Description

G-III Apparel Group, Ltd. (ticker GIII) is a cheap and financially strong company with positive operating momentum. At $8.00 the stock is at about 7 times the $1.10-$1.15 fully taxed EPS the company is estimating for its current fiscal year. However, we think management is low-balling that estimate, and believe that EPS is more likely to be in the $1.50 area or perhaps even materially higher. So far in the first half of this year, revenues are up about 21%, with substantial sales growth also expected for the rest of the year, and materially higher margins vs last year. While the stock is trading near the high end of its annual range of $5-$8, this should be only the beginning of a substantial upward price move, given the very low PE and terrific operating momentum. If we’re right about the $1.50+ of EPS, the stock should be $20, perhaps within six months.


GIII is an apparel manufacturer historically focused on leather outerwear, with a lesser emphasis on non-leather apparel as well. GIII owns a variety of its own brands, such as G-III, Black Rivet, Siena Studia, and also produces apparel under a variety of licenses, including under the brand names Nine West, Cole Haan, Kenneth Cole, Jones New York, Sean John, and Timberland. Apparel is sold through a variety of channels, from department stores to specialty stores to mass marketers. Leather is not an easy business from an operational perspective (requiring sourcing expertise in terms of sourcing quality leather and having the product manufactured overseas, plus it’s a very seasonal business), which provides the incentive to owners of apparel brands such as Nine West, Cole Haan, Jones New York, etc. to license their brand names to GIII for leather outerwear.

The big improvement in profits this year appears to be attributable to (a) manufacturing efficiencies gained via the closing of their Indonesian plant, and (b) higher sales and better margins in the licensed athletic apparel business. GIII makes athletic outwear through licenses with the NFL, NHL, MLB, NBA, and more than 50 universities nationwide. They make retro athletic apparel under the Hardwood Classics and Cooperstown labels (think of leather jackets using NBA and MLB logos).

As noted, we believe that in 2003 (actually FYE January 2004) GIII will actually do significantly better than the $1.10-$1.15 guidance they just gave. Year to date in 2003 (first six months ended July), GIII has generated revenues of $64 mm versus $53 mm last year, with gross margins of 31% versus 22% last year, and $0.4mm EBIT (not EBITDA) vs negative EBIT of $5.3 mm last year. Seasonally speaking, they make all of their money in the second half of each year, which is understandable for a leather-focused apparel company, so to break even in the first half is actually a big accomplishment. This year they’ve done EPS of $0.01 in the first half, versus a loss of $0.54 in the first half of last year.

They are now projecting $220 mm revenues for the full year (so about $156 mm of revenues in their important second half), versus $203 mm of total revenues last year (they did about $150 mm of revenues in the second half of last year). So they are projecting revenues to increase about 4% in the second half of the year, even though they revealed on yesterday’s conference call that their order book is up about 10% for the second half and gross margins have been running substantially higher. In the second half of last year the company generated gross margins of 25% (less than what they are doing in the seasonally weak first half this year) and operating margins of 8.9%. Last year on $150 mm of revenue in the second half of the year, the company generated EBIT of $13 mm. If you take their implied guidance for the second half of the year of $156 mm of revenues (which as noted is likely too low) and assume a 30% profit margin (which is also likely too low given that second half margins should be higher than first half), that is $47 mm gross profit in the second half, less say $28 mm of SG&A (up 15% from what they spent in the second half of last year), that results in $19 mm of EBIT in the second half of the year. This would result in full year EBIT of $19.4mm, less about $1mm of interest expense and a 40% tax rate, would basically result in net income for the year of about $11 mm and EPS of $1.50 on a fully diluted 7.4mm shares. With even higher revenues and/or margins (both of which we expect), this EPS number obviously could be higher.

As an example of management low-balling EPS projections this year, note that in May 2003, GIII gave guidance of $0.10-$0.12 of EPS for their Q2 – in reality it turned out that they did $0.37 of EPS, on basically the same revenues as they had projected in May. So it’s certainly not impossible that their guidance could be understated significantly.

For a little historical perspective, note that GIII did $1.52 of fully taxed EPS in 2000 (FYE 1-01) – in 2000 they did $187 mm in revenues, had 27% gross margins for the year, and did about 11% operating margins, generating about $21 mm in operating profit. After some interest expense and taxes, this was $11.2 mm of net income or $1.52 per diluted share. In 2001 and 2002 (FYE’s 1-02 and 1-03), the company had some struggles – doing $0.32 EPS in 2001 on $201 mm of revenues and $0.52 EPS in 2002 on $203 mm of revenues – results were hurt in these years by things like 9/11, the weak economy in general, difficulties in their Indonesian manufacturing facility (which has been closed), plus a particularly warm winter which hurts the outerwear business. But now the company appears to be back on track to demonstrating its more normal earnings power. If the company were to do 11% operating margins this year on $220 mm of revenue, that would generate about $24 mm of operating profit, which would work out to close to $1.90 of EPS. The beauty of this idea is that even if we’re wrong in our belief that management is low-balling the EPS projection, the stock is still way too cheap at 7x management’s EPS projection.

GIII has about 7.4 mm diluted shares. At the $8.00 stock price, the market cap is about $59 mm. Insiders own 60%, and appear to be motivated to grow the company and reward all shareholders. We have not seen evidence of insiders favoring themselves. Two hedge funds (Buckingham and Wynnefield) own 15%. And as noted, the company’s only debt is a working capital revolver that they need to fund seasonal working capital (given the big holiday season their third quarter is especially big), but they end their fiscal year with zero on the revolver, and they should end this coming year with a substantial net cash position. In summary, at $8.00 the stock is trading at 7 times management’s projected EPS for 2003, but we think there is a real probability that EPS will be $1.50 or better, given the operating momentum the company currently has. If the company surprises on the upside and does as well or better than we expect, the stock could easily go to $20 based on a still relatively modest PE multiple. If all they do is the $1.10-$1.15 they are currently projecting, the stock is still very cheap, and should be headed toward at least $13.

Catalyst

Way too cheap at a fully taxed PE of somewhere around 5x to 7x, great operating momentum, great trends vs last year just now becoming evident.