Kenneth Cole: More Tough Times Ahead

Includes: JNY, KATE, KCP, RL
by: Jake Berzon
When I last looked at clothing companies on May 3, 2007, it was already rather clear that these apparel makers were in for hard times. I called for mid tier brands like Liz Claiborne Inc. (LIZ) and Jones Apparel Group Inc. (NYSE:JNY) to disappoint, and the more upscale Kenneth Cole Productions Inc. (NYSE:KCP) and Polo Ralph Lauren Corp. (NYSE:RL) to be less affected. Indeed, over the next two years, as the recession deepened, KCP and RL handily outperformed LIZ and JNY.

However, even the best of these clothiers, Polo Ralph Lauren lost 66% of its value from the time of that witting 'till the spring 2009 market lows. Then, as the summer bull made its impressive run, the clothiers caught a ride back up. The most recent leg of the run up in Kenneth Cole shares appears to be most speculative, fueled by two things - hopes and trends.

Firstly, a successful launch of the Kenneth Cole New York 925 Silver Edition – a new line of women’s comfortable fashion shoes – in New York. The company and its shareholders are hoping for the silver bullet with this introduction. I am concerned that even if it is very successful, no single product will be able to pull Kenneth Cole out of the tailspin it entered in 2007.

Since Q4, 2007 and through Q2 of this year the company lost a relatively modest $1.59, but quarterly sales have also consistently declined – more than 30% from Q2, 2006 through Q2, 2009.

Despite the dropped dividend, cash reserves have shrunk from the high of $130 million at the end of 2005 to less than half that at the end of 2008. Other current assets declined, as well, while current liabilities crept up almost 20%. The company has historically had razor-thin, lower than the industry pre-tax margins, averaging only 8% over the past 10 years.

To return to sustainable profitability and grow, Kenneth Cole desperately needs to increase sales north of 20%. Given the current economic situation and the company’s product subcategory mix, this scenario appears highly unlikely. A savior in the form of an acquirer is still a possibility, but given Kenneth’s personal attachment to the company and the company’s current market valuation, this possibility is also remote.

Secondly, technical traders like SmarTrend have been pitching this stock lately as being in a significant uptrend. Such technical pitches often lead to extensions of trends being pitched, in effect manipulating this stock higher than it would go, absent such promotion. These pops are normally short-lived, with stock falling back to its equilibrium price. Relatively low trading volume stocks such as Kenneth Cole are prone to such manipulation.

KCP’s price action and volume data over the past 5 days is consistent with this explanation. The stock was stalled in a tight price range with normal trading volume around $10.40 last week. Then it shot up on high volume in the first hour of trading on Monday, just as Smart Trend pitched it and continued to advance in fits and starts on slower volume, hitting a high of $12.13 an hour before closing bell on Tuesday. High volume sellers then returned and drove the price back down to $11.38 at close.

Disclosure: On Tuesday, September 15, 2009 morning I closed out my small Kenneth Cole position at $11.44/share (more than double the stock's 52 week low, reached earlier in the year), resulting in a loss of 45% from my January 9, 2007 purchase price, accounting for past dividends.

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