Cherokee has an interesting and unique business model. The company, once a manufacturer of Cherokee brand apparel, has found a niche as a licensor of this brand and others to large retailers. No longer do they design, manufacture, market, and sell apparel, but instead they simply license an array of brands and let retailers and wholesalers do the leg work. This way, the retailers utilize their economies of scale to produce the branded apparel cheaply, and CHKE enjoys high margins and eliminates inventory risk.
Currently, the majority of revenues come from the U.S., through royalty payments primarily from Target and Mervyn’s, but the company is working to diversify the business. An agreement signed with the Carrefour Group of France in late 2000 should start contributing international revenues in late 2001. Carrefour is the second largest retailer in the world. Also, CHKE acted as an agent in brokering a licensing deal between Mossimo and Target, from which CHKE is to receive 15% of all royalty payments as a finder’s fee.
Additionally, the company seeks to represent other brands, such as it did with Mossimo, in soliciting similar licensing arrangements. Chairman and CEO Robert Margolis is a well-connected person in this industry, and (from what I can tell) deserves the credit for making CHKE’s relationship-based business succeed. He’s been with CHKE for 20 years, and owns over 20% of the company.
The valuation of this stock is compelling. Trading at less than 7X trailing earnings, and with a 38% net margin, there are gobs of free cash coming in. ($1.34 in FY2001*) EBITDA in FY 2001 was approx. 2.40 per share. And there is negligible CapEx required by this business. The EV to trailing EBITDA is 5, and the $30 million of debt is continually being paid down. And now consider the 14% revenue growth, which resulted in 34% net income growth, and CHKE is just plain cheap. (37% EPS growth after buy-backs) Management expects this growth to continue at least for the next 1-2 years, as Target further increases sales and the new Carrefour agreement begins to kick in revenues. And surely there are more deals in the pipeline.
The company purchased the Sideout brand in 1997, which has proved a successful plug-and-play for this business. Management has indicated they are always on the lookout for other reasonably-priced purchases, and with such high cash flow, such an acquisition shouldn’t be difficult. Currently most FCF is used to repurchase shares and pay down debt.
The bottom line is CHKE has found a creative (and very profitable) way to add value in the mass retailing and wholesaling industry. Their costs are fairly fixed, (largely compensation for the 14 employees) and nearly all new royalty revenue and licensing agreements should drop right to the bottom line. (During FY 2001 pre-tax margins increased by 11%, to 63%)
*FY2001 ended 2/3/01
1. Sheer value.
2. Continued growth from current licensing agreements.
3. Increasing contributions from new international licensees.
4. Expanding margins. (relatively fixed costs)