There seems to be a lot of hype surrounding CHKE’s turnaround. From management’s commentary to message boards to financial newsletters and websites, everybody seems very bullish. Let’s take a closer look at the numbers and trends.
Cherokee licenses its brand names to several retailers in the U.S. and abroad. In F2011 (ending Jan 2011) CHKE derived 42% of its revenue from Target, 27% from Tesco (U.K. and parts of Europe), and 7% from Wal-Mart (Norma Kamali). CHKE’s three largest clients make up to 76% of revenue.
New management buzzwords like: “vision”, wonderful”, “strong”, “360-degree approach”, “brand DNA”, “positioning statement”, “iconic”, “social media” (Add in the word “Synergy” and Carter Duryea would have field day with these buzz words!), tell a d different story to the numbers. 76% of this highly concentrated brand portfolio is ALL declining. Revenue from Target has been declining for several years, down 2% in F2011 and 13% in F2010. Tesco declined 31% in F2011 and 21% in F2010. The Norma Kamali business at Wal-Mart which totaled $2.2 million in F2011 was discontinued at the end of F2011 and will go down to $0 in F2012.
In the recently filed 10K the company notes that:
“We believe the decrease in Tesco's retail sales of Cherokee branded products is due to Tesco's commitment to bolster its private label brand within the children’s product categories and the reduction of Cherokee branded products in the men's and women's categories.”
While CHKE is adding new licenses, which is a positive, they are very small and take years to ramp up. The company’s three largest revenue sources are declining as past management invested little in the brand and let it dwindle down. Target will likely stay flat, Tesco will likely continue to decline at a rapid pace as the company promotes its private label brand and the 7% of revenue from Wal-Mart will disappear in F2012.
With recent management changes, SG&A will be down, but not as significantly as people think. The company averages roughly $3.3 million in any given quarter. With the turnaround strategy that number jumped $3.8 million in 3Q:F11. Take out the old CEO’s $2 million annual bonus and his $800k salary and the new SG&A expense will look closer to $12 million annually or about $3 million a quarter especially if new management is spending on the brand to help the turnaround. With the newly added debt, we think EPS for F2012 will likely be closer to $1 per share, give or take.
Valuation is the key. The market seems to be giving CHKE the benefit of the doubt. Since when does a dying brand get a 20x multiple? Especially now that the company has debt and is increasing spending on a turnaround. Since when does a company with a highly concentrated customer base, who have the option to cancel these agreements with only months notice get a 20x multiple?
A big positive is the dividend which I acknowledge is great benefit, but we ask ourselves how many companies with declining revenue, debt, in turnaround mode, are paying such a huge dividend. The dividend has been cut 3 times, and should the turnaround slow, consumer spending slow or if either Tesco or Target canceled their contracts, the dividend would be gone. In fact the largest risk to CHKE has always been that if Target decided to take the same clothes, (Target manufactures/sources all Cherokee products themselves), remove the Cherokee label and replace it with a made up in house tag, CHKE would likely have no business at all.
Thesis: CHKE should be trading at 10x-12x EPS (like most other retailers) of anywhere from $0.90-$1.10 which is anywhere from a $9 stock to $13 stock, until management proves they can turn the business around and stop the bleeding. But right now it’s priced for perfection and another quarter or two of declining revenue (a 100% certainty, given the factors mentioned above) investors may stop seeing a glass half full rather one that is half empty.
Disclosure: I am short CHKE.