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Overview

True Religion (NASDAQ:TRLG) is a company that we see has good value and excellent financial health. While the company does not have any glaring weak spots, there are some weaker spots in growth, cash flow/efficiency, and profitability. Overall, we see the company as fair valued as valuation seems in line with our current expectations for growth as well as potential buyout bid pricing. With a merger on the horizon, we cannot be sure of its growth going into 2014. With all things considered we rate this company as a Hold.


(Click to enlarge)

Value

TRLG has good value that we believe is priced appropriately into the stock at this point. The stock's PE is 22.2, above what we look for value below 15. TRLG's future PE at 15.3 is much closer to the fair valuation we look for.

Two of the company's strong points are price/OCF and price/FCF. In general, the higher these ratios are, the more expensive the company is. These low ratios, at 0.5 and 0.8 respectively, indicate the company is low-priced and has a good cash flow. These are all positive points for TRLG.

EV/sales and price/sales are two ratios that give similar snapshots of a company's valuation. EV/sales is considered more accurate because it takes into account the company's debt levels and the time to pay off those liabilities. TRLG's EV/sales ratio is 1.3, again a good score that indicates good value. In fact, this ratio is more encouraging than TRLG's price/sales ratio because at 1.7 the ratio only scores a 7. Since TRLG has no debt its EV/Sales ratio is higher and more accurate for judging the value of the company.

One of TRLG's weak points is its PEG ratio. PEG shows a company's value in comparison to its growth capabilities. At 1, the company is very valuable in comparison to growth. At 3.8 the company does not show good value in comparison to growth. We will explore growth for TRLG later in the article.

Finally, TRLG has 0 debt, a huge advantage for any company. This can give TRLG the financial freedom to focus its resources on building the company's valuation instead of having to pay down debt.

Growth

Growth is not strong for True Religion, and we believe that those that like TRLG should not buy it for growth. 2013 is anticipated to be a good year for the company's sales growth, which should continue for the most part into 2014. Its EPS growth has not been strong. Even less encouraging is its YoY ROIC growth and 5-year ROIC growth. Let's look at the company's plans for growth.

In TRLG's Q1 report for 2013 the company saw a 13.1% net sales increase to $120.8 million. TRLG's Consumer Direct net sales increased 12.1% and same-store sales increased 0.7%. For the quarter GAAP diluted earnings per share were $0.02 versus $0.41 for the same period in 2012. These numbers reflect what our ratios are reporting. Already in the first quarter of the fiscal year TRLF is seeing increases in sales, which is encouraging, but the company has seen a significant decrease in EPS YoY.

Return on invested capital (ROIC) is a measurement of the company's efficiency at allocating its capital to profitable investments. This is essentially a way to see how well the company is using money available in order to generate returns. According to our ratios collected, TRLG is consistently shrinking its ROIC. With -11.0% as its YoY ROIC growth and -57.5% as its 5-Year ROIC growth, the company does not seem to be using its capital wisely to create new profits on investment opportunities.

The largest piece of news surrounding TRLG's future and its growth potential is a controversial merger with TowerBrook Capital Partners L.P. The company will buyout TRLG for $32 a share, a price that many believe is too low and are therefore contesting the merger. We will hash out the details of this move later in our Catalyst section. For now, since buyouts are generally a method for inorganically growing a business, this is where TRLG finds its growth potential, although it is not enormous potential.

Profitability

Profitability is decent for True Religion as it sits at neutral. TRLG's strong point is gross margin, and its low point is operating margin growth. Let's see how the company compares to competition.

The company's closest competitors are V.F. Corporation (NYSE:VFC), Lululemon Athletica Inc. (NASDAQ:LULU), and Under Armour, Inc. (NYSE:UA). Operating margins for TRLG are moderate at 13.3%. How does that compare to VFC, LULU, and UA? The companies have operating margins at 13.8%, 25.8%, and 10.3%, respectively. We can see that TRLG trails much of its competition. When we look at gross margins, the companies have ratios at 47.1%, 54.3%, and 47.9%, respectively. This time TRLG is leading the competition.

What is holding TRLG's operating margin back?

TRLG reported in its Q1 filing for 2013 that its SG&A expenses increased 36.7% to $70.6 million up from $51.7 million in the same period for 2012. The company attributes these increased costs to executive separation costs of $7.5 million and costs associated with the company's review of strategic alternatives of $0.8 million. TRLG also claims it needed more resources to operate the company's expanded retail footprint which totaled $2.8 million for its US Consumer Direct Segment and @2.3 million in its International segment. All these increase costs hurt True Religion's ultimate operating margin.

TRLG underlines again its increase in retail stores as a main factor of increase in sales and reduction in operating margin. The company reports that its retail stores moved from 137 retail stores in 2012 to 155 retail stores in 2013. This large investment will need time to pay off in profitability for TRLG.

Cash Flow/Efficiency

TRLG scores neutral for cash flow/efficiency because it had a mix of strong points and weaker points in this category. As a positive the company has good cash flow and has seen growth in this area of the past 5 years. On the other hand the company has a slow cash conversion cycle. Since the company is in apparel manufacturing, this may not be such a negative point. Apparel manufacturing companies tend to have slower cycles. Later we will compare TRLG to the competitors to see how negative this really is.

First, the company has good OCF/Sales at over 13%, and it has seen 85% growth in operating cash flow in the last five years. OCF is important to dividends because it is what is used to pay off dividends. FCF is important to see to believe that dividend hikes can occur. The company is still good in its FCF/Sales ratio at 8.7%, and the company has seen 82% rise in free cash flow in the past five years, which is also good.

