Description

JILL is among the most misperceived small cap situations we’ve encountered. It is indiscriminately hated by the sell side and equally shunned by the buyside, having botched an IPO and resigned itself to a revolving door of seemingly directionless chief executives. Add to the untrained or at least uninterested eye an ostensibly precarious balance sheet amidst “retail apocalypse” getting shouted from rooftops for the last five years and one wondered if JILL would ever see it’s day on the weighing vs voting machine. My guess is that day is upon arrival. The other side of the story is that J Jill’s beginnings as a direct business has over an extended period of time amassed (almost) dumbfounding customer loyalty (at least relative to Wall Street perception). I had to triple check that NPS data to believe it when I learned its peers in customer affinity were more to the tune of Lululemon and Apple (JILL’s net promoter scores are in fact higher than both those brands) than they are the hodge-podge of mall-based brands it is generally associated with. The perhaps equally valuable element of the company’s lineage as a direct business is that today, as the world shifts to omnipresence, roughly half of it’s revenue is already digital and the physical locations they do have are in markedly better mall and lifestyle centers than most all companies it is generally compared to (on top of this, the pandemic period gave them an opportunity they rightly seized — it allowed them to renegotiate/reset/abate a large number of its existing leases). The final component of the direct-business origin worth noting is that JILL’s appropriate peers are not predominantly physical-store based retailers — rather, they are companies like Land’s End, Duluth Trading, and (slightly more of a stretch but) Aritzia, all of which trade at double digit multiples on EV/EBITDA and in most cases 20x or greater their free cash flow (band of 19.5x to 42x on this year; 14x to 23x on next year). Note as you read my colleague’s more bullet-point-based write up to follow that we are in this regard being almost insensibly conservative in the multiple we’re assigning to these KPIs in valuing JILL. To the extent one were to apply these comparable multiples JILL is a multi-bagger, not just a double, as my team member posits. 

But the bigger part of what we do focuses on timing fundamental inflections and how markets under and overshoot in revaluing them. We think this quarter JILL will get close to break-even at the EBITDA line, even while roughly half the quarter was operated under what we’ll call pre-reopening conditions. If they are indeed close to break-even at the EBITDA level reasonable analysts will have to conclude an exit-rate implying a substantially profitable and cash flow generative 2Q and extrapolation thereafter. And indeed the real juice is in the 2Q / 3Q and beyond periods — JILL serves a customer who came of age in the 70s / 80s (about the most materialistic time imaginable), who has reasonable discretionary income, who hasn’t shopped in over a year, and who is going to have endless events, travel itineraries, and other excuses to go on a spree. I’ll bet my bottom dollar that we’re under-appreciating just how indiscriminate demand will be, and the magnitude of what a restructured fix cost base and dramatically less promotional environment means to underlying fundamentals. Remember (for those few who have covered the company over time) that JILL is now at 1.80 p/ share adjusted for the 10-1 split relative to its IPO in the 7-8 range. We prognosticate that in a couple of quarters from now both JILL’s a) actual underlying KPIs and, determinatively, cash flow per share and b) the market’s perception of the long-term quality of its brand and business are likely to be quite a bit higher than when it came public. Even adjusting for rights offerings and other dilution, that’s a hell of a lot of upside from here without having to put to sharp a pencil on it. 

Business Description / Background

J. Jill is an omnichannel specialty retailer of women’s apparel & accessories. The company operates 267 stores under the J. Jill banner in addition to its e-commerce operations.

Overview

3 straightforward points

-          Company’s (highly) loyal customer base to drive accelerated recovery

-          Expect reduced promotionality to drive significant gross margin uplift

-          Current valuation fails to reflect the inflection observed in the company’s fundamentals

Our work suggests the company’s underlying trends have inflected meaningfully, with sales approaching 2019 levels in recent weeks (both Retail & Direct accelerating concurrently). We expect these trends to continue to strengthen (as an amalgamation of our research suggests), leading to revenue potentially eclipsing 2019 levels by 3Q and reaching $653mm for the full year. Additionally, similar to what we have observed across the retail space broadly, we expect JILL to post meaningful sequential gross margin improvement in 1Q (& up significantly Y/Y, although not back to 2019 levels) and for the strength to persist throughout the remainder of the year. Assuming +758 bps improvement Y/Y to gross margin and incorporating certain operating expense items, we arrive at the company generating $55-$60mm of FCF ($4.25 to $4.65/share). Assuming 10x FCF multiple on $4.50/share of FCF implies a target price of $45 (+151% upside). If one were to assume it trades back to 2017 multiples when the company was posting positive comps, we see upside of +227% (13x $4.50/share).

