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Emma X. Lei is an analyst who has always had something to say beyond the nymbers.
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  • Go Private Or Not, FNP Would Be A Safe Investment - Analysis Based On Fundamentals

    "Fifth & Pacific Companies, Inc ("FNP"), a company with major transformation and low valuation, would become the next PE target, and go private at $20/share", a holistic Bloomberg news report dated back April 12, 2012 says. However, at 2Q earning conference, management indicated that still, there's no plan for the business to change, and the company will continue to operate on its own…

    My view is, no matter FNP will go private or not, it remains a safe investment given its gradually improving operational profile, and the upside potential at its Kate Spade and Lucky Brands banners.

    Company Background:

    Formerly known as Liz Claiborne, Inc ("LIZ"), Fifth & Pacific Companies, Inc is an apparel manufacturer, licensor, and retailer, with a portfolio of premium brands including JUICY COUTURE (33% of consolidated sales in 1H'12), KATE SPADE (29%) and LUCKY BRAND (33%). FNP also maintains an 18.75% stake in MEXX, a European and Canadian apparel and accessories brand, and has a private brand jewelry design and development division that markets brands through department stores (primarily JCPenney and Kohl's), with both being reported under the Adelington Design & Other segment ("ADP"; 5%). After four consecutive years' net losses (largely due to sales decline at existed brands and heavy interest burden), again in FY11, the company incurred $172mio net loss on $1,519mio revenue, and ended the year with $446mio in gross debt and negative $228mio in tangible net-worth.

    Recent update:

    During 2011, FNP sold or existed several underperforming brands (including but not limited to LIZ CLAIBORNE, MONET, MEXX, KENSIE, DANA BUCHMAN, and DKNY® Jeans), and realized an aggregate $455.5mio cash inflow from these transactions (which was used towards debt reduction). In addition, starting 2Q'11 the company implemented a series of cost cutting initiatives (e.g. streamline distribution channel, workforce reduction, store closures) and hopefully, will fully realize these saving by the end of 2012.

    Subsequent 2Q'12, FNP announced a plan to acquire the remaining 51% interest in Kate Spade Japan Co, Ltd, a business with $71mio revenue in FY11. The purchase price is estimated to be $45-50mio, and will be funded with a combination of cash on hand and proceeds from a newly issued $152mio 2019 Senior Secured Notes. The transaction is expected to complete in 4Q'12, and results will be incrementally consolidated into Kate Spade in '13. In light of the strong sales trend in Kate Spade and the low double-digit EBITDA capacity at the acquired business, top- and bottom-line synergy is surely expected. Though the purchase price, which is about 8-9 times of target's EBITDA, seems a little pricey.

    Financial Summary:

    After incurring 5 consecutive years of net losses, it seems that FNP is ready for a comeback in '12.

    For 1H'12, revenue decreased $37mio, or 5.3% yoy to $654mio. However, excluding the $112mio negative impact from existed brands, sales went up by nearly $75mio on stronger results at Lucky ($32mio, or 17.6% topline growth) and Kate ($60mio, or 47.1%). Driven by poor inventory management (e.g. popular items were sold out too early) and sub-optimal product offerings at outlets (e.g. too many out-of-season merchandises, or "fashion obsolesce"), Juicy, on the other hand, continued to underperform, reporting $17mio, or 7.4% yoy sales decline.

    What is eye-catching is that strong top-line trends at Lucky and Kate were not driven primarily by channel expansion (e.g. during 1H'12, retail store count for Lucky decreased by 7 to 172 and outlet stores only added by 3; while Kate merely added 4 retail stores and kept its outlet count unchanged), but by impressive comp. store sales growth (14.1% for Lucky and 35.7% for Kate; both were fueled by traffic increase as little price increase was observed). We are also cautious about the fact that a change of accounting treatment for Kate's on-line store (operated by third-party until 09/2011 and thus, on-line sales was not consolidated into segment revenue prior 4Q'11) partially explained Kate's 47.1% top-line or 35.7% CSS expansion, but the thing is that e-commerce alone, is only of small part of the business, implying the remaining parts, say, specialty retail, outlet, and wholesale channels, still experienced superb growth.