Solid cash flow is also helpful to pay off debt levels and improve the business without taking on more debt, which can help improve profitability. Fortunately for TRLG, it does not have any debt. This means the company can funnel this cash into other places instead of paying down debt.

Let's see how TRLG compares to VFC, LULU, and UA in days sales outstanding, days inventory, and the cash conversion cycle. VFC sits with 40.3, 92.3, and 102.0, respectively. LULU is at 1.6 for days sales outstanding, 70.1 for days inventory, and 69.5 for cash conversion cycle. For UA, the company has 42.0 days sales outstanding, 118.1 days in inventory, and 119.4 cash conversion cycle. As we can see TRLG does not have very strong efficiency, although UA has a similar efficiency rate. The company has outstanding 21.8 days sales outstanding and 118.8 cash conversion cycle. The most impressive ration may be its 16.7 receivables turnover. That compares to 8.7 at UA, 227.0 at LULU, and 9.1 at VFC. Although TRLG does not beat LULU, receivables turnover shows that the company uses its assets well in comparison with competitors.

Financial Health

Financial health is good for TRLG. The company's current ratio at 6.2 is well above the 1.0 threshold we look at for financial health, and the quick ratio at 4.5 is again well above the level we look at before we see a major red flag at 0.5. How do these ratios compare to its competition?

VFC has a current ratio at 1.9 and quick ratio at 0.9. LULU has a current ratio at 8.5 and quick ratio at 6.5. Finally, UA has a current ratio at 4.3 and quick ratio at 2.4. So, we can see that TRLG does trail LULU, but overall has strong numbers compared to most competitors. This is a positive.

High debt levels versus equity levels can affect the company's ability to generate earnings as a result of high interest payments. Fortunately TRLG does not have any debt so we see perfect 10s in Debt/Equity with a ratio of 0.0, Gross profit to current liabilities with a ratio of 24.5, Operating cash flow to current liabilities with a ratio of 5.2, cash & cash equivalents to total liabilities with a ratio of 3.7, and debt as a % of total liabilities/equity with a ratio of 0.0. Even though the company scores a 1 for interest coverage ratio, this is actually a positive because the company does not have any interest to pay. Zero debt is definitely the key to TRLG's strong financial health.

Overall, the company has great financial health mostly due to the fact it does not hold any debt.

Catalyst

As mentioned earlier in this article, the most apparent opportunity for growth for TRLG is the merger it announced in Q1 filings for 2013. The company announced entering into a definitive merger agreement with the affiliate of funds managed by TowerBrook Capital Partners L.P. This is a New York and London-based investment management firm who agreed to a take-private transaction valued at approximately $835 million. The terms of the agreement state that TowerBrook will buy all of the outstanding shares of True Religion common stock for $32 per share in cash. The merger is still subject to approval by stockholders, regulatory approvals, and other customary closing conditions. The date of the transaction is anticipated for the third quarter of 2013. The company has suspended all of the conference calls addressing earnings during the pendency of the merger agreement.

Many analysts are claiming that TRLG deserves a higher price from TowerBrook and is comparing the merger to others in the industry. Columbia Sportswear Company (NASDAQ:COLM) paid 9.3 times EV/EBITDA for Timberland which equals a valuation current to COLM's and much higher than what TowerBrook is paying for TRLG. $32 a share for TRLG equals about 7.23 times EV/EBITDA, much lower than the comparable COLM and Timberland deal.

On a more practical level TRLG is continuing to offer new products to its consumers to grow the business. In its Fall 2013 line the company is offering bootcut, straight leg, skinny, and cropped jeans in a variety of washes for women. Alongside its signature jeans, TRLG offers shirts, tanks, jackets, and accessories. For men TRLG's fall line offers jeans in a variety of fits and washes, shorts, shirts, tanks, hats, and accessories. TRLG also offers miniature versions of men's and women's styles for youth. The new fall line for kids mirrors the men's and women's line offering trendy options in a variety of styles for boys and girls.

Another area where TRLG could grow is continuing to expand retail store presence. We reported earlier that TRLG has been opening new stores in 2013, but how this expansion will continue is unclear with the merger scheduled to happen Q3 of this year.

Price Target Analysis

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

2013 Projections

2014 Projections

2015 Projections

2016 Projections

2017 Projections

Operating Income

69

92

108

123

140

Taxes

29

39

45

52

59

Depreciation

14

24

36

56

71

Capital Expendit.

-22

-24

-26

-32

-36

Working Capital

50

50

50

50

50

Available Cash Flow

-18

3

23

45

66

Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for TRLG: 10.0%

2013

2014

2015

2016

2017

PV Factor of WACC

0.9091

0.8264

0.8713

0.6830

*

PV of Available Cash Flow

-16

3

17

31

*

Step 3.

For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. Cap Rate for TRLG: 6.0%

2017

Available Cash Flow

66

Divided by Cap Rate

6.0%

Residual Value

1103

Multiply by 20167PV Factor

0.6830

PV of Residual Value

754

Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of Available Cash Flows

34

PV of Residual Value

754

Cash/Cash Equivalents

0.0

Interest Bearing Debt

71

Equity Value

859

Step 5.

Divide equity value by shares outstanding:

Equity Value

859

Shares Outstanding

25.58

Price Target

$34

Source: True Religion: Is The Buyout For Real Or More Upside Potential?