In this article, I will run you through my value analysis for two stocks in the fashion retailing sector leading up to the conclusion to sell one and buy the other.
My value analysis includes a set of the subject stocks' comparable peers, and the estimated stock values are determined by equally weighting valuations calculated by five peer average multiples - EV/Sales, EV/EBITDA, P/E, P/S, and EV/FCF.
Limited Brands, Inc. (LTD) - Bearish
Shares of Limited Brands have posted a stellar 12-month performance by returning 37.38%. At $49.14, the stock is trading very close to its 52-week high of $51.84 hit in early May. Apparently, the 1-year upward moving trend has pushed the valuations to a lofty and likely unsustainable level relative to the company's fundamentals.
The following analysis for Limited Brands is based on the table shown below:
Click to enlarge
In terms of growth potential, Limited Brands' revenues and EPS are likely to grow at a substantially slower pace relative to the peer average, and the EBITDA margin is fairly in line with the group. Limited Brands' profitability margins are generally higher than peer averages, but the gap is however not quite significant. Its LTM ROE at 162.7% is somewhat distorted by its high leverage reflected by 102.9% debt to capitalization ratio, and the company's ROIC is lower than average.
In addition, the company's LTM FCF margin is lower than the peer average, and its interest coverage rate is just 5.4x, significantly lower than the average of 87.1x. Due to the heavy debt burden, both the current and quick ratios are below par as well.
Nevertheless, the current stock price of $49.14 implies a sizable 55.4% valuation premium over the five peer average multiples (see below), indicating that this investment indeed offers almost no margin of safety. In the light of the extremely unfavorable risk/reward profile, I'd suggest investors either avoiding or even shorting the stock over the long term.
Guess? Inc. (GES) - Bullish
On the other side, the GES stock presents a very attractive risk/reward profile. The stock has declined 19.99% over the past 12 months, and now trades very close to its 52-week low of $24.23 achieved in May and pays a 2.8% dividend. Not only the investment offers a solid margin of safety given the attractive valuations, it is also poised for a potential buyout opportunity.
The following analysis for GES is based on the table shown below:
GES' only major issue appears to be the sluggish growth due to its exposure to the European market. All of the company's revenue, EBITDA, and EPS growth estimates are below group averages. However, GES' profitability is superior to the group average. All of the margin measures are above average. Although both the ROE and ROIC are lower, they are not significantly far off.
Robust liquidity is the company's brightest spot. GES has a substantially higher LTM FCF margin and carries almost no debt. Both the current and quick ratios are much better than peers'.
However, at $28,89 per share, GES is trading at a merely 21.7% valuation discount to the five peer average multiples - a very attractive price level (see below).
So why did I say GES is poised for a potential takeover? There are five reasons:
1) The stock is cheap, and in addition to the low valuation multiple, 18.4% of the market cap is in cash;
2) The total enterprise value is approximately $2.1B - a very affordable size for either a strategic acquirer or a financial sponsor;
3) The company has almost no debt, making a leverage buyout viable;
4) The company's strong FCF margin would allow it to quickly pay off the debt burden resulted from a leverage buyout; and
5) The company's strong brand would definitely be an asset for leverage in repositioning the company for better growth prospects.
As such, GES would be a great value play. I recommend acquiring the shares at the current price.
All tables are created by author and all financial data is sourced from Capital IQ and Morningstar.
Disclosure: I am long GES.
