In the last two articles on Iconix Brand Group (NASDAQ:ICON), which you can read here and here, I went into detail on the current fiscal year which ends December 31st. In this article, I will examine 2017. Thus, while the next earnings call is this Thursday after the close, this article is a forecast of the longer term.
While forecasting anything in the future is imperfect, choosing which stocks to invest in inherently means we have to do our best to look into the future because how our companies do in the future is what will determine how much money we make (or lose) on our investments.
I've broken down 2017 into "easier to predict" items and "harder to predict" items. Let's start with the easier ones.
Increased profits from reduced expenses
I'm fairly sure the following things will occur in 2017:
* Transition compensation expenses related to the hiring of new CEO John Haugh will go to 0. Iconix gave him a significant signing bonus to lure him away from his previous job, and that obviously will go away in 2017.
* Expenses from all other bonuses will go down, likely in half. On the last earnings call, CFO David Jones explained that up until 2016, bonuses for each year were both expensed and paid to employees the following year. So in past years, bonuses for a given year didn't affect earnings for that year and instead reduced earnings for the following year.
This year, Iconix is shifting to expensing bonuses for the current year over the course of the year. So bonuses will hit the books the same year they're earned. Thus, 2016 total expenses include both the 2015 bonuses (which were not expensed in 2015) and the 2016 bonuses, which are being expensed this year.
For example, bonuses in last quarter's earnings were roughly double what they would normally be. That means that 2017 bonus expenses will be about 50% less than 2016 expenses because they will include only the accrual of 2017 bonuses, compared to 2016 expenses which include two years.
* Revenues from Peanuts will go down, particularly in the first quarter of 2017 on a year over year basis. The impact on earnings will be moderated significantly by the fact that Peanuts revenues (and other entertainment revenues) have a much smaller profit margin than the apparel and home goods segments. The year over year difference for the second quarter of 2017 will be far smaller. The year over year differences between 2016 and 2016 for the third and fourth quarters will be negligible for Peanuts.
* Revenues from Strawberry Shortcake will likely be up somewhat, particularly in the first 1-2 quarters on a year over year basis because Strawberry Shortcake revenues were low the first two quarters of this year, and Iconix is now beefing up its content creation and merchandise selection. Strawberry Shortcake's revenues are based on TV, books and merchandise, and not on movies. So after Iconix beefs up the brand in those three areas, it probably will produce revenues on a fairly consistent basis.
* Legal expenses will go down, probably dramatically. The company has spent large amounts the last several months on the SEC comment letter process, the SEC probe and lawsuits. The SEC comment letter process is basically done and won't be an expense in 2017. The SEC probe will likely be resolved by the end of the year and most likely by the end of Q1 2017, so this will also be a reduction of expenses on a year over year basis for most or all of the 2017 quarters.
* I estimate interest expenses will be roughly neutral compared to 2017. On one hand, Q1 2017 interest expenses will be higher than Q1 2016 because for the first months of 2016, Iconix was paying a lower interest rate on its $300 million in 2016 debt. On the other hand, expenses in Q1 and Q2 2017 will be partly lower because the company was paying interest on $105 million in debt for the first two quarters of 2016 that it won't be in 2017 due to its buyback of $105 million in debt.
* I also estimate marketing/advertising spending will be roughly neutral. The company already increased its spending by about 15% this year, and Cuneo has emphasized that the quality of spending is as important as the quantity, so I don't think Iconix will increase it again. I also don't think they'll decrease it much because if the increase is successful this year, they probably won't cut back on something that's working.
On the whole, I forecast 2017 profits will gain about 7 to 9 cents per share just from the total of the items above. I don't have time at this moment to look up whether that earnings gain will be all GAAP, all non-GAAP, or a mix (as it will depend on how they treated those in recent quarters). But either way, it's a gain, and a gain that should be ongoing in that those expenses aren't due to return.
Gains from other areas
Next, let's look at the areas that are harder to predict. With the exception of Strawberry Shortcake, the above things don't include any earnings gains from:
* the many initiatives to increase revenues that the company has already started in the last several months
* the initiatives the company will announce when it unveils its long-term growth plans at an Investor Day at the end of the summer.
I estimate Iconix will gain between 2% and 6% in 2017 from the variety of initiatives and from Cuneo and Haugh re-energizing the staff, plus shifting to performance based bonuses rather than "discretionary" bonuses that employees typically get regardless of a company's performance.
