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MagicDiligence researches and recommends the most attractive value stock investing opportunities from Joel Greenblatt's Magic Formula Investing and similar screens. We use fundamental (and some technical) analysis to find equities of great companies with growth potential, outstanding management,... More
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  • Can New Management Get Cherokee Back On Track? 2 comments
    Jun 9, 2011 9:46 AM | about stocks: CHKE, TGT, TJX
    For those who have ever wandered into a Target (NYSE:TGT) to buy new clothes or shoes, encountering the Cherokee (NASDAQ:CHKE) brand is inevitable. What you may not know is that this remarkable little company has only a handful of full time employees, less owned property then many small families, and yet collected over $30 million dollars in revenue last year and turned 40% of those revenues into free cash for its stockholders! Clearly this is one remarkable business - and according to the Magic Formula its stock is also on sale. Let's take a look at this intriguing little ($160 million) company.

    First, the business. Cherokee is strictly a brand licensor. It owns the Cherokee, Sideout, and Carole Little brands (among others), which it licenses to selected retailers. The company does no product design, no production sourcing, and little marketing - this is left to the licensees. Cherokee provides and fosters well-known brands that allow customers to charge more for what is, in effect, store-brand merchandise. This is what's known as a "light" business model, requiring next to no capital investment and few expenses save for paying the handful of employees and maintaining the brand trademarks in various countries. As a result, Cherokee is a phenomenally efficient business, with post-tax returns on capital routinely climbing above 150%.

    Cherokee gets paid a percentage of the net sales of licensed products, and most of their deals also have a minimum annual payment clause. The largest deal, by far, is one with Target to sell Cherokee-branded apparel, which has accounted for about 42% of revenue for the last several years. This deal runs through January of 2013. The other large contract is with U.K.-based Tesco, the third-largest global retailer. In fiscal 2011 (roughly calendar 2010), Tesco contributed 27% of sales. The remaining 30% or so are spread out through multiple agreements with retailers both big and small, domestic and international. Examples include a licensing deal for the Carol Little brand toTJX Companies (NYSE:TJX) and Sideout to volleyball equipment maker Mikasa Sports.

    This is a company in a bit of a transition. Cherokee has stagnated badly over the past 5 years, with revenues declining 29% and operating profits down 25% since 2006. In that same period, the dividend has been cut from $3 a share in 2007 down to $0.80 today (a still respectable 4.4% yield). Tesco, in particular, has not been a very good partner, with royalties down almost by half from just 3 years ago, and failing to expand Cherokee's brands into Asia. Predictably, the stock price has followed suit, down to the high teen's today from about $45, 5 years ago.

    The wheels started turning last August, when long-time CEO Robert Margolis handed the reins over to licensing veteran Henry Stupp. In January, Margolis also gave up his chairmanship, effectively leaving the company (though he does still have a 7% ownership stake). There was turnover at CFO as well. This should help Cherokee in several ways. For one, the company is in need of some fresh energy to ignite growth. Secondly, Margolis was handsomely paid. His salary was $800k, and Cherokee will end up spending nearly $13 million in severance (through bonuses, severance, and buying back some of his stock) - $10 million of which they had to secure debt for! Stupp's compensation, at $375k, is much more reasonable, and the difference is material to such a small business.

    Cherokee's dividend has been its biggest attraction for many years. It once paid out a 8-10% yield, but was never sustainable. The current dividend should be. It represents just 50% of last year's free cash flow, and provides the firm additional cash to pay down the newly minted debt, and also to pursue growth avenues, such as acquiring new brands.

    Modeling low single-digit growth going forward, the stock looks to be worth about $22 a share. That is 25% upside from current prices (including the dividend). That makes Cherokee a solid Magic Formula pick. Given the management turnover, downward trend, and revenue concentration between 2 customers, I'd like to see the stock get a bit cheaper before considering it for a Top Buyrecommendation, however.

    Steve owns no position in any stocks discussed in this article.
    Themes: apparel, brands Stocks: CHKE, TGT, TJX
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  • Backlog Investor
    , contributor
    Comments (6) | Send Message
     
    Wow Steve, what a great article! I especially like the way you hedge your bets on this call. "this remarkable little company" but "I'd like to see the stock get a bit cheaper before considering it for a "top buy" recommendation". That way if it goes up you can say "see I told you its a remarkable company" and if it goes down then you say "see I told you we should wait for a pullback".

     

    Interesting how you posted your article the day of earnings. "Modeling low single-digit growth going forward"... Interesting model... Revenue declined more than 15% and when the Wal-Mart business expires in Q3 revenues will likely fall 20% per quarter.

     

    The sad part is, is that you spent about 15 minutes reviewing the company, overlooked all the important facts, hedged your bets and hoped that they put up a decent quarter so people would subscribe to your blog.
    10 Jun 2011, 12:09 AM Reply Like
  • MagicDiligence
    , contributor
    Comments (243) | Send Message
     
    Author’s reply » If you say so. All of the important facts on this company are in the article - dividend coverage, revenue concentration, management turnover, downward trend. Unlike many, I don't see investments in black and white - Cherokee has a lot of gray areas considering the facts presented in the article. I modeled modest growth assuming that new management would be more aggressive about signing new deals, but clearly that may have been a mistake given this awful quarter.

     

    Unlike you, I did not have the hindsight of a published quarter to bash other people's work on. That makes it kind of easy, doesn't it?
    10 Jun 2011, 09:34 AM Reply Like
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