Highly loyal customer base to drive accelerated recovery

-          A key aspect specific to JILL (compared to other specialty retailers that have been challenged more recently) is its customer loyalty. Pre-COVID the company managed to consistently grow its customer base every year while receiving overwhelmingly positive feedback from its customers in doing so

o   However, given its core customer is a 55+ year old woman, this demographic has not yet returned to pre-COVID mobility levels (greater concern re COVID compared to other age groups) (explains the lack of recovery observed in JILL’s business in 3Q & 4Q)

o   We expect a combination of increased vaccination rates and warmer weather to serve as the catalyst for JILL’s fundamentals to inflect positively  

-          Brand affinity - Company’s Net Promoter Score (NPS) of 83 places JILL in good company (same neighborhood as the likes of Costco (79) and Starbucks (77)), emphasizing the strong customer affinity towards the brand

o   Former CMO “the [JILL] customer is very loyal…. She loves to go to stores”

-          Strong customer base – JILL Active Customers grew +0.4% Y/Y in 2019 to 1.85mm (most recent disclosure) (grew at 7.2% CAGR from 2015 to 2018)

o   Pre-COVID, the J. Jill customer base was expanding every year” – former Director of CRM

-          Pent up demand – JILL core customer (55+ year old woman), initially hesitant to return to pre-COVID shopping behavior, now returning to in-store shopping as a combination of increased vaccination rates and warmer weather drive increased mobility

o   Store level commentary indicate vaccinations playing a significant role

§  Former EVP Chief Creative & Merchandising Officer feedback following store level checks - “hearing customers are responding positively”

§  “Starting a couple of months ago [we] began seeing a large increase in traffic due to vaccinations” – store check

§  “Dramatic increase in traffic over the past 3-3.5 weeks due to vaccinations” – store check

§  “April & May have been steadily growing because of more customers becoming vaccinated and more comfortable shopping” – store check

Expect reduced promotionality to drive significant gross margin uplift

-          Margin expansion

o   Consistent with the retail space more broadly, our work (a combination of daily web scraping to conduct historical daily comparative analysis in addition to store checks) indicate the company has dramatically pulled back on its promotional strategy on a 1-yr basis and largely in-line with 2019 levels

§  Feedback from store checks conducted by two former JILL employees provides additional support

·       Former JILL SVP of Retail feedback following store level checks “[JILL] is definitely pulling back on promotions”

·       Former JILL VP of Product Development feedback following store level checks - “[JILL] has been much less promotional”

-          Top-line rebound

o   Highly predictive credit card panels (92.1% correlation) indicate 1Q sales growth of +49% (corresponds to approx. 77% of 1Q19 sales), with trends continuing to improve sequentially (May exit rate approaching 2019 levels)

o   Extensive channel checks across multiple geographies at the store level corroborate the trends observed in the data – with stores experiencing an acceleration of trends following vaccinations and sales steadily closing the gap versus 2019 levels in recent weeks.

§  One store manager sensed that the strength has been broad-based, noting “Other stores are definitely seeing the same comeback and continued strength” based on his read of other managers he speaks with

-          Store footprint optimized

o   The company used COVID as an opportunity to high-grade its store footprint, closing 20 underperforming stores (mall based) in 2020 (approx. 7% of store base)

§  We expect this to provide a boost to overall company reported profitability vs. pre-COVID levels as sales return

Current valuation fails to reflect the positive inflection of the company’s fundamentals and the associated cash flow

-          We see a reasonable path to JILL generating $4.50/share of FCF this year (approx. 25% of the current market cap)

-          The company operates under two segments – 1) Retail and 2) Direct

o   Retail (34% of revenue in 2020) declined 64% in 2020

o   Direct (66% of revenue in 2020) declined 7.5% in 2020

-          Bridge

o   Retail (In-Store) ended 4Q at 51% of 2019 levels on a per store basis – we expect this to have accelerated to 74% in 1Q (as indicated by our primary research), with sequential improvement throughout the remainder of the year

o   Direct ended 4Q at 98% of 2019 levels – we expect a slight deceleration sequentially in 1Q (largely attributable to weak February trends) before accelerating throughout the remainder of the year

o   We expect significant gross margin improvement as the company opportunistically pulled forward taxable losses in 4Q (inventory liquidation) and dialed back its promotional cadence to in-line with 2019 levels

o   This corresponds to $4.50/share of FCF – assuming 10x multiple equates to equity value per share of $45 (+151% upside)

§  If you assume it trades at 13.5x, the multiple the company traded at when it was posting positive comp results, that gets you to $58.50 (+227%)

Risks

-          Revenue fails to return to pre-COVID levels or recovery is slower than anticipated, potentially pressuring cash flow and raising liquidity concerns

-          Profitability uplift could be short-lived if the company returns to its previous promotional strategy

-          COVID-driven digitization of behavior structurally reduces in-store traffic

Catalyst

Covid-driven company-specific initaitives to drive structural uplift to profitability