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American Apparel (NYSEMKT:APP) is interesting to me since my business revolves around printing on shirts through DTG (direct-to-garment) technology, and I've previously looked into other industry-related stocks such as Xerox (NYSE:XRX), and Canon (NYSE:CAJ). Frankly, I was surprised to see such a revered brand so down in the dumps, and I was absolutely dumbfounded that phrases involving words like "bankruptcy" and "worthless" were correlated with the brand.

When searching for turnaround companies, there are three major factors I initially look for before getting down and dirty with the number crunching. American Apparel looks like a good candidate for recovery and as a long investment opportunity.

1. A Great Product

First and foremost, in my experience, this brand is considered high quality in the shirt printing industry. Many customers and designers searching for custom shirts specifically ask for American Apparel blank clothing to be printed on, since they manufacture trendy styles and the garments generally feel more comfortable than other brands. This extraordinary demand is especially true for clients developing a new brand and/or boutique.

American Apparel got its start selling high-quality t-shirts to screen printers and boutiques in 1990. Although the company transitioned into a primarily retail brand, it is still one of the largest wholesalers in the country. American Apparel shirts are often used for band merchandise and concert t-shirts. Bands such as Van Halen, Death Cab for Cutie, Foursquare, Vampire Weekend, Metric, and Flogging Molly -- as well as popular websites like Threadless, Zazzle, and Busted Tees -- rely on American Apparel to further enhance their own image, which speaks volumes.

When observing any company's possible turnaround, I always start with the product first. That's the entrepreneur in me. With American Apparel products, we're dealing with top quality and a fashionable brand.

2. Early Signs of Growth

This past quarter, the company reported that net sales increased a decent 9% to $162.2 million due to a 7% increase in comparable-store sales and a whopping 16% increase in wholesale net sales. The adjusted EBITDA was $7.9 million from $7.6 million in the second quarter of 2012. The company is updating its 2013 adjusted EBITDA outlook to a range of $46 million to $51 million. These numbers show signs of recovery and growth from a practically overlooked company, and a good formula for buying in.

3. A Solid Plan

  • Opening more retail stores: As Pendulem points out, the company has noted they plan to open 60-70 stores over the next three to five years and believes the company could possibly open up as many as 500 stores compared to industry competitors.
  • Focusing on more wholesale: American Apparel intends to expand its wholesale strategy, which is a good move in my opinion. For the last few years, the company has made decent strides in this area and hopes to expand by 25% in the next three to five years.
  • Controlling debt: American Apparel completed a refinancing of its debt. The debt refinancing includes $206 million of 13% senior secured notes due 2020 to Capital One and entering into a new $35 million revolver with Capital One (see here) while cash flow begins to improve. While 13% interest may sound high, it is lower than what the company was paying previously.

This is a solid, realistic plan that I can support.

Understanding the Risks

American Apparel has faced much scrutiny -- deservedly so. They are plagued with debt, barely escaping bankruptcy, and have had a serious cash flow problem for years. These financial issues have already been broken down a few weeks ago by Josh Arnold in his Seeking Alpha article "American Apparel: A Worthless Stock On Sale For $2." I urge investors to read this article to properly gauge the risks involved.

The company is also saddled with press backlash due to numerous lawsuits. CEO Dov Charney is a controversial person who has been sued many times, including for sexual harassment. The company has also been subject to these same issues on top of past troubles with undocumented workers and questionable advertising practices. It is highly advisable to read their 10-K and 10-Q.

Conclusion

American Apparel has great potential to be a turnaround success story when observing its core business strengths. This entry point appears to be a good time to enter into a long position, but only for people who can stomach a little turbulence.

Source: 3 Factors Indicating An American Apparel Turnaround