Description

Casual Male is characteristic of the most vexing subset of value investing: a concept stock. Read no further if you require well masticated extrapolations of past financials. Additionally, the corporate strategy and identity have suffered from chronic schizophrenia. All the nonsense ended in May of 2002 when jewelry retailer Seymour Holtzman (a 15% shareholder) purchased Casual Male out of bankruptcy. In October of 2004, he completed the acquisition of 22 store chain Rochester Big & Tall at an extremely attractive price. He has prudently refinanced the balance sheet, sold all unrelated activities, and signed famous fat man George Forman to a licensing deal. With over 500 stores, the corporate destiny will hang almost exclusively on the evolution on apparel for “big and tall” (read fat and fatter) American males. A small Canadian division will sell through Sears Canada (where the opportunity exists for significant catalog sales) and in translating “big and tall” into Canadian, read tall and taller. So the operating history is both brief and tortured, the balance sheet is challenged – though not in any imminent risk – and the mandate is altogether new. That mandate is the ever expanding population of overweight males. A trip to Disney World or a walk through your local high school will provide ample anecdotal evidence of a national reality: about 30% of Americans are fat. Consuming calories from fat is atavistically enjoyable, exercise is painful, and buying SUVs is social acceptable, so I don’t see the trend reversing until someone develops a pill that melts midsections. Not unsurprisingly, fat people hate to shop for clothes, unless they are transvestites (and Casual Male is not that casual). Similarly, Abercrombie, J. Crew, Aeropostale, et.al, don’t warm to the vision of Samoan royalty disturbing their hard-won, way-cool images. Ergo, we have a growing population underserved by mainstream merchants; in short, a promising business model. About 80% of the current inventory is “brand” name (IZOD, Nautica, etc.) and with the addition of George Forman clothes and shoes, it will soon be 100%. A three price- point strategy is now in place after a failed attempt to eliminate “value” clothes, and targeted marketing has begun – mostly in the form of coupons to past customers. Fiscal 2003 (Jan) operating profit margin was 3.5%, and has diminished to 2.2% ltm. The principal reason is a loss of traffic. Compounded by write-offs in discontinued operations, net income is negative. Comp store sales were recently up 4.8%, but had traffic not declined (5%), SSS would have been up 10%. EBITDA margins are projected (by management) to expand 150-200 basis points next year. Because the company has high fixed costs, and high financial leverage, small improvements are significant. What about Wal-Mart? Populations are by definition bell-shape distributions. For example, in men’s trousers the median waist size is 34-36. A one sigma shift is small, so that typically merchants carry waist sizes up to 42-44. Obviously, the distribution of waist sizes for Casual Male is also bell shaped, but centers around 50-52, too far from the norm to make it practical for mainstream merchants to stock sufficient inventory. Sears tried it, and got out of the business. The floor space required, and the very low inventory turn, make this business unattractive – unless you can target this specific audience perspicaciously enough to raise traffic levels to critical mass. Turns for CMRG are about 2.6x vs. six times for fashionistas. Internet sales have been limited by the perceived need for oversized males to try things on. The valuation metrics based on historical data are not entirely encouraging: If CMRG earns $0.14 this year, the PE is 39; price to book is 2.7; EV/ CF is 17x; no yield; debt to CF is 8 times; price to sales is 0.4 times. But the business is very clean now – no more surprises; the management is new and experienced; the operating leverage is very high; the financial leverage is high; opportunities abound for expansion; and there is little competition in their market. All that remains is to drive traffic. It is my assumption that operating margins will double next year (2006jan), debt will be lower at year end (according to management), and that new initiatives in the form of Geo Forman, NFL/ NBA deals, Rochester Big and Tall, and their value priced private label will have materialized. They should earn $0.30 next year, and $0.45 the following year. Obviously, this makes the values look better, but still not fabulous in f2005 (2006jan): PE= 18, EV/ CF= 5, TD/ CF= 6. This name reminds me of Goodyear Tire one year ago: a very promising but highly occluded name – a name I owned, but didn’t write-up because it was impossible to defend. One technical caveat: Holtzman recently bought 46k shares (equating to just 13bp in shares outstanding), and the stock subsequently rose a dollar; my guess is the any lukewarm news would push the stock back to $4.50.

Catalyst

Holtzman wants out
Large retailer wants in
New initives drive sales