Iconix: Assessment Of The Spring And Preview Of The Next Report (Part 2 Of 2)

| About: Iconix Brand (ICON)

Summary

Iconix will likely beat earnings guidance this year by 30% to 50%.

It will probably also beat free cash flow guidance significantly.

These numbers will show up in the coming 1 to 7 months on the next three earnings calls.

The next earnings call is about 5-6 weeks away. Investors should consider taking advantage of low prices and accumulating shares.

The previous article focused on the last three months for Iconix Brand Group (NASDAQ:ICON). This article examines the coming earnings call and the two after that.

Earnings per share

Iconix is currently forecasting EPS of between $1.06-$1.21, with a mid-point of $1.135. Those are excellent earnings for a company with a share price of $7, placing it at a very low P/E ratio of 6.17. That's two-thirds lower than the average P/E of both the S & P 500 and Russell 2000.

In addition, I forecast a major earnings beat for the year higher than the earnings levels above for four reasons:

1) Iconix is not currently including its gain on buying back $105 million in debt at a discount in its EPS guidance. If they save $12.6 million via a 12% discount, that is a gain of approximately 23 cents in EPS, and an increase of 20.26% over the current mid-point. If they got a 15% discount and saved $15.75 million, that's a gain of 28.6 cents per share, which is a 25.2% beat in EPS.

2) Iconix is not currently including its gain on the Complex Media sale, which I estimate will be 10 cents to 18 cents per share. That is an earnings increase of 8.81% to 15.86%.

Iconix owns 11.18% of Complex Media. The Wall Street Journal reported the deal will close between $250 million and $300 million. From the enthusiasm of Verizon's statement about Complex, I think they're willing to spend a lot to acquire it.

Also, I used to be the executive coach and advisor of Google's VP of Sales and he was hired away by AOL in 2009 to be their CEO.

He put an extremely heavy focus on online content and grew the company significantly to the point where Verizon spent $4.4 billion to buy AOL. While at Google, he was a key player in making a number of huge deals that caused Google to grow dramatically. Since buying AOL, Verizon has given him significant power within Verizon.

He's extremely big on online content creation and his goal (which has become Verizon's goal) is to turn Verizon/AOL into the largest content and advertising company in the world by 2020 -- bigger than either Google or Facebook. They plan to do this in good measure through acquiring other content companies and getting economies of scale and cross-marketing opportunities and synergies between the content websites, and between the websites and Verizon.

He acquired several other content companies at AOL including the Huffington Post, and the strategy paid off a lot for him. So I don't think he's going to balk at doing more. And as this Wall Street Journal article details, Verizon is fully on board with his plan to spend heavily on acquiring more content companies.

Another reason I think the deal has a good chance of closing in the upper end of the range is the bidding war that has taken place for another content company: Yahoo. There has been far more interest than most people expected. Clearly there are many companies with cash seeking to buy content companies.

So I think that the probability is very high that the Complex Media deal will close in the $250m to $300m range reported by the WSJ, and a good chance of closing in the upper end of the range. Iconix owns 11.8% of Complex Media, and spent $25 million for their stake. If it closes at $250 million, Iconix will get $29.5 million for a gain of $4.5 million. That would be about 8.6 cents EPS. If it closes at $300 million, it will get $35.4 million for a gain of $10.4 million. That would be about 20 cents EPS.

3) Even without the above, Iconix had EPS of 53 cents in the first quarter alone. That means after only one quarter reported, they're already half-way to meeting the low end of guidance of $1.06. They only have to do 20 cents per quarter to meet the mid-point of guidance, and 23 cents per quarter to beat the top end of guidance.

4) Related to that, the 12 cent non-GAAP beat on the last earnings report indicates that the company is probably being very conservative in its EPS guidance. That earnings beat was blurred by the company marking down a few of its intangible assets on its books, which it has to report as an expense on its GAAP earnings. Most of Iconix's intangible assets are worth more than they are shown on its books because a company can never increase the value of its existing intangible assets on its books.

So the intangible number is somewhat meaningless and arbitrary, yet if a company marks them down, they have to show it as a loss in their GAAP profit and loss statement. As a result, ICON's GAAP trailing EPS is a negative number, which is misleading to investors who see it on some websites that feature GAAP numbers.

Many investors don't bother to view both GAAP and non-GAAP numbers and examine their particulars as it relates to profits and FCF. Investors who do bother to can see if the true picture is one of profitability. If it is and the superficial view gives the impression of no profitability or poor profitability, you get make a lot of money on that.

Over time, the underlying profitability will become visible even in superficial views, and the stock will rise considerably.

Free cash flow

Besides earnings, I think we're going to see a beat on free cash flow this year, which is probably more important than a beat on earnings. As this article and many others explain, FCF is a better measure of a company's profitability and valuation than earnings and P/E ratio.

One reason I think Iconix will beat on FCF is that Cuneo was very conservative on free cash flow guidance in the second half of 2015, saying as recently as November 2015 that the company estimated FCF of $170 million to $175 million for the full year, with a mid-point of $172.5 million. They came in $17.5 million over guidance with $189 million in FCF, 10% higher than guided.

They are guiding FCF for 2016 at a mid-point of $162.5 million, which is close to the total FCF in 2014 when the stock traded between a low of $33.31 and a high of $44.14.

With only 3 months left in 2015, the company probably had a pretty good handle on what FCF for the year was going to be, yet it appears it guided 10% below it in order to be on the safe side.

