True Religion Apparel: No Longer a Leap of Faith

Here’s a real test for the old saw that there’s no such thing as bad publicity. The good news: the New York Yankees’ Alex Rodriguez, A-Rod, the highest-paid player in Major League Baseball, is photographed wearing your True Religion brand jeans. The bad news: the photograph is taken in Las Vegas to catch A-Rod stepping out on his wife with a stripper.

This is the kind of quirky event that has kept True Religion Apparel, Inc. (TRLG) on a roller coaster. Somehow it worked better when Paris Hilton conspicuously wore True Religion jeans on her way to jail. Another marital issue affecting the stock: True Religion CEO Jeffrey Lubell last month had to sell 2.3 million company shares, about one-fourth of his holdings, as part of a divorce settlement with his ex-wife, Kymberly Gold-Lubell, who used to be in charge of women’s design for the maker of premium jeans and other sport apparel.

On the financial front, True Religion rocketed upwards at the end of May when Sterne Agee analyst Ronald Bookbinder upgraded the stock to “Buy” from “Sell.” The stock went shooting up in the following days to nearly $20 from about $16, in keeping with Bookbinder’s new target. Last week CIBC analyst Dorothy Lakner upgraded True Religion to “Sector Outperform” from “Sector Perform.”

At the same time, True Religion ended its talks with Goldman Sachs about looking for a possible buyer. The company has felt for some time that its stock is undervalued, but decided for now to remain independent.

While True Religion is forging ahead on several fronts, the biggest plus for analysts is the company’s aggressive expansion of its direct retail operations as it opens its own stores in all the trendy shopping venues. When a company manages to sell a pair of jeans for an average $200 apiece and already has a gross margin north of 50%, it might seem hard to significantly improve margins. But direct retail does it – True Religion was realizing a 75% gross margin in the four stores it had open by the end of 2006. Plans call for having 14 stores by the end of this year, 30 by the end of 2008 and more than 50 by the end of 2009.

In addition to the direct impact on profit margins, the company sees added advantages in having its own stores – they increase brand awareness and encourage department stores to carry a wider range of True Religion products.

The company continues to introduce new models and fashions in its denim products and is expanding its apparel lines to include knit tops, sweaters, and skirts, as well as a full range of licensed products, such as footwear, scarves, outerwear, and – as announced last month in a deal with InGear – swimwear. A host of other licensing opportunities – from belts to watches to fragrances – beckons for the future.

This is heady expansion for a company that started business in December 2002. Sales reached $139 million in 2006 and the forecast for this year is $167 million. With the stock price hovering above $20 in recent trading, current market cap is about $472 million. Analysts’ median target is $21.60, with a high target of $25.00.

True Religion lost one-third of its value last November when it badly missed third-quarter 2006 estimates, plunging to its 52-week low of $14.65, compared with the 52-week high of $23.88 established in November shortly before the earnings report. The company also missed estimates for the quarter ended March 31, posting $0.24 a share, compared with the average estimate of $0.26. The estimate for the quarter ended June 30 is $0.26, flat with the year-earlier period.

But the company has beefed up its management over the past year, hiring industry veterans as president and CFO, and getting well-known designers to take Ms. Lubell’s place. Company guidance for full-year earnings is $1.24 to $1.27 per share, compared with $1.12 in 2006. For 2008, analysts are forecasting $1.52.

One of the peculiarities of True Religion stock is the high percentage of its float in short sales, about 45%. This figure could well be inflated by systematic naked shorting (when traders illegally short a stock without possessing or borrowing the stock to sell). True Religion’s persistent presence on Nasdaq’s list of threshold securities – those with such a high level of fails to deliver that further short sales are restricted – is a strong indication that this is the case. It’s a phenomenon that afflicts other new, fast-growing companies such as Netflix, Inc. (NFLX) or Overstock.com, Inc. (OSTK) until they can convince the short-sellers that their growth is for real. The short sales, however, can reinforce an upswing like last month’s as shorts buy stock to close out their positions.

In addition to its domestic growth, True Religion is expanding abroad, with strong beachheads in Japan, the United Kingdom and several other countries. In Japan, for instance, True Religion plans to build on its flourishing wholesale business with direct retail through its own stores and the shop-in-shop concessions popular there. True Religion believes it can attain $50 million in sales in Japan in the next few years.

True Religion sees its product as "aspirational," and photos of celebrity tastemakers from Beyonce to Beckham to Britney (not to mention A-Rod and Paris) wearing True Religion products feed those aspirations. In recent months, investing in True Religion has sometimes entailed a leap of faith, but the company now seems poised to turn more people into true believers.

TRLG 1-yr chart:

Disclosure: none