J. Crew Shares Are Overvalued

The retailers have been on a run. The Retail HOLDERs (RTH) has bounced roughly 40% off of the bottom in early March. While signs of “green shoots” have become evident, one wonders whether the cause is underlying business strength or the sugar high of a huge stimulus package working its way through the system. What is more obvious is that the consumer will not lead us out of this recession. In fact, the consumer will face headwinds for a time due to an increased savings rate needed to work off an over-leveraged balance sheet.

Given the headwinds to the consumer and diminished disposable income available for discretionary purposes, I would expect the retailers to continue to be under pressure. However, this has not been the case. As an example, J. Crew (JCG) has more than quadrupled off of a year low of $8/share. While J. Crew is a great brand in the retail space, I believe shares more than value this.

At a current price of $35.23, JCG has a market cap of $2.2 billion. Against this, I forecast net income of $54 million ($0.88/share) for 2009 (Note: JCG’s fiscal year ends in January) and $1.19/share in 2010. Historically, earnings peaked at $97 million in 2008.

So even at peak earnings, shares trade for over 22x earnings. How about cash flow? If we take free cash flow (defined as operating cash flow-maintenance capex) of $54 million in 2009 and $84 million in 2010, JCG still looks quite expensive. Apparently CEO Millard Drexler agrees as he has sold $33 million of stock in September.

In my estimation, 15x normalized FCF of $100mm makes sense to me, or a price of $24/share, given headwinds in retail and capital intensive nature of growing the business.

Disclosure: My fund is short JCG and short JCG calls. No position in RTH.

Comments

[talld]

My indicators say that if you add the influence of oil with the influence of the strength/weakness of the American dollar you get an indicator just as obviously tied to RTH as consumer is.

In times like this when essentially a single event triggered such a melt-down people are waiting to see if the world recovers, and what that recovery might look like. So, for this reason, stocks are all very similarly related and hitching a stock to its natural indexes dont make as much sense as they otherwise might.

So, yeah, it is true that RTH is heavily tied to consumer, but all the indicators are waiting for one event right now.

2009 Sep 19 08:42 PM

[GoochyPuppy]

No s**t, Sherlock.

2009 Sep 22 05:53 PM