I would be surprised if they exceed 8% year over year gains in 2017 because efforts in retail usually have a lag time of 6 to 15 months between efforts and results. For example, the lack of focus of former CEO Neil Cole on running the business his last 18 months (2014 and the first half of 2015) showed up in 2015 revenues.
The initiatives Iconix started in 2016 will start to show up in the last 1-2 quarters of 2016. The initiatives they take the last few months of 2016 after the Investors Day will start to show up around mid-2017, so their effects won't boost all of 2017.
So while I would be surprised if Iconix exceeds 8% growth, I would also be surprised if it has no gain in 2017. Even if general retail sales in the U.S. go down 1-2% in 2017, I'm somewhat sure that Iconix will offset that in two major ways:
1) Its return to putting care into running the business
Apparel requires care and attention, and marketing requires the same. When I owned and ran two high-traffic retail stores in the Boston market, when my staff and I didn't put enough effort and attention in, our numbers went down.
If we didn't regularly go to the fashion trade shows to keep up on the latest trends, our numbers went down. If we didn't regularly talk to customers to get feedback on the fashions and products they wanted, and then get those items, our numbers went down. Honestly, sometimes after 1 or 2 years of strong sales, we started to coast and forget what got us the strong numbers. We also became less hungry. If we had a below average year, we buckled down and did everything needed in order for the next year to be strong again.
Cole in his last 18 to 24 months wasn't nearly attentive enough to the company's operations, and to a fair degree had checked out mentally - which is much worse than coasting. I use coasting to mean you're still there and doing it, but with less effort and hunger. Like when a top basketball team coasts in the last month of the season rather than staying hungry. Checking out is when a player is missing some practices and even a few games; and when he is at practice and games, his effort is lackluster, his focus is sub-par and is performance is below average.
As I explained in this article, Cole by nature was a visionary and deal-maker more interested in starting a company than running one, and more interested in making one-time deals than the laborious work of servicing long-term relationships with partners and customers. So naturally, the brands and the relationships with DTRs and wholesalers languished somewhat and earnings went down.
I think that even if Iconix simply put a normal amount of attention and care into its business (i.e. no new initiatives, but simply doing the basics in a satisfactory way) and had hired a decent quality CEO to do that, there would be gains of probably 3% to 4% from that alone - more than enough to offset a 2% decline in broader retail.
The current team of Haugh and Cuneo is high quality (much better than decent quality) and is putting strong amounts of attention into the day-to-day running of the business, so I expect the gain from "taking care of business" to be 4% to 5% for 2017 compared to 2016.
2) New high quality initiatives
As I described in the first article about the current year, Iconix has several high quality initiatives under way, and is going to announce more at the Investor Day at the end of the summer. For example, the initiative to shift marketing money to an online focus will likely result in 1% to 3% in growth by the end of 2017, and has potential to do higher than that.
One online thing management mentioned on the last earnings call materialized (no pun intended) in mid-July with celebrity Pia Mia making her official debut as the fashion director and campaign face of Madonna's Material Girl line. Popular online fashion site StyleHaul released a six-part docuseries about Pia Mia's life and love of fashion. The series is described in this AOL article.
As fashion bible Women's Wear Daily explains: "Each episode will be shoppable and include a link to "Pia's Picks," a collection of her favorite Material Girl items available on Macy's e-commerce site." The same day, MG Icon, the name of the joint venture between Iconix, Guy Oseary and Madonna, also unveiled Material Girl's first ads for fall 2016.
The initiative to do an ongoing Peanuts TV series rather than only a one-off movie won't move the needle, but small initiatives quickly add up. Holding special brand days for wholesalers and DTRs will help sales.
The initiative to make bonuses performance-based I think will show up in increased gains in a variety of ways. While performance-based bonuses can sometimes cause hidden issues if they lead employees to overly focus on specific metrics at the expense of other metrics, I think Iconix's bonuses approach will avoid that for two reasons: 1) Cuneo has successfully used performance based bonus systems in turning around other companies, and he's got a wealth of experience in how to implement them correctly. 2) According to reports filed with the SEC in recent months, an approach the company is using is to split the bonuses somewhat evenly between meeting A) company revenue targets, B) company profitability/earnings targets and C) achieving individual targets set for the individual.
