the next 2 years.

• iPad (and other devices) trading. Read what $EBAY has to say on the subject.
• Interest rates won't stay at zero forever. PayPal benefits from higher interest rates.
• Marketplace gaining traction with a better offering. Scot Wingo has this to say about $EBAY comp sales. Look at how nicely they are trending up.
• Motors is on fire and that should continue.
• I have never found $EBAY management to be inspiring but lately they seem to have become more focused on innovation than ever before.
• Paypal's entry in the card reading business.

Anything else that can move $EBAY in 2012?

Written by Michael Bigger. Follow me on Twitter and StockTwits. 

American Apparel 4th Quarter 2011 Conference Call

American Apparel's CFO, John Lutrell made some very interesting comments during the company's 2011 4th quarter conference call. You can listen to the call right here.

This is what I found interesting in this call:

1. The products resonate with customers and this is responsible for most of the gain in same store sales.
2. Although management guided to a less than one percent increase in sale in 2012, it also expects comp sales gain (currently running at +10%) to be sustainable in 2012. With no plan to increase the number of stores, revenues should increase by about the same amount.
3. Management is focused on shortening its cash conversion cycle. This should allow the company to reduce inventory by $20 million (my conservative estimate).  The resulting excess cash could be used to reduce debt.
4. The priority is to replace the Lion credit facility which comes at an 18 percent interest rate cost. We think the company will soon be able to start paying down this facility. Current interest expense is about $37mm per year, and the company forecasts 2012 EBITDA at $32mm to $40mm (which we think is conservative, based on the sales estimates we point out above.  Reducing interest expense will boost the bottom line tremendously.

We will monitor the March sales figure very carefully. They are due to be coming our in early April. We are long the stock. This is a highly speculative position as the outcome is somewhat binary. Either the company is able to generate a sustainable profit, in which case it is worth several dollars per share, or it declares bankruptcy and is worthless.  We think it is a good risk/reward tradeoff at the current price. 

Written by Michael Bigger. Follow me on Twitter and StockTwits. 

My Issue with Startups

My issue with startups is this idea that an Entrepreneur can use angel money today and set the valuation of this investment when the VCs come in at a later date. The initial capital is critical to bringing the company to the stage at which VCs are willing to invest.  Without this angel capital, the entrepreneur's ideas and hard work are just not enough. 

Shouldn't the angel investors get a return on that first round of capital? Entrepreneurs are quick to defend the behaviour by saying "well that is the way it's being done in the industry". 

I am not a fan of investing under these conditions. I have done it though with small amounts but I have never made much money following the prevailing wisdom of industries.

This post is a call to myself to wake up.

Written by Michael Bigger. Follow me on Twitter and StockTwits. 

Tesco PLC: How Spread and Ratio Trading Helped Me Unwind A Position Months Before the Stock Crash

Whenever we talk to people about spread trading, most of them think it is something related to statistical-arbitrage, mean-reversion and pairs trading.  While this is true, for me there’s more to spread trading than stat-arbitrage.  For me it is also a valuable tool for measuring the relative value of a stock against another stock.

Let me give a recent real-life example here. 

The first chart you see below is the ratio of Tesco PLC/Sainsbury’s PLC. These two supermarket giants are headquartered in the UK.

Around February-March 2011, you can see from the chart that TSCO.L was looking very cheap compared to SBRY.L. I decided to purchase shares of TSCO.L at £3.79/share on the 17th of March 2011.

After a few months, I checked the ratio again. TSCO.L was looking expensive relative to SBRY.L as if it was telling us to get out of TSCO.L and Buy SBRY.L. I trusted the Math here.  I decided to Buy some SBRY.L shares at average price of £2.68/share in late September and unwind all my TSCO.L position in early October at £4.06/share for a 7% return. 

 

Today the share price of TSCO.L is hovering around £3.13/share. It crashed nearly 19% in three days after the company reported a sluggish Christmas Trading. £5 Billion was wiped off the value of Tesco Plc. I must say I got very lucky for getting out in October thanks to the ratio chart. Otherwise my Large-Cap Portfolio would have been treading water. 

I've been using the ratio tool and the spread analyzer to compare other equities that operates in similar market or sector especially before the earnings season. There's plenty of names out there ORCL/MSFT, AMZN/AAPL, GOOG/BIDU, NFLX/BIDU, CROX/SKX etc. You'll be surprised what this tool will reveal!

When the ratio reaches the bottom blue line on the first chart, I’ll add TSCO.L in my medium term portfolio. Michael Bigger termed this area as “Fat Margin of Safety”. 

Michael Bigger illustrated this in his book “In Praise of Speculation”.

“..let’s plot the trajectory of Stock1 and Stock2 versus time (Figure 1). Let’s assume both stocks have an identical intrinsic value term structure. According to Figure 1, a trader who uses a value framework for making investment decisions would buy Stock2 and sell Stock1 at time t1. .”