For that reason, when the company gave guidance in March this year when there were over 9 months remaining in the year, I believe they guided about 15% below where they expect to be at the end of the year and 20% below where they hope to be.

If they come in at 10% above the mid-point of guidance, that will be $178.85 million in FCF per year. If they come in at 15% above, that will be $186.87 million in FCF per year. It bears repeating that in 2014 FCF was 10% to 15% lower than those numbers, and ICON traded between a low of $33.31 and a high of $44.14.

I'm not saying it should trade that high. But it should be trading far higher than present, and I'm fairly sure it will trade much higher within 1 to 7 months.

The stock investment research company I trust the most is Valuentum Securities, which has a proprietary analysis for valuing stocks based on value, momentum and a host of other detailed factors. They have a strong emphasis on free cash flows, which is smart.

Their fair value estimate for ICON is $22, with a fair value range of $17 to $28. Note that Valuentum doesn't overvalue stocks and prides itself on debunking overpriced stocks. It is somewhat known for having forecast the collapse of Kinder Morgan's stock, and also correctly forecasting its later rebound.

It regularly takes down stocks that are overvalued. For example, it says Ross Stores are overvalued by 14%. Its fair value estimate for ICON is roughly triple the current trading price.

It also notes that ICON's peer group trades at a forward P/E of 20.5, which is more than triple ICON's P/E, which indicates the stock will gain. It forecasts Iconix will have 6.7% EPS growth average over the next five years, and says, "Its business model has very high margins."

Share price gains

Headlines and superficial news stories on Iconix the last 2-3 months have missed nearly all of the above details. The headlines and stories on the debt buybacks focused primarily on the 9 cent reduction in guidance to the number I mentioned above. Most ignored the fact that Iconix stated it was not yet counting the gain on buying the debt at a discount in its current EPS guidance.

I'd bet that most investors haven't taken the time and effort to calculate what the probable gain will be. In fact, knowing how busy (or lazy) most of us, myself included at times, are, I'd bet the majority of current and potential ICON investors who saw the headline of the article I wrote on the debt buybacks in which I did the calculations and probabilities, haven't read it yet. That's not a criticism. It's just a fact that people are busy and don't do much research, let alone in-depth research.

More people would probably read the articles if I made them shorter, but I'm a firm believer in giving plenty of information. And I don't like to put forth statements without backing them up. So probably fewer people are benefiting from these articles than could, but I can't change who I am.

The main point is, though, that most of the numbers above are going to start showing up on earnings calls soon, and I'm 99% sure they'll show up within 7 months by the end of the next three calls. When they do, the stock price is going to shoot up. The combination of the low end of the first two items above is a 29.07% beat and the high end is a 41.06% beat.

That's not factoring in the company mostly likely being conservative in its guidance that excludes those two items. In fact, it gave the guidance before it even knew Complex Media would be bought or that it was going to buy back $105 million in debt at a discount. And it specifically said it had not yet added those to guidance, probably because they need to wait for them to fully close to do so. So add between 0% and 10% based on the degree to which you think management was being conservative in its guidance. That's a range of about a 30% to 50% beat.

Whether that 30% to 50% will show up on earnings calls about a third at a time over the next three calls (with ongoing beats of 10% to 17%), or mostly on the August/November calls, or mostly on the November/February calls, I can't say. But beats are coming soon.

The numbers can show up either in earnings beats or increases in guidance. Both usually send stock prices higher, just like earnings misses and reductions in guidance usually send a stock lower. The size of the gain often depends on the size of the beat. And I think ICON's beats are going to be sizable.

The share gains in ICON will probably be magnified by the fact that the stock is priced like it's going to fail, and expectations are low. When "suddenly" the company is having serious EPS beats, and has a very low P/E and very high FCF, investors will buy shares to take advantage of the upside.

Besides the large catalyst of earnings beats, there are three other catalysts on the horizon that will increase the share price, including one that will likely give it a 10% to 20% boost. I will write about these in an upcoming article.

In the next article, I will examine 2017 in detail, including a number of ways in which the year will probably be different than 2016 based on information that is already available.

Recommendations

The next earnings call is probably going to be in 5 to 6 weeks. I think the very low prices ICON is trading at on the market reaction to Brexit are a rare opportunity to make a lot of money. I've bought a large number of shares between $6.50 and $7.10 in the last few days, and was buying between $7.10 and $8 before that. The chairman of the company and recent interim CEO bought $400,000 at $7.99 several weeks ago.

You might consider that at $6.50, the stock only needs to go to $7.15 for you to get a 10% gain, to $7.80 to get a 20% gain and to $8.13 for 25%. I don't recommend exiting your main position at lower than $8.15. But when the price is below $7.5, I recommend considering reducing your positions in a few other stocks to mobilize the money short-term in ICON and sell for a gain when it goes up 5% to 15%. Then you can move the money back into the other positions. Buying at $7, it only needs to go to $8.05 to get a 15% gain.

ICON was trading at $8.15 three weeks ago and little related to the company's outlook has changed since then. I'm fairly sure it's going to trade a lot higher than $8.15 in the months ahead as the FCF and EPS gains above start showing up soon. So my recommendation is to consider establishing a large position at prices below $8.15, and if the price is under $7, back the truck up and load it up for short-term gains.

Disclosure: I am/we are long ICON.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.