Cherokee Likely To Return To Its Growing Pattern

| About: Cherokee Inc. (CHKE)

Cherokee (NASDAQ:CHKE) is a company that markets and licenses its brands for apparel, footwear and accessories in the world. It also consults and provides services for companies or anyone looking to add brands to their own line of products. Some of its major brands include Cherokee (which is their best seller), Carole Little and Sideout.

The reason it licenses and doesn't produce on its own is because its mid-priced brands are better suited for larger retailers with economies of scale.

There is an opportunity in this stock because it recently missed analyst earnings expectations and the stock price dropped 25%. A big chunk of the earnings drop can be attributed to a revenue drop of 9% compared to the same quarter last year. Most of the revenue drop can be blamed on the sale of the Mossimo agreement last year, which cut the royalty stream, and the drop in sales of Cherokee products in Target (NYSE:TGT) stores.

Industry

The clothing industry is very competitive, although most of the competitors do not have the same business model Cherokee has. Trends can change quickly and it is up to Cherokee’s management and the retailers with whom it has agreements to make sure it stays on top of the trends. And it is up to Cherokee’s management, to make sure that the retailers it has agreements with promote its products in their stores.

The Cherokee brand, which is mid-priced apparel, competes with the big clothing firms such as Levi Strauss & Co., The Gap (NYSE:GPS), Old Navy and VF Corp. (NYSE:VFC) The Sideout brand, which is in the active wear business, competes with companies like Nike (NYSE:NKE) and Quiksilver (NYSE:ZQK). In the international arena, it also competes with the countries’ local companies.

Company

Cherokee has been around for over 30 years. Its revenues heavily rely on its top two clients, Target in the United States and Tesco (TESOF) in Europe and Asia. Not including the one-time Mossimo gain, the two retailers combined for over 70% of Cherokee’s revenue in fiscal 2007. It runs a very lean operation with only 18 employees.

After the price recent drop, there were two significant insider purchases; the CFO Russell Riopelle and a director named Jess Ravich purchased over $600k worth of stock combined. Their track record on purchasing Cherokee shares is good, with an average return of 27% for Ravich and 21% for Riopelle for the following 6 months after a purchase, according to www.form4oracle.com. On a side note, insiders own over 16% of the company.

Revenue has been steadily growing over the past 5 years but growth has been slowing, not taking into account the one-time gain. On average, revenue growth has been a little over 7% a year over the same period.

Valuation

CHKE is trading at a trailing price/earnings ratio of 9.81, although that is a little misleading due to the one-time again, and a forward price/earnings ratio of 16.8. It has a very solid balance sheet with no debt and over $22 million in cash. There was a rise in Accounts Receivable of over 63% compared to the same period of last year, even with revenue dropping. It has a dividend yield of 8% at current prices. Cash flow from operations has been higher than its net income for each of the past 3 years. Return on Equity has ranged from 52.1% to 96.3% over the past 4 years. CHKE was in the top 25 Magic Formula stocks with a market cap of over $100m as of 7/8/2007.

Technicals

CHKE is currently trading below its 3 major moving averages with all of them, besides the 200DMA, trending down. It just found support at a previous support level of $36 a share. The stock was in a very healthy uptrend before the earnings miss, the long-term trend is neutral, the medium-term trend is down and the short-term trend is up. Volume increased significantly on the way down. The stock mostly never moves quickly so I doubt the stock will run away from here, but if it breaks overhead resistance at $38 a share, this will probably be the last time you see $36 in the near future.

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CHKE_07_08_2007

Conclusion

The major obstacles this company is facing is its drop in royalty revenues from Target and the need for new revenue streams. Target is Cherokee’s biggest client and the drop in revenue from Target has not been made up by the gains in Cherokee’s other contracts. Target is expected to open new stores and that should increase Cherokee’s cut from them. Cherokee’s other biggest client, Tesco, has been growing at a healthy clip and just got Cherokee’s permission to be the sole Cherokee label distributor in new markets in Asia and Eastern Europe.

Although Cherokee will not be a high flier growing its revenue at 15% a year, it would be valid to assume it will continue to grow at its previous growth rate of 7% a year. It has a great business model and its 8% dividend is excellent. Management also actively searches for new brands to acquire. Target’s store expansion and Tesco’s territory expansion should help Cherokee get back to its growing ways.

Disclosure: I don’t have a position in CHKE.