Statistical-Arbitrage Comparison (Dollar-Neutral)

The second chart below is the spread +10 * TSCO.L - 13 * SBRY.L.  In our book, when we spread two securities, we also measure the standard deviation from the mean of the spread. A 2 standard deviation below the mean is considered an oversold spread i.e. TSCO.L is cheap relative to SBRY.L. A 2 standard deviation above the mean is considered an overbought spread i.e. TSCO.L is expensive relative to SBRY.L. Standard deviations are shown in the third chart. 

We can map the spread and their equivalent standard deviations at time t as can be seen below:

-1000pts ~ 2 Standard Deviations below the mean of the spread at t = March 2011

200pts ~ 2 Standard Deviations above the mean of the spread at t = September 2011

Now around March the spread was trading at 2 standard deviations below the mean. If one bought the spread here: Long 10 * Shares of TESCO/Short 13 Shares of Sainsbury's at -1000pts and got out in September at 2 standard deviations above the mean at +200pts, the profit would be +200 - (-1000) = 1200pts per spread. 

Written by Aris David. Follow me on Twitter and StockTwits.

Every Single Day

I am reminded to repeat the following mantra for a few minutes:

Avoid the Mediocres

Today, the beat goes on with Barnes and Noble (BKS), and of course Eastman Kodak (EK).

Written by Michael Bigger. Follow me on Twitter and StockTwits.

Metrics for a Good Business: Current Earnings or Platform for Future Earnings?

Legendary investor Bill Ruane said this about good businesses:

The single most important indicator of a good business is its return on capital. In almost every case in which a company earns a superior return on capital over a long period of time it is because it enjoys a unique proprietary position in its industry and/or has outstanding management. The ability to earn a high return on capital means that the earnings which are not paid out as dividends but rather retained in the business are likely to be re-invested at a high rate of return to provide for good future earnings and equity growth with low capital requirement.

Based on his description, Amazon.com ($AMZN) is a good business. It has high returns on capital. Look at the stock price trajectory since its IPO. It is up about 200 times. In addition, $AMZN is drowning in reinvestment opportunities.   Yet, when the company puts capital towards these investment opportunities, GAAP requires that they be classified as “operating expenses”.  As a result, earnings are negatively impacted and the bears come out to sell.

$AMZN confuses the heck out of investors. How should we classify the investments it makes in its own platform? Are they capital expenditures or operating expenses? Jeff Bezos’ 2010 annual letter to shareholders shed some light on the subject. Here is what he had to say:

All the effort we put into technology might not matter that much if we kept technology off to the side in some sort of R&D department, but we don’t take that approach. Technology infuses all of our teams, all of our processes, our decision-making, and our approach to innovation in each of our businesses. It is deeply integrated into everything we do.

At $AMZN technology is an integral part of operations, current and future.. Current earnings are depressed because some of its operating expense are investments that will generate payoffs 3 to 5 years down the road. Current earnings suffer but the platform value compounds nicely over time.

Cash, earnings and the business platform are all economic assets. In the case of $AMZN, Jeff Bezos is clearly investing in the platform for the long term. Bezos is doing the right thing.

Written by Michael Bigger. Follow me on Twitter and StockTwits.

Taming a Wild Croc

 

I got kicked very hard in my investment portfolio after $CROX pre announced earnings that fell short of expectation. It is hard to escape when an investment drops 40 percent in a matter of second.

The company’s announcement about 3rd quarter result was not so bad but the 4th quarter expectation is nothing to write home about. CROX’s management is encountering some resistance in its effort to turn the company into a 4 seasons shoe provider.

The stock is currently trading at about 10 times earnings and until growth returns, I doubt very much the stock will be moving much from these levels (mid teens).

I could easily give up on the company and move on to greener pasture. That is easier said than done. I find it hard to find great companies worthy of my money and trading at reasonable valuations. Yes, there are many cheap companies out there. Cheap only is not good enough for me. I crave greatness.

In the light of this earning revision, I must revisit the thesis that CROX is a great company with strong growth potential.

In order to answer this question, I focus on the success factors that will not change in the future. I focus on the constants. In a changing environment you must focus on the things that do not change. That is a trick I learned from Jeff Bezos.

Here is how I think about CROX’s greatness and its potential future:

• Comfort. Customers buy Crocs shoes for their comfort.
• Crocs are still the best-sellers shoes on Amazon.com. The product resonates.
• Deep internet product genetic (rating, reviews, etc.).
• Retail space expansion at 20% clip for many years to come as Amazon.com bulldozes retailers around the globe, freeing prime retail space for the retailer winners (Apple, Crocs, etc).
• No debt.
• Well managed.
• Inventory under control (that is the biggest risk).
• Pace of innovation unabated (Chameleon, Translucent, new retail concept, etc.).
• Persistently strong backlog outside of 4th quarter.
• Design capabilities.
• Weight of the product. Shipping advantage.
• High return on capital.

For these reasons, I bought more shares on the selloff and I have no intention of selling my shares. CROX is an exceptional company. It rarely pays to sell an exceptional company until it loses this characteristic.

What do you think?

Written by Michael Bigger. Follow me on Twitter and StockTwits.