JLM Couture - Will The Stagnant Results Continue To Offset The Attractive Valuation?

| About: JLM Couture, (JLMC)

Summary

This bridal wear company is trading at a significant discount to its NCAV value while being profitable and not showcasing any immediate fundamental issues.

While this seems attractive, investors should consider few things before initiating a position, which should be at most a statistical one (less than 1% of portfolio).

Most importantly, it is the fact that the company is unable to shed its operating costs in order to expand its bottom line.

Furthermore, top line is facing issues as the organic growth opportunity is likely limited. The cash flow is also strained. Thus the company is unable to produce much shareholder value.

All this is then topped by a management that is not disclosing much and likely runs the company as a private one making it uncertain that change should ensue soon.

Company Introduction

JLM Couture (OTCPK:JLMC) is a company focused on designing and selling bridal dresses. It operates as a multi-label design house, among some of JLMC's brands are Hayley Paige, Alvina Valenta, Tara Keely. The company was founded in 1988 by Joseph L. Murphy who was originally in the business of raising money for micro-caps but then decided to try to replicate the success of LVMH holdings in the bridal industry. He is still the CEO and a major shareholder. The company went public in 1994 and was subsequently delisted from NASDAQ in 2005 and now trades OTC. The reason for delisting was most likely to save cost on auditing and compliance with the SEC.

The company does not segment its revenue, but the company states that it operates internationally mainly through maintaining a presence in a significant number of retail bridal shops. The company also owns one 'flagship' store in Los Angeles. The company's revenue run rate was $29 million in FY2015 with a gross margin of 42.86% and operating margin of 2.62%.

The company's market capitalization is roughly $5.01 million now. 30-day average volume of traded shares was 33 shares and on the last traded day there was a volume of 1,000 shares (according to OTC markets and Google Finance). The company has 1.72 million outstanding shares and a likely free float of around 0.9 million.

The company's auditor is RSM (formerly McGladrey), which is the sixth largest multi-national network of accountancy firms. This should ensure that the financials reflect the economic reality of the business.

Investment thesis

Investors might be attracted to JLMC as the stock is trading at a deep discount to the NCAV with the value being 67% higher than the current market cap while showcasing stable revenue stream and profitability without many operational challenges.

I believe though that one should consider the following points when deciding whether to invest.

  • While the fundamentals are stable, they are stagnating and the business strategy going forward is unclear. The company does not have enough capital to expand its own retail stores and an international expansion, while slowly ongoing, has not been able to meaningfully increase the revenue base.
  • The core market for JLMC (the US) is also likely to be saturated. In 2011, the company's products were in roughly 620 stores across the country and five years later, the number is almost identical as the company is now in 637 stores. Therefore, there does not seem to be much room for organic growth.
  • Not only that revenues are likely to stagnate, but the company seems to be unable to improve its margins. Gross margins have not seen any major improvements in the last seven years and the operating costs continue to strain any gross profit that JLMC delivers as the company does not want to or cannot slash its SG&A cost base.
  • This then strains operational cash flow, which is then further constrained by the company's need to produce a significant amount of samples for trunk shows or for the retailers' offering. The company is thus unable to produce almost any free cash flow, which prevents the company from increasing shareholder value. In the last seven years, the company was not able to produce any free cash flow as it lost $1.06 million through its operational and investing cash flow.
  • Furthermore, the management is not yet incentivized to change anything as it is still breaking even. Moreover, there are no annual meetings and the CEO is likely running the company as if almost private and therefore, there could be a lack of interest to change anything. Should the operations continue breaking even the management is less likely to act.
  • One should also consider the waiting period until next material information because the company recently announced its Q3 and usually showcases its annual report in April or May next year.

That being said the company might pass as a statistical pick, because the stability of the results is not likely to be gone in the next quarter or maybe even a year and the discount could be meaningful as the inventories and account receivables, the main source of the NCAV value, does not seem to be problematic. Also, the possibility of JLMC being acquired is not a distant one, but uncertain regarding timing.

Operational challenge

As mentioned, the main issue of the company is that it is has been so far unable to do anything about its cost base, which continues to pressure the bottom line as seen below.

Click to enlarge

While the company did grow its revenue, albeit slowly, JLMC was not able to translate that into more bottom-line profit. This is likely caused by either of the following two scenarios.

First, as the management is not showcasing its compensation it could be that it is paying significant portions to itself. This could be supported by the fact that in 2004 and 2003, (prior to 'going dark' in 2005 to 2007) the company had higher margins, lower SG&A base and achieved this with the 'burden' of audit costs etc. as seen below (especially when one compares 2003 and 2015).

Click to enlarge

On the other hand, this point could be countered by the fact that the company's management did not overpay itself in the period when it was still reporting to the SEC. The last DEF 14A shows that the CEO was paid $0.32 million, the CFO $0.1 million and the brother of the CEO, Mr. Mark Murphy who is the VP of the company was also paid $0.1 million. While there were a couple of bonuses that raised the salary for the CEO over $0.5 million during that period it was nothing that would clearly show that he was overpaying himself. This though might have changed.

Secondly, the inability to slash operating cost might exist because of the nature of the company and its business. JLMC is able to win various awards and maintains a solid customer perception due to its designers, which are likely demanding in terms of compensation. Therefore, it could be that the staff of the company is expensive to maintain. Should this be the reason behind the inability to cut costs, this could present a serious challenge for the company's ability to expand its bottom line in the long run.

