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Summary

  • Lpp is one of the fastest developing fashion retailers in the world.
  • Apart from that, the company’s shares are in the group of the best-performing stocks in Poland.
  • Presently, due to some problems the company faces in Russia and Ukraine, the investors should have the opportunity to buy these shares at lower prices.

(Editor's Note: Investors should be mindful of the risks of transacting in illiquid securities such as LPGDF.)

Lpp (OTC:LPGDF) is a Poland-based company, one of the fastest developing fashion retailers in the world.

The company's shares have been an investment hit in Poland for longer than a decade. Since 2001 (initial public offering took place in May 2001) LPP shares have been appreciating nearly constantly, with only two major corrections. In my opinion, there is a big chance that this company, due to a very efficient business model, will continue this trend in the coming years. At that point one would ask me why I am recommending buying shares of the company, which has appreciated by a factor of 250 since its first listing. Well, the answer is simple. Old people say that the trend is your friend, which could be interpreted that the shares of an excellent company should continue its long term upward trend as long as the company is excellent. In my opinion LPP is still the excellent company but due to some unfavorable, but only temporary, circumstances taking place these days, a major correction of its share prices is probable. This way, those looking for an opportunity to buy this stock at relatively low prices may find their lottery ticket.

But first, let me start with a little bit of history.

Everything started in the early nineties of the last century shortly after Poland decided to transform it s inefficient centrally planned economy into a market economy. Two Polish businessmen, Marek Piechocki and Jerzy Lubianiec, started their first business. It was a simple concept - buying clothing in Asia and selling it to store-chains in Poland. Soon they set up their first brand, Reserved and…that was it. I remember these times - LPP was the first clothing company of Polish origin, which understood very well what this business was about. While most of Polish clothing companies have been trying to design, sew and sell their product, LPP was interested only in designing and selling. The fabric and sewing were contracted to the Asian producers. The idea (design) and the art of selling was the thing LPP was the best at. And from the very beginning they were thinking big. They wanted to sell as much as possible. And at that time (the end of the last century) the shopping mall was the brand new idea in Poland and in the former Eastern bloc countries, which LPP started to use as its main selling vehicle. With some modifications this model is still efficient and viable.

Summarizing, the LPP's business model is quite simple:

  1. Design a collection in Poland
  2. Go to Asia (mainly China) to have the collection made as cheaply as possible
  3. Sell the collection to customers in the former Eastern bloc countries, mainly through a network of stores located in big shopping malls.

LPP is not a luxury retailer. Its products, whatever they are, are not generally more expensive than €50 a piece. To give the readers some idea of what LPP is, I would compare it to Zara. Zara is a global brand of Spanish origin, which also sells its products through a network of stores in Poland (offering a range of products similar to LPP: ready-to-wear clothes, footwear, some accessories). In 2013 Zara reported sales of €10.8 billion (in case of LPP it was €1.0 billion) with the operating profit of €2.09 billion (LPP: €0.15 billion), which means that the operating profit constituted 19.35% of sales. In case of LPP it was 14.96%. I am calculating these measures on purpose. Zara brand, established in 1975, is much older that Reserved and other LPP's brands. Logically, it should be "stronger" brand than each of the LPP's brands and this strength should be mirrored in Zara's financial statements. The numbers mentioned above evidence it - Zara's sales generate higher operating results than LPP. But these results are higher by 4.39 percentage points only (19.35% minus 14.96%), which, in my opinion, is not much. For the time being LPP's brands are losing to Zara but in the long run, looking at the LPP brands' dynamics (details below) and their popularity among customers I am firmly optimistic about LPP.

One digression.

Measuring the brand's strength, using a ratio calculated as the operating profit divided by sales, results in interesting observations. In case of Gucci, a very strong and world-famous fashion brand, this ratio stands at 31.3%. At Richemont, one of world's most prestigious luxury goods retailer (with such well-known names as Piaget, Chloè, Vacheron Constantin, Baume & Mercier etc.), this ratio stands at 22.7%.

What are the main brands of LPP?

Presently there are five brands:

  1. Reserved (the flagship brand) - this brand consists of four lines called: Modern, Street Fashion, Young Fashion Lab and Reserved Kids; this brand is designed for the broadest range of customers, from children to elders
  2. Cropp - this brand is dedicated to young people living in towns
  3. Mohito - brand dedicated to young women
  4. House - a brand created for young people interested mainly in clubbing
  5. Sinsay - the newest brand designed for girls aged 15 - 24

Although the above listed brands appear to be designed for specific customers, believe me, every time I am in the LPP stores I find them full of people, from the youngest to the older ones.

Now, let me go through some features of LPP's brands.

This brand is the oldest in LPP's portfolio. At the end of 2013 Reserved had 386 stores located in Poland, Lithuania, Latvia, Estonia, Czech Republic, Slovakia, Hungary, Romania, Bulgaria, Ukraine and Russia. The average store's floor area is 834 square meters - these stores are the largest in LPP's portfolio (the other brands have stores with the average floor area of 300 square meters).

