Description

Kenneth Cole Production is a fashion designer which markets its products (shoes, handbags, apparels, etc) through three divisions: wholesales, consumer direct, and licensing. The wholesales division sells its products to high end fashion retailers such as Federated Department Stores (the parent company of Macy, Bloomingdale, Barneys.), Dillard Department Stores, Nordstrom, Saks Fifth Avenue, etc. The Consumer Direct division operates its retail stores, e-commerce, and direct mail. The licensing division broadens the distribution of its products by expanding into various product categories and internationally.

The Investment Merit of Kenneth Cole:
1. Tremendous Future Growth Potential.
Historically, KCP has been a fast grower, Sales and N/I were growing north of 30 percent. However, they hit a bump recently due to tough retail environment and slow down in economy. At this point, I feel that Kenneth Cole has future long term sustainable growth prospect. The reasons that undermine my believe are:

a. As of Dec 31, 2000 Kenneth Cole has only 69 stores. (vs. 3,647 of GAP)
For comparison, I have decided to provide some leading national retailers and the stores they operate.
Ann Taylor 467 A&F 350 American Eagle 556
Buckle 276 Cache 214 GAP 3,647
Intimate Brand 2,385 Men Warehouse 571 The Limited 2,826

From the comparison above, we can easily see that that Kenneth Cole Retail Operation is very small. I feel that Kenneth Cole has the potential for long term sustainable growth ahead. In addition, virtually all KCP's retail stores are profitable which in our opinion: a crutial information to know.

b. The newly introduced women fashion can ultimately become the largest segment of the company.
Historically, Kenneth Cole has been associated with men fashion and Kenneth Cole's women apparel business is very small.In Fall 2000, KCP and Liz Claiborne signed a licensing agreement in which both companies decide to market Kenneth Cole women fashion. At several times the size of that of men, women's apparel market present large potential for Kenneth Cole. In addition, the partnership with Liz Claiborne is an excellent business decision on the part of Kenneth Cole because of the long and succesfull experience in women apparel segment on the part of Liz Claiborne.

c. International Expansion can provide additional growth opportunity.
Currently, KCP opearates one store in Netherlands, and its international licensees has only 8 international stores. Both domestic and international markets that Kenneth Cole and its licensees serve are underpenetrated. At this point, only one percent of the company business is generated internationally. Eventually, the company expects that the international operation will be approximately 15-30 percent of sales.

d. Oppotunity in new product categories such as watches, optical eyewares, luggages, children apparels, etc-growth opportunity.


2. Historically, Kenneth Cole has been highly profitable and we feel it will continue to be highly profitable.
2000 1999 1998 1997 1996 1995
ROA 17.7 15.0 16.0 15.7 18.6 22.3
ROC 19.0 15.9 16.8 16.4 19.3 23.3
ROE 39.3 36.7 52.1 77.5 136.5 -227.4

Because of the growth potential mentioned previously, we feel Kenneth Cole is able to maintain its highly profitable operation in the future.

3. Kenneth Cole is well managed and has executed brilliantly in the past.
All managers has long experience in the fashion industry. I think the best measurement of the management competency is through the excellent results delivered to shareholders. I more willing to bet my hard earned dollar on proven management such as Kenneth Cole. In addition, we are dealing with a company that has beat or meet Wall Street estimate for 14 consecutive quarters. (For me this is a huge plus, because I would rather deal with people who could give me upside surprises rather than the other way around.)

In addition, our analysis of the company has yielded us some very encouraging data:
a. Margin has shown continous improvement over the past three years. (kindly note, this will not be the case in the current fiscal year due to tough retail environment and slowdown in economy.)
b. Good execution in each segments has yielded high growth and hig profitability.
c. Good working capital management has enabled this company to grow so fast, yet generate large amount of positive cash flows.
d. Sales and profit per square foot and per store have also been very good.

4. Kenneth Cole Balance Sheet and Solvency Ratio are "Bullet Proof" (Zero Debt, Thirty Five Percent of Asset consists of Cash.)-so protection during tough retail environment and slowdown in economy exists in this issue.

5. Good products, Strong brand names and good product positions.
Ask the people around you, whether they have used Kenneth Cole product. I personally owned some and am very satified with the products. Kenneth Cole is very popular with Generation X. ALMOST EVERY ANALYST AGREE THAT KENNETH COLE CAN BE THE NEXT MEGA BRAND SIMILAR TO POLO or TOMMY.

