Description

Haggar, $125mm equity market cap, $100mm Enterprise Value, designs, manufactures, imports and markets men’s casual and dress apparel including pants and shorts. We believe HGGR is an interesting long because of its: (i) attractive valuation (reported numbers include many 1 time items…using “adjusted” numbers this unlevered company trades at 4.9x LTM EBITDA, 4.4x FYE Sept 2004E EBITDA, minimal capex, 0.8x tangible book), (ii) fairly predictable revenue stream (non-fadish men’s clothing), which caters to favorable demographic trends (older and fatter people), (iii) management’s recent commitment to utilize its overcapitalized balance sheet to enhance shareholder value (most likely thru stock buyback/increased dividend), (iv) forthcoming new product introductions and (v) significant insider ownership.

HGGR derives approximately 90% of revenues from menswear, which provides for a fairly predictable revenue stream (especially compared to the more fashion sensitive, and thus harder to predict, women’s wear companies). Furthermore, with its flexible waistline pants, HGGR’s products are compelling to American consumers who are getting older and fatter. The company derives approximately 90% of revenue from wholesale markets, with the remaining revenue coming from 70 company operated stores. The Company also has a profitable and growing licensing strategy, making products for Claiborne and Kenneth Cole, which allows HGGR to capitalize on its core competencies (sourcing and design) and leverage sg&a. In FY 2003, HGGR’s largest customers were JC Penny (20% of revenue), Kohls (16%) and Walmart (8%).

HGGR outsources overseas virtually all of its manufacturing which allows it to minimize capex and continually shift manufacturing to the most attractive markets. Note that recent capex is deceiving as it includes expenditures for a new HQ and some new store openings. Management estimates that maintenance capex (excluding any new store openings) is approximately $1.0-$1.5mm/year.

There are many non-recurring items impacting the company’s reported financials including relocation and legal expenses which the company breaks out clearly in the 8ks listing the quarterly results. However these items cause some confusion in the marketplace so to clarify, management’s midpoint guidance for reported eps for fye 9/04 is $1.29; however, this includes $0.12/share of non-recurring items so the adjusted eps guidance (the company calls it “Core EPS”) is $1.41 and Core EBITDA is expected to be $24.5mm. The only analyst that covers the stock, First Dallas, is at $1.41 and $1.68 of Core EPS for FY 2004 and 2005, respectively. Management is very conservative in terms of eps guidance…they believe in underpromising and overdelivering. They have historically exceeded their published guidance, but last quarter they only reported in-line with their estimates, although they did increase mid-point of full year guidance.

We have become even more positive on HGGR after recent conversations with Management revealed they are finally prepared to use their overcapitalized balance sheet to increase ROE….and if management doesn’t do it themselves, we suspect someone will do it for them either by buying the company outright or by taking an activist shareholder role. Management has historically been very (if not too) conservative in terms of their use of capital; however, we believe they are more fully cognizant of the benefits of having a slightly more levered balance sheet and the desire of shareholders that the company be more levered. HGGR is debt free and as a result its ROE is low. We believe the most likely uses of capital would be a combination of a stock buyback and an increased dividend (currently at 1% yield). Management theoretically could also use its balance sheet for a major acquisition; however we doubt they would do a foolish/risky acquisition since they are conservative by nature, have resisted doing foolish deals in the past, are personally significant shareholders and the Haggar family is still involved in the company and probably does not want to jeopardize its family name with a foolish transaction. With $22mm of Adj. LTM EBITDA and very little capex, HGGR could easily assume well in excess of 1.5x LTM EBITDA of net debt. If we owned the entire company, we would put several turns of leverage on the company, but let’s assume a very conservative recap of net debt/adj. ltm ebitda of 1.5x. You can all run your models, but if you assume the company uses the uses it existing $15mm of its net cash and incurs $33mm of new debt to buyback 2.3mm shares at a 20% premium (and does not increase dividend) such a move would increase projected FY 2004E Core eps of $1.41 by 35% to $1.90 and decrease the implied p/e from 12.2x to 9.0x, while not jeopardizing the company’s financial flexibility.

Haggar has been very successful in part due to its new product introductions. The company is well known for its men’s “comfort fit pants” which have a hidden expandable waist line - perfect for Americans who are getting older and fatter. The company is now introducing the comfort fit concept into its women’s line with introductions at JCP, Kohl, WMT and Dillards. In the Fall of this year, the company will introduce its Forevernew line, which is a proprietary new treatment for cotton slacks and shirts that eliminates the fading and shrinking after as many as 30 launderings. HGGR is the first company to introduce this technology and management is very enthusiastic about its prospects.

HGGR’s largest competitor, Dockers is for sale. While it’s unclear who will buy it, Dockers, owned by financially troubled Levi’s, has been keeping prices low in an effort to maintain market share. We believe/hope that whoever buys Dockers will restore a more rational pricing to the industry, especially since Dockers, which is significantly larger than HGGR, would benefit the most from higher pricing. However, in its projections management is not anticipating a more favorable pricing environment so a more rationale pricing strategy from Docker’s new owner would be “gravy” for HGGR.

Furthermore, whoever buys Dockers should seriously consider buying HGGR as well. The financial cost savings/synergies would be massive and a combination would be very logical considering their market shares in dress/casual mens pants: HGGR (22%/10%) and Dockers (13% / 37%).

Executive officers of the company own 14% of the company and officers and directors own 28%. Included in the 28% are the Kahn Brothers (12%) who several years ago launched a proxy fight against the company. A standstill agreement was signed and relations appear to be good. We are encouraged that the Kahn Brothers, a sophisticated shareholder group, are committed to enhancing long term shareholder value.
Last May the company’s CFO resigned to become the CFO of Dollar General. We spoke with him soon after the announcement and believe his decision was based solely on the opportunity to run a company significantly larger than HGGR. The company has named a highly capable internal person as interim CFO and has yet to announce if he or an outsider will be the permanent CFO.

The stock has traded off recently like many small caps because of its retail exposure, lack of liquidity/analyst coverage and perhaps because the company did not beat guidance last quarter. For those of you concerned about retail risk, you may consider hedging your position by shorting the Retail ETF or JCP or Kohls which are HGGR’s largest customers.

Catalyst

Recapitalization, including stock buyback and perhaps increasing dividend. If management doesn’t do it, someone will do it for them.

New product introductions

Increased investor relations- Company presenting at conferences in NYC and Dallas in coming weeks.