    Gross margin also improved to 62.5% from 58.7% as of year ago on better product mix (e.g. inventories at existed brands had been largely cleared out and thus, lessened margin impact), as well as on higher percentage of sales from direct-to-customer channel. Specifically, on better pricing strategies (e.g. deliberated reduced the scale of markdowns), Lucky alone contributed 720bps specialty retail gross margin expansion in 2Q. While Kate kept gross margin stable, Juicy saw another contraction on poor inventory planning (e.g. inventory had to be shipped from international locations to fill domestic demands).

    However, these improvements were insufficient to drive the company to profitability, resulting in an operating loss of $70.5mio (-10.8% margin) for 1H'12, vs. a loss of $60.8mio (-8.8%) for 1H'11. The softness at Juicy ($37.7mio operating loss in 1H'12, vs. $19.6mio loss in 1H'11) can surely explain this widened loss, but more importantly, the heightened SG&A expenses (67.3% of sales in 1H'12, vs. 61.3% in 1H'11) tells more. Previous we mentioned that the higher mix of direct-to-customer sales boosted FNP's gross margin, but this did not come at no cost. In order to improve specialty retail channels, the company invested heavily in streamlining distribution and marketing, while previous brand existing/business restructuring incurred higher payroll costs (due to workforce reduction). Expense ratio is high compared to industry standards, but hopefully this would decrease in 2H'12 as the company approaches the end of these projects. Specifically, the company reported that during 1H'12, $37.3mio expense was related to streamlining ($24.6mio of which was non-cash charges), while the figure is guided down to $19.7mio for the next 12 months.

    On the balance sheet side, the company ended 2Q with $174mio in cash and $261mio availability under its 08/2014 senior secured RCF ($350mio total limit). The combined liquidity, plus the $80-90mio normalized OCF capacity (excluding the impact from discontinued businesses), will be more than adequate to cover FNP's near-term debt obligations ($21mio short-term borrowings and $67mio 07/2013 Euro notes) and the $59mio projected CAPEX for 2H'12. Liquidity position should further improve, assuming the company continues to maintain the high traffic during 2H (higher the traffic, higher the inventory turnover, and thus, lower the working capital usage and higher the OCF). Actually, excluding the impact of existed brands, inventory did get managed down for all brands (down 18% yoy to $188mio), except for Kate, in hopes of restoring a better balance of supply to current demand (with expectations for further improvement in segment gross margin).

    Further, the company reaffirmed its EBITDA guidance to be $125-140mio for FY12. If achieved, this figure would imply a forward gross debt/EBITDA leverage ratio of 3.3-3.8x, a major improvement given the recent high leverage history and a considerable improvement from current leverage level of 5.8x (based on heavily adjusted comparable LTM EBITDA of ~$85mio)

    Outlook:

    At 2Q earning call, management blamed poor inventory planning and weak accessories sales (down 26% in 2Q on a comp basis at the specialty retail channel) are the major culprit for Juicy's sub-par results, and accordingly, replaced Juicy's CFO to address these issues. I don't know how this will benefit Juicy's inventory planning (and thus sales), but judging on the announcement ("in addition to financial planning, the new CFO will oversee customer service, order management, merchandise planning and real estate"), I doubt that the declining sales trend at Juicy could be reversed, as this multi-responsibility would dilute the new CFO's focus; not to mention that any beneficial change takes time to materialize. In addition, management claimed that it was the lack of relevance in the handbag line that dragged Juicy's sales, and they have since made progress in making the design more relevant. However, when comparing the Spring/Summer and the Fall/Winter catalogues, I didn't see there's big change in product designs, except for color and prints, which become obviously bolder (how many girls are willing to carry animal prints bags on a daily basis?). Nevertheless, Juicy accounts ~33% of overall sales and its share has been ever decreasing, and I believe any weakness should be offset by strong performance at Kate and Lucky (both generate sales primarily from domestic channels, thus less affected by the slowdown in Europe and China).

    Summary:

    Though 2H comp store growth was guided down to high singles for Lucky (from Low teens at 1Q earning call) and to mid singles for Juicy (from 10%), management maintained the high teens growth projection for Kate. In addition, if the $125-140mio adj. EBITDA is realized, the forward FCF should swing positive (after $44mio full year cash interest and $90mio CAPEX). Profitability would like to return as well, in light of the potentially declining SG&A expense ratio, as well as the lightened impact from discontinued operations. Improving operational metrics do not necessarily imply improving share price, but I do not see fundamental factors that say FNP is not a safe holding.

    Disclosure: I am long FNP.

    Aug 06 8:14 AM | Link | 1 Comment
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