The Negative Attributes and Risk of this company:
1. The long term growth rate will likely to slow down from 30 percent to 15-20. This is fine with me, because as company grow, size will hinder the growth rate.
2. Fashion Risk- (I would like to spent some time here because I consider this risk to be very important.)
Historically, Kenneth Cole has been very dependent on fashion oriented customers. The consumer taste can change rapidly. We are glad however, Kenneth Cole has been able to anticipate the trend correctly. But we will not rule out the risk that Kenneth Cole can make fashion mistake in the future.

Recently, Kenneth Cole makes some immaterial "fashion mistakes" adjustments on its fashion lines because of the shift from modern to more traditional fashion styles. Kenneth Cole also ran short of leather for boots, jackets, and handbags. Kenneth Cole also put out its short sleeves, and sandals too early while the weather this year is colder than that of previous years.

In the market, there is a shift in the fashion style from modern to contemporary. The problem with this shift is that historically, Kenneth COle has been associated with contemporary fashion. (As the CFO put it: we have always been associated with modern fashion with a twist.) As the shift occurs, the company is faced with two difficult choices: the first is to maintain its image as a contemporary fashion designer while losing its fashion oriented consumers or adapt while losing its core consumers.

The company informs us they are going to allocate part of their resources to adapt while allocating the rest to serve its core consumers. This " compromise" strategy is usually used in the past. The company also informed us that the shift can be swayed with the fact that NAUTICA and POLO has been utilizing aggresive pricing strategy due to slow retail environment to take market share. Hence, the action by POLO and NAUTICA create additional sales in the traditional line.

There are two factors that might cushion this fashion risk.
a. Management long tenure and succesful in the fashion industry. We feel that the shift in fashion trend is definitely not new to the management and believe that they could at least react to the shift.
b. Kenneth Cole has been very successful for 18 years. There are been many shifts in fashion from early 1980 to today. The way I see it, if this company could survive and be succesful for 18 years, I feel that the management has reasonable ability to predict or to the very least, react to fashion shift.

3. Operating Lease are growing and will be expected to grow.,

VALUATION:
AT 31.50, Kenneth Cole is fairly priced. At our estimate of 2.20 and growth rate of 15-20, Kenneth Cole fair valuation should be between 33-44. If we are taking 17 as the fair P/E multiple, the fair valuation is 37.
THIS IS NOT A CIGAR BUTT issue but over longer term, the upsite potential are definitely present.

There are however catalysts that could cause P/ multiple to expand beyond our expectation, they are:
1. Acceleration of growth rate due to historical conservative estimate.
2. Current unfavorable macro economic events reverse.
3. Kenneth Cole is trading at a discount to its average two years P/E.
4. Our estimate is conservative and there is a possibility that Kenneth Cole could beat our numbers.
2002E 2001E 2000A 1999A 1998A 1997A 1996A
GM 47.0 48.0 46.6 45.6 43.3 41.4 42.8
SGA 33.0 31.8 31.6 32.5 31.6 30.5 29.2

Let look at some facts:
a. Actual operating GM from 1996 to 2000 has been improving.
b. 2001E is derived from management guidance. (Note that we are dealing with management which has meat or beat Wall Street estimate for 14 consecutive quarters.)
c. Rather than continue to improve GM, we DROPPED our GM by 100 bp.
d. Our SGA estimate is THE HIGHEST of all years.

Kenneth Cole can beat our numbers due to several factors:
1. GM can improve or hold steady.
2. SGA can hold steady.
3. Historically, expense management has translated to expansion in margins.
4. Growth potential plus conservative management's estimates.
5. The guidance for the last two quarter for FY 2001 assumes 20 percent revenue growth, while we are using 17 percent.
6. Share repurchase will increse EPS.
7. Our secnarion analysis by varying rev in 15-20, GM 47-48, SGA 32-33 yielded us EPS from 2.16 to 2.56. Thus at 2.20, we are at the low end of the range.

WHY SHOULD YOU INVEST:
Sometimes, we need to buy good and well managed company at reasonable price. At 31.50, it is reasonably priced. It is a good opportunity to get in because of the potential KCP offers. The long term sustainable growth prospect is excellent. Revisiing guidance is more of a bump rather than permanent impairment of the business. The products are still strong and the financial position are also strong. We feel recent weakness on the price offers an attractive entry point for intemidiate to LT-investors.


I APOLOGIZE IN ADVANCE FOR ANY SPEELING ERROR-I AM ON THE RUN-GOT TO GO

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