This is wise because bonuses for revenue encourage employees to increase sales, while at the same time bonuses for earnings encourage employees to refrain from spending/wasting money while increasing sales. If you do A without doing B, it can cause problems because people might spend like sailors to increase sales. If you do B without A, it can cause people to cut costs to improve earnings, at the expense of growing sales.
Another reason doing both A and B is smart is those are the two most key areas and are broad enough to encompass all the work people do. Related, they cause people to focus on teamwork and how their work affects the whole company. Including some bonuses for individual targets is also smart to encourage focus on achieving those, but not focusing on them at the expense of hurting the whole company's revenues and earnings.
The filings I found were primarily for upper management, and had 37.5% for revenue goals, 37.5% for earnings goals and 25% for individual goals. I assume a similar smart approach to the rest of the staff will be used. In a sense, it's like profit-sharing, but better.
Retail rebound predicted, though uncertain
The majority of retailers have rallied significantly in the last two months. This is in large part due to a number of retail experts forecasting that retailers are about to rebound because: a) they have made strong improvements in their online stores so it's now as easy to order from them as Amazon, and shipping times have shortened, b) they have an advantage over Amazon because customers can return online purchases at stores with no shipping expense and without having to print a label, package it and mail it. c) they on average have strong management teams.
I would add to it that the majority of people want to try clothing on before they buy it so they make sure it fits, in comfortable and looks good on them. So I don't think Amazon will make the same inroads in apparel and shoes as they did in books, music and electronics.
On Tuesday, there was a pullback in many retail names, yet even with it, most are still up by a lot over the last two months. On CNBC's Fast Money after Tuesday's close, panelist Guy Adami said: "First of all, I think the retailers have all bounced since May so this sell-off maybe you could say it's a sell-off off an oversold condition - we had a nice bounce. …. I don't think you can say the consumer is dead because every time you've tried to write off the consumer over the last 10 years, it's been wrong."
Panelist Karen Finerman said: "I think this retail sell-off today is very overblown…. Looking at those personal spending numbers, I think those are decent, and I think employment is good, and I think back to school will get started now, and it probably has started in many places, so I'm much more optimistic. I think this market in general - people are just throwing out anything that's rallied in the last few weeks." Host Michelle Lee said that because so many Americans have bought new cars in the last three years and won't need to in the coming few years, that they'll have more money to spend on other items.
A related note is that the price of oil is likely going to stay between $40 and $60 for the next few years. This is because whenever it goes over $50, frackers will bring rigs and wells online and increase the supply well before it can get over $60 and drive the price back down. So consumers are going to continue to save about 40% on gas for the next several years. While during the first 18 months of low gas prices consumers tended to put the extra money into home improvement and new cars, some of that extra money is probably going to go into apparel and home goods in the coming 18 months.
Related, many retail experts are saying that Q1 of 2017 will have favorable comparisons to Q1 of 2016 (due to the warm winter hurting apparel sales) and will probably see a gain. It probably won't be a gain of more than 3%, and spread out over a whole year, a 3% rise in one quarter is .75% annualized. So it won't make a big difference, but combined with the other factors above could lead to a 2-3% increase for the year.
A person might make arguments that the market is wrong, and that retail will be flat or down 1% in 2017. I don't think retail being up 2-3%, flat or down 1% makes a huge difference because even if it's down 1% as a sector, some brands and some lines are going to sell very well. When I was in retail, there were some lines that we brought into the stores that sold like wildfire during a recession, some that were weak and some at various points in between. The retail world is a big world, and there will be plenty of winners even if the total of sales is down a little.
Iconix profits and valuation
I forecast that Iconix will be among those that grow. More importantly, Iconix is already a profit-making machine. Its expected earnings-per-share for 2016 is already a huge number, and it is highly undervalued.
If it continues to show stabilization for another 1 to 2 quarters and that it can meet existing guidance for the current year, I think the stock price will go up based on that alone. I will go into that in more detail in the next article where I do a breakdown on valuation and describe near-term catalysts. But in a nutshell: a stock with $1.10 EPS, high profit margins, a large number of long-term customers, high FCF and a high quality management team is not going to continue to trade at these bargain levels for long.
For people who don't have positions, I think it makes sense to establish one now before the earnings report on Thursday because the stock might well jump 10% after it and not look back again.
For investors who already have positions, investing is often about being patient and avoiding "selling low." I can't say whether only two more days (the coming call) or two more quarters of patience are needed before investors are rewarded, but I think the probability is strong that patience will be nicely rewarded before too long.
Disclosure: I am/we are long ICON.