Description

Jones is a leading designer/marketer of women's apparel, footwear and accessories, third in apparel sector total revenues behind VF Corp. and Nike. Jones mainly competes in the "better" and "moderate" areas of women's apparel (56% of revs) and footwear (36% of revs), and sells a large but declining percentage or goods through traditional department stores. Target customers are largely female baby boomers in the 30-64 age-range. JNY markets a plethora of leading brands, including Jones New York, Evan-Picone, Ralph by Ralph Lauren, Lauren by Ralph Lauren, Polo Jeans Company, Todd Oldham, Nine West, Easy Spirit, Enzo Angiolini, and Napier. Recent acquisitions include McNaughton (Norton McNaughton, Erika, Energie, Jamie Scott and Currants brands) and Judith Jack (jewelry). They also license some of their brands to other manufacturers.

JNY's traditional core business is wholesaling to department stores. Over the past few years this business has declined from 90% to less than 60% of revenues. During their 30-year history they have developed strong relationships with major department stores. JNY has a state-of-the-art logistics system and often writes orders for retailers, which greatly improves in-stock levels and inventory management. They stay involved once the product hits stores via in-store "concept shops" and through co-employing selling specialists. As the department store industry has undergone major consolidation, JNY has continued to garner increasing share of this mature channel. About a quarter of revenues is derived from their own specialty retail shops (Nine West stores and others), which mainly sell footwear. The real growth potential however is via private label and new lines in the mass market and discount channels, which currently are about 15% of sales and increasing. Recent Holiday sales data has demonstrated the strength of this sector, and JNY should benefit as they gain share in retailers such as Kohl's, Target, Sears and Walmart.

JNY has a seasoned and extremely proficient management team. They are consummate apparel retailers with many years of experience in the industry and long tenures at the company (a rarity in the apparel industry). Chairman and CEO Sidney Kimmel founded the company 30 years ago, and took it public in 1991. I had the opportunity to sit down with Jacki Nemerov (President and COO, with JNY since 1985) and Anita Britt (IR) this summer, pre-disaster. They stated that target revenue growth going forward is 10-15%, EPS growth is 15%, and operating margin should come in the mid-upper teens. Nemerov stated they are absolutely focussed on driving FCF growth, which will be used for buying back shares, paying down debt (target 38% debt/capital = 10% WACC vs. ROIC of 15% or so) and making acquisitions. They continue to look for targets with strong FCF growth potential, and see 2-4 acquisition ideas a day but have strict criteria. They felt Nine West was the most compelling opportunity they had ever seen, as it had huge share and a great brand but was "run like a country club". They are focussed on realizing this potential through leaning out Nine West's SG&A and closing under-performing stores. They are also keenly aware of inventory management, with 4.2 turns in '00. Jones mitigates its exposure to fashion risk through a variety of means. Most of their products are basic and traditional fashion items as opposed to chasing the hottest trend. Combine this with a diversity of products, brands, and channels, and volatility due to fashion misses is greatly reduced.

JNY traded as high as $47mid-year. The stock's drop was precipitated by the usual concerns regarding fashion sales in a recession, as well as a badly placed bet on sandals at Nine West this spring. The stock bounced around $25 after the disaster, but since has had a decent run to the $33 range. I think the stock is still pretty cheap especially if you plan to hold into the next economic growth cycle. However, I wouldn't be surprised to see the stock pull back some on Q4 results, as the buzz about poor Xmas sales at traditional department stores may not bode well. Berkshire Hathaway (GEICO/Lou Simpson) was a large (10%+) owner of the stock until early this year when they began selling in the high 30s to low 40s range. They sold throughout the spring, selling several million shares. Recent filings however have disclosed that Berkshire began repurchasing in Q3, buying over 600k shares, probably in the mid-20s. As of 9/30 they owned 8.65M shares, or close to 7% of the company.

In the low 30s, JNY trades for about 12.5x expected 2001 and 2002 FCF, and less than 13x consensus '01 and '02 earnings (adding back .32 goodwill amortization for '01) versus an average historical range of 11-21, and an average historical discount to the market multiple of 20%. Before 9/11, consensus earnings for '02 were 3.16, and the company was expecting FCF of about $3 per share. Assuming that it only takes a rebound in the economy to get back to this level, we could have a $44 stock at a 14 multiple within a relatively short timeframe. At an enterprise value of about $5.9B ($1.45B total debt) the stock trades at around 8 x EV/ '00 and '02 EBITDA (closer to 10x depressed '01 EBITDA) vs. a historic range of 6.6-12.2. From 1991 to 1997 (before the Sun Apparel and Nine West acquisitions) revenues grew at a 26.5% CAGR, while EPS grew at a 21.6% rate. If you run this through the recent large acquisitions to the end of 2000, the numbers become 32.28% and 24.36%. Yet I believe the current price reflects expectations of only about 4% annual growth in FCF over the next 10 years, based on a DCF model (owner's earnings) using a 12% discount rate and a terminal PE of 12. The women's apparel market as a whole grew at approximately 4.3% during the 90s. Clearly JNY has had no problem substantially outgrowing the market in the past, and should have plenty of opportunity to do so in the future seeing that JNY's total share of retail apparel is around 3%, and footwear is at about 10%.

Future growth should come from driving further operating efficiencies at Nine West, cross leveraging brands, and through acquisitions. As mentioned, continued penetration of the private label mass market and discount channels should also drive growth. Nemerov stated that they have several brands "sitting in their pocket" that they will carefully introduce as they see fit. In the low $30's, I think the stock is a fine longer-term buy with good upside if the economy bounces back. If it gets into the mid-20s again, I think it is a table-pounder.

Catalyst

The major catalyst would be a turn in the economy with a corresponding return to the company's true earnings power.