At the end of 2013 this brand had 337 stores located in the same countries as Reserved.

After commencing its operations in 2009, today this brand has 292 stores located in the same countries as Reserved, apart from Hungary; additionally there are stores in Belarus.

This brand started its operations in 2010 - presently it has 301 stores located in the same countries as Reserved, apart from Romania

This is the youngest brand (started its operations in 2013) with only 62 stores.

Apart from selling its products through chain stores, LPP also uses such distribution channels as the online stores. Franchise agreements are implemented with a caution - only Cropp and House offer this possibility.

As was stated above, the core LPP's brand is Reserved. This brand is the oldest in the company's portfolio, has the biggest chain of stores and is the most recognizable by the customers. The revenues generated by this brand comprise 55% of the overall company's revenues (as of 31 March 2014); the Reserved's share in sales is slightly decreasing as new brands enter the company's portfolio but Reserved is still the biggest company's cash cow. One should say that LPP stands on Reserved. I am pretty sure that nearly nobody in Poland knows about LPP but the majority of people know very well what Reserved is.

To show the strength of Reserved and other brands below I present the LPP revenues breakdown by brands:

millions of PLN

Brand

2013

operations starting from

compound annual growth rate (CAGR)

Reserved

2,058

2004

19.67%

Cropp

681

2004

35.48%

House

554

2009

17.58%

Mohito

445

2010

92.65%

Sinsay

74

2013

n/a

Total

3,812

26.68%

In my opinion, the most impressive are the results of Reserved. Since 2004 the brand's revenues have been growing at a rate of 19.67% per year. This number shows the power of this brand - fashion is changing but Reserved develops its network of stores finding more and more customers all around the former Soviet bloc countries. The other brands can also boast of impressive results, especially Cropp, growing at a rate of 35.48%. The lowest CAGR has been recorded by House - only 17.58% - much below the average LPP's CAGR (26.68%).

Sinsay, the youngest LPP's brand, started its operations in 2013 so it is far too early to find compound annual growth rate for this brand.

Apart from focusing on brands' development, the company's strategy is to go to the East. Writing "East" I mean Russia and Ukraine. These countries entail more risk than European Union but LPP is strongly determined to invest and grow its business in there. Let me analyze this expansion a little bit closer.

Since 2004, sales recorded in Russia and Ukraine have been growing at a yearly rate of 81.75% and 41.70% respectively. These growth rates are much higher than the average LPP brand's CAGR (26.68%) so the company is absolutely right that Russia and Ukraine have the potential. But there is quite a serious risk factor in that strategy as well.

Since 2006 LPP has invested PLN 1,138 million (around $380 million) in the European Union countries. It was much more money than that invested in the East (PLN 416 million or $140 million). But in 2009 the company started to invest very strongly in Russia and Ukraine with the culmination of that process taking place in 2012 (when 45% of the company's capital expenditure was spent in the East) - see the chart below.

(click to enlarge)

What about risks associated with investments in Russia and Ukraine? Well, despite investing heavily in the East, the results recorded there have been poor. Between 2006 and 2013 the company reported operating income of PLN 2,837 million in the European Union while in Russia and Ukraine it reported only PLN 200 million. What is more, this negative relationship is widening most recently. In the first quarter of 2014 LPP incurred a loss of PLN 32 million in Russia and Ukraine (in the European Union it earned PLN 151 million). With the present ongoing crisis in Ukraine and very bad diplomatic relationships between Poland and Russia it is very probable that the company's operations in the East will be weighing down the overall results. That is a risk for LPP and, on the other hand, an opportunity to buy this stock cheaper in the coming future.

Let me summarize these remarks in the table below:

in millions of PLN

1q 2014

1q 2013

2013

2012

2006 - 1 quarter 2014

Sales:

European Union

730.6

563.9

3,164.6

2,586.0

15,473,9

Russia and Ukraine

214.4

186.9

951.7

637.7

3,016.4

Total

945.0

750.8

4,116.3

3,223.8

18,490.3

Segment's results:

European Union

150.8

71.8

733.8

557.6

2,988.1

Russia and Ukraine

-32.3

-1.8

46.7

41.0

168.1

Total

118.4

70.0

780.5

598.6

3,156.2

Segment's margins:

European Union

20.6%

12.7%

23.2%

21.6%

19.3%

Russia and Ukraine

-15.1%

-0.9%

4.9%

6.4%

5.6%

Total

12.5%

9.3%

19.0%

18.6%

17.1%

Segment's assets:

European Union

2,418

1,814

Russia and Ukraine

664

451

Total

3,082

2,265

Segment capital expenditure:

European Union

346

159

1,139

Russia and Ukraine

150

129

416

Total

496

287

1,556

Main shareholders

Two founders of LPP, Marek Piechocki and Jerzy Lubianiec, are the main company's shareholders, having 54.2% of voting rights at the shareholders general assembly (they hold 19.11% of the company's shares outstanding but their shares are privileged in their voting rights at the rate of 5:1). This high participation of the founders of LPP (Marek Piechocki is CEO and Jerzy Lubianiec is the head of the supervisory board) is a very important and positive factor for anybody interested in investing in LPP's shares.

