Description

Valuation and Multiples (as of 6/23/04)
Equity Value: $332.0mm TEV/LTM EBITDA: 3.8x Net Debt/EBITDA: 0.0x
Net Debt: ($109.2)mm TEV/LTM EBIT 6.0x LTM FCF Yield: 6.5%
Enterprise Value: $228.8mm P/FY04 EPS: 14.3x Dividend: 1.2%
TEV/Sales 0.2x P/FY05 EPS: 12.3x Return on Equity: 10.1%

Company Description and Background
Goody’s Family Clothing, Inc. (NASDAQ: GDYS) is a moderately priced department store chain with locations in small to midsize markets in the Southeast and Midwest. As of April 30, 2004, GDYS operated 340 stores with average footprint of approximately 28,000 square feet predominantly located in strip centers.

Investment Thesis
GDYS has limited downside given its low valuation and strong cash position with the potential significant upside from current levels. At an absolute and relatively low valuation compared to its peers, the stock is discounting extremely low expectations for its near-term fundamental outlook. With strong free cash generation and an un-levered balance sheet, the company is in no imminent financial risk. The stock will move higher when the earnings outlook improves through expanded margins from increased penetration of private label merchandise and accelerated store growth.

Increased Private Label Penetration: GDYS recently acquired the Duck Head brand from Tropical Sportswear (NASDAQ: TSIC) for $4mm and will be offering men’s, women’s, and children’s apparel under this brand exclusively at its stores. The current mix of private label at GDYS is 27% as of the end of 2003. Management has suggested that the mix of private label including Duck Head can conservatively increase to 30% this year. Private label merchandise typically has 6-8% better gross margins than branded merchandise. Each 1% increase in private label penetration yields about 30-40bps in operating margin expansion. With operating margins at 2.2%, each 1% increase in private label can improve current earnings power by about 20%.

Accelerated Square Footage Growth: After some missteps with new stores out of its core markets, GDYS is now poised to accelerate square footage growth again. The GDYS operating model is best executed in areas with populations fewer than 100,000 where competition from larger department stores is minimal. A few years ago, an executive was hired from a larger department store chain and was responsible for changing to real estate strategy to include opening stores in larger cities. The stores opened under this plan significantly underperformed taking management’s focus away from opening stores in its core markets. This executive has since left the company. With only 340 stores, GDYS has the potential to open stores at a high single digit growth rate for the foreseeable future as its core demographic is still underserved in branded apparel.

Earnings Target and Price Objective: GDYS currently has significant earnings leverage potential on depressed operating margins. Assuming private label penetration including Duck Head can reach 30% of sales at 36% gross margins, GDYS should generate $75mm in EBITDA and earn $1.00 per share in FY05. At current prices, GDYS is only trading at 3.0x EBITDA and 9.8x EPS. A regional department store with growth potential should reasonably trade for at least 6x EBITDA. At this multiple, GDYS should trade at $17 representing 73% upside from current levels with relatively low risk as the balance sheet is pristine with no debt and over $100mm in cash.

Investment Risks
Private Label Initiatives Fail: Although Duck Head is an established brand, there is always risk in launching new lines and significantly altering product mix. Management has indicated that significantly exceeded internal budget plans since the rollout began in March.

CEO Sells Stock: Robert Goodfriend, current Chairman/CEO and grandson of the founder of GDYS, is the largest holder and owns 13mm shares or 39.9% of the company. He has indicated his intention to sell about a third of his holdings, but not at current prices. While a significant secondary could pressure the shares, it would ultimately improve the trading liquidity and would be beneficial in the long run.

Catalyst

1. Increase penetration of private label merchandise through introduction of Duckhead brand
2. Accelerated square footage growth