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True Religion Brand Jeans (TRLG) is an upscale apparel company known for it's quality denim products. After earnings came in below analyst expectations in February, the price of the stock plummeted by more than 25%, as you can see by the chart below.

Click to enlarge.

This large drop may present an opportunity to buy this stock at a considerable discount. Let's take a look at the financials:

2007 2008 2009 2010 2011
Revenue (Mil $) 173 270 311 364 420
Free Cash Flow (Mil $) 0.8 30.9 46.3 50.1 51
FCF % of Revenue 0.46% 11.4% 14.9% 13.8% 12.1%

Revenue grew at 15% over the last year, and outlook for revenue next year was lowered to $450-460 million. This is well below analyst expectations of $494 million. Although 7-9% growth in revenue is a disappointment, I believe the steep drop in price is an overreaction. The balance sheet is strong, with $200 million in cash and no debt with a float of 25M shares. That is $8 per share in cash, or almost a third of the market capitalization. Another positive is that the company operates just 125 stores as of the end of 2011, with plans to open 13 more by the end of 2012. This leaves a lot of room for growth.

Valuation

I calculate the intrinsic value of a stock using a discounted cash flow analysis. I attempt to be conservative in my revenue projections:

2012 2013 2014 2015 2016 2017-2021 2021-
YoY Revenue Growth 9% 9% 9% 9% 9% 6% 3%

Note that analysts predict 20% earnings growth annually for the next five years.

I use a 15% discount rate and assume a FCF margin of 12.5%. I arrive at a fair value of $32 per share. Requiring a 25% Margin of Safety gives a buy target of $24 per share. The current stock price as of this writing is $26 per share, so the stock is undervalued but not quite enough for my margin of safety requirement. Here are buy targets for various margins of safety:

Margin of Safety Buy Target
10% $28.80
15% $27.20
20% $25.60
25% $24.00

So depending on your preferences, True Religion may offer a compelling investment. If the stock price drops below $24, I will be the first in line.

Source: True Religion Looks Like A Bargain