LPP's strategy

In 2014 the company plans to increase its stores' floor area by 25%. Due to problems in Russia and Ukraine, this time it is the European Union where the floor area will increase the most (55%). LPP also plans to start its operations in Western Europe adding to its portfolio three new stores in Germany. Apart from that LPP will also enter two new markets - Croatia (five stores) and the Middle East (at least one store in Qatar). In my opinion these are the right decisions - the new markets, especially Germany and the Middle East, bear much less risk than Russia and Ukraine.

Financial results

The basic metrics are shown in the table below:

in millions of PLN

1q 2014

2013

2012

2011

2010

2009

2008

Revenues

945

4,116

3,224

2,493

2,079

2,003

1,623

Gross profit on sales

99

804

599

456

296

285

328

Operating Income

48

616

454

343

199

181

215

Income (loss) before taxes

-12

524

424

331

181

139

0.2

Net earnings

-14

433

354

269

137

105

168

In the first quarter of 2014 LPP incurred a net loss of PLN 14 million. The main reasons for that were the lower exchange rates of the Russian ruble and the Ukrainian hryvnia against PLN (ruble was 6.3% lower against PLN and hryvnia 27.3%). Due to the fact that the stores in Russia sell their products for rubles and incur expenses mainly in "hard" currencies (for example store rents are denominated in dollars; the exchange rate between PLN and $ was generally unchanged in the first quarter of 2014) the Russian and Ukrainian segment incurred a loss of PLN 32.3 million. Add to that the lower values of the Russian and Ukrainian inventories and receivables (by PLN 57.4 million) and you have a quarterly loss. Fortunately, in the second quarter of 2014 the ruble is stronger against PLN (the hryvnia is still a little bit weaker) so these losses could have easily reversed into gains in the next quarters.

in millions of PLN

Balance sheet's elements:

1q 2014

2013

2012

2011

2010

2009

2008

Inventories

838

805

656

595

424

323

463

Cash and cash equivalents

105

149

159

117

96

197

90

Tangible fixed assets

945

897

599

448

420

441

469

Total assets

2,543

2,492

1,932

117

96

197

90

Debt

514

358

186

290

368

425

553

Equity

1,484

1,496

1,211

909

734

685

565

Cash flow elements

1q 2014

2013

2012

2011

2010

2009

2008

Cash flow from operating activities without working capital issues

-8

595

495

391

239

194

261

Purchase of intangible assets and tangible fixed assets

-117

-542

-288

-129

-101

-95

-253

Dividends

0

155

142

135

86

0

0

financial ratios

1q 2014

2013

2012

2011

2010

2009

2008

liquidity ratio

1.5

1.6

1.7

0.6

1.1

2.4

0.4

gross margin

56.9%

58.5%

56.7%

57.1%

54.5%

52.8%

59.5%

EBITDA

92

773

566

445

295

273

305

Strategy of the investment in LPP's shares

Presently LPP's shares are trading at around PLN 8,400. Such a price means that the ratio: enterprise value (EV) / EBITDA (recorded in 2013) is 20.34. In my opinion it is a very high ratio - for example in case of the shares of Inditex, the owner of Zara, this ratio amounts to 16.75. Therefore, in my opinion, LPP's shares are overvalued at the moment. Then, what is the decent LPP shares' price?

The company has not published any financial forecasts for 2014 so to find the decent price I will use a mean reversion concept. To be consistent with my previous argument I have chosen the ratio EV / EBITDA as a basis. Between 2008 and 2013, during the ongoing current upward trend in the prices of LPP, the average ratio EV / EBITDA was standing at 12.64. According to the mean reversion concept, the stock valuations oscillate around that average ratio - sometimes they are above the average and then they are below the average. Then the process repeats. In theory, it should only be a question of time when the present LPP's stock prices are back to this average. Therefore, assuming 12.64 as a mean, a decent LPP's stock price is PLN 5,100.

the chart illustrating LPP's price action:

(click to enlarge)

Summary

For the last decade LPP has been one of the best performing stock in Poland. What is more, the stock behavior has been followed by the company's fundamentals. LPP's brands became the market leaders in Poland and in the former Eastern bloc countries. This year the company plans to open its new stores in Germany and the Middle East, which should strengthen the company's position. In my opinion, during the last two years the investors were chasing the share prices of LPP, making them overvalued. These days it seems that the shares of LPP have started their correction. This correction seems to be strengthened by the problems the company has in Russia and Ukraine. Therefore I think the investors should wait for the price to ease a little bit. As a target I have proposed the price of PLN 5,100. This stock is still a very good place to be but there is no hurry for those willing to buy it at less risk.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Source: Lpp - The Coming Opportunity To Buy This Top Fashion Retailer's Shares At Lower Prices