Strained Cash Flow

Since the company is unable to drive more profit, the cash flow is meager as seen below.

Click to enlarge

This is despite the lack of need for significant CapEx. Another negative point is that inventories and account receivables, which could be possible drivers for operational cash flow do not seem to be out of proportion to revenue and thus it is unlikely that the company would be able to slash either of the two soon.

Click to enlarge

Lastly, samples that the company needs to send to the retail stores and to have ready for its trunk shows also further strain the cash flow. JLMC accounts for them in the following way;

The samples are all capitalized and accounted for as long-term assets. The samples that are used in retail stores as a product showcase are amortized over a four-year period and the samples that are used in trunk shows are amortized in one year. While this would not be a significant issue on its own, the company's need for samples is increasing and therefore it continuously ends up with more capitalized costs.

Click to enlarge

Due to all this then the company is unable to create much shareholder value.

What is though positive on the fundamental side is that the customers seem to be content with the product offering and had mostly good experience with the brand in its flagship store in Los Angeles. Some reviews also seemed to convey that the brands are thought of as premium and original.

Future Strategy

Another fundamental challenge that the company is facing is its top-line growth. In order to keep on expanding revenue the company will need to adopt some sort of business strategy that I think is now lacking. Therefore, for now, the revenue stream is likely to stagnate in the coming years.

The biggest issue I see with JLMC is that its organic growth opportunities are likely to be limited. Using 'The Way Back Machine' (internet archive) I compared the number of US stores where a customer could get a JLMC product in 2011 (earliest archive data) to the current number of the stores, which is 637. The store count in 2011 totaled exactly 600 stores, but the archive, unfortunately, did not save the page with the Texas listing, where the company has now 25 stores and so we could roughly say that JLMC most likely had at least 615/620 stores in 2011. This means that the company has likely a limited ability to expand further in the US.

Internationally, the company seems to be expanding, but at a slow pace. The archive did not save the listings for each foreign country, but JLMC seemed to expand to several countries (Brazil for example) since 2011. This though I believe is not going to bring in meaningful amount of revenue as many other foreign countries have less potential customers (due to demographics and wealth distribution) and in developed countries, such as the UK for example, the company already has a formidable base of stores, 108 in the case of the United Kingdom. A more aggressive international expansion is also unlikely due to the lack of capital.

As mentioned, the company does have one 'flagship' store in Los Angeles which was opened in 2012, but it is unlikely that the company would be able to expand its own network due to lack of funds and the likely already saturated market of bridal stores across the USA.

This then leaves the management with an uneasy task to grow the company's revenue in this environment.

Lastly, while some macro trends point to a stable and positive picture for the wedding industry in general, such as the number of weddings that is not decreasing significantly and the spending on each wedding, there are others that I believe offset this, such as price competitiveness of e-commerce or alternative channels of purchasing the bridal wear.

Valuation

While the fundamental situation is not looking too positive, the company's valuation is partly offsetting this. The company's NCAV value is currently 67% higher than the market cap as seen below.

One could though argue that the liquidation value might be lower as not all account receivables or inventories could be collected/sold off at the book value. I believe that while this might be true, as I have shown, the DIO and the proportion of account receivables to revenue are not alarming. Also, the inventories are mostly consisting of raw materials ($4.2 million of $5.20 million as seen in the latest quarterly report) and lastly, the company's properties might offset any leftover discount that one would want to apply to the current assets in a liquidation scenario.

While the NCAV value seems to be reasonable and the discount is significant, the key question here is how the minority shareholder could get benefit out of this.

Management Issue

I believe that one of the only ways that the company's share price could appreciate is that the CEO, Mr. Joseph Murphy, would want to sell his stake that is likely to be around 36.41% (based on the last public DEF 14A). This is not an entirely far-fetched scenario as a PE fund or a competitor (such as David Bridal Inc. etc.) might be interested in the brand value but as Mr. Murphy is only 61 years old, he might not want to relinquish his position yet.

If the M&A should not be an option, the company could be stuck with what is most likely a stale status quo (inability to grow revenue or slash costs, lack of disclosure and business strategy). As mentioned should the operational results continue in this manner, this is even more likely to stay true.

The only time that the management has been active and tried to create value since emerging from darkness was in 2010 and 2011 when it initiated a buyback of its shares (roughly 11%), but this has not been repeated on a similar scale since then and therefore, it is uncertain that it would want to perform this at the current share price. The buybacks though could also be a way for Mr. Murphy to further increase his stake in the company.

Conclusion

As it is with some OTC stocks, JLMC is managed almost as a private company. The management is not disclosing much, it does not hold annual meetings and does not seem to try to reward its minority shareholders. On top of that, the fundamentals are most likely solid but stagnant and the management does not seem to pursue a strong growth strategy (opening new stores or expanding international sales) or have a visible alternative business strategy in place. Moreover, the bottom line has expanded only minimally and the company is either unwilling or unable to slash costs. The cash flow is then strained by these operations and can't produce any shareholder value.

That being said, the company did, in the past, trade at deeper discounts as seen below.

This might not have been entirely reasonable and thus, should the share price drop in these territories again without a change in the fundamentals investors might benefit from establishing a position.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.