Description

SUMMARY

I believe that the stock price of Lands’ End (LE) today is compellingly attractive, with the potential to gain 200% (and possibly more than 350%) over the next three to five years. After the company’s spinoff from Sears in April 2014, and with a new CEO since 2017, new life has been breathed into the business. The brand is being rejuvenated. The economics of the business are—and have always been—outstanding. Under the benign neglect of former owner Sears from 2002 to 2014 the topline stagnated but the company remained immensely profitable. Under a misguided new CEO from February 2015 to September 2016, Lands’ End drifted into more fashionable apparel with disastrous results, though the company continued to be moderately profitable. Current CEO Jerome Griffith was brought in in early 2017. Sales and margins have since improved, and have the potential to improve significantly more over the next few years, which should result in a significantly higher stock price.

I previously posted Lands’ End on VIC in January 2019. The stock price was $15.76, and I recommended exiting in February 2021 after the stock had doubled. Much has changed in the three-and-a-half years since my previous write-up, including the impact of the pandemic and the concomitant supply chain issues. Surprisingly, while the company is bigger, more profitable, financially stronger, and with a higher likelihood of growth and increased profitability than it was when I previously posted, the stock price is barely higher than it was at that time, and down by more than 60% from its recent high of more than $44 a year ago. (The stock’s all-time high price was $56 some months after it was spun off in 2014.)

If you’re still reading, I encourage you to read my previous writeup of January 2019, where I describe why I think Lands’ End has excellent economic characteristics, providing 20 years of data to back this up. I won’t repeat that analysis here. Do also read TheEnterprisingInvestor’s report of January 2018, where he recommended the stock at $18.30; and timp9990’s writeup of August 2020, in which he recommended investing in the term loan due April 2021 at a discount. Their conclusions were very similar to mine, though the slant of their analysis varied somewhat from my approach. Each of these three previous recommendations worked out well.

RECENT FINANCIAL PERFORMANCE

Since Jerome Griffith took over as CEO in early 2017, profit margins have improved meaningfully, as can be seen in the two tables below, which show EBITDA margins by year (2008-2021) and EBIT margins by quarter (2013 to 2022). While 2021 margins were significantly higher than in 2016, they still lag the levels achieved between 2008 and 2014. Management has expressed confidence that they can increase profitability over the next few years through a combination of modest gross margin gains and SG&A cost improvement through the leverage of higher sales. 

Operating (EBIT) margins increased from 1.5% in 2016 to 4.9% in 2021 and should exceed 8% by about 2026. EBIT margins were as high as 8.8% as recently as 2014 and exceeded 12% in the late 2000s. EBITDA margins have similarly recovered from 2.9% in 2016 to 7.3% in 2021, after being at 10.2% in 2014 and over 13% in the late 2000s. This should exceed 10% by about 2026.

2022 results will be affected by supply chain issues—a combination of inventory shortages and higher shipping costs, which will hurt sales and profit margins. This won’t derail the company’s growth plans, but could slightly delay achievement of management’s financial targets.

FINANCIAL TARGETS

At a conference in January, management laid out clearly its five-year goals for the company.

Top-line growth of 10% CAGR is projected through 2026. The global eCommerce business (DTC, primarily online, both U.S. and international), which is the company’s core business, is expecting MSD growth. Outfitters (uniforms), which is divided roughly equally between school uniforms, national accounts (including Delta, American Airlines, Avis), and small- and medium-businesses (150,000 accounts), is projected to increase from about 15% of revenues in 2021 to 18% by 2026. Third Party sales—including sales through Amazon, Kohl’s, and recently-launched QVC—has the greatest growth potential and is targeted to be 15% of sales by 2026 from 5.3% last year.

Sales and profits in the early months of 2022 have been below expectations, primarily due to supply chain issues, and projections for 2022 have been scaled back. In the table below I have accordingly reduced sales estimates for 2026, under the assumption that one year of growth has been lost. 

Note 1: “U.S. eCommerce” numbers in 2016 and 2017 include International sales.

Note 2: Retail sales from 2014 to 2018 were virtually all through Lands’ End stores within Sears stores.

As Sears’ difficulties compounded during the last decade, and following the spinoff in 2014, Lands’ End started shutting down their stores in Sears stores. In 2014 those stores accounted for $235 million, or 15.1%, of Lands’ End total sales. All of these stores had been closed by the end of 2019. That loss of sales has, impressively, been more than offset since then by growth in the main eCommerce DTC business, and to a lesser extent from the third party and outfitters businesses.

Using my 2026 sales model above, along with some assumptions of expected improvement in operating margins, plus reduction in the total interest burden and modest stock buybacks results in my estimate of $4.51 EPS in 2026 below. This is shy of management’s $5.00 EPS goal which was spelled out in January 2022 but may be appropriate given the difficult environment the business is facing this year.

These projections assume EBIT margins of 8.4% and EBITDA of 10.5% in 2026, similar to 2014 levels and well below the 13% to 14.2% EBITDA margins of 2008 to 2010. These appear eminently achievable to me.

EPS growth should begin in earnest in 2023. The 2022 top-line will be about flat compared with 2021. 10% growth in revenues next year, with modest margin improvements plus the benefit of much lower interest expense and a slightly reduced share count could result in $1.71 EPS in 2023 for a P/E multiple of 9.5x today’s price. The same factors—revenue growth, margin improvements, continued lower interest expense, and a modestly lower number of shares outstanding—should cause EPS to surge to $4.50 to $5.00 by 2026.

If the company achieves its $5.00 EPS target (or my more modest $4.51 above) in 2026, it isn’t hard to imagine a price of over $50 (which would be a gain of more than 200% from the current price), or even $75, a gain of over 350%. To me this earnings goal seems achievable, assuming we don’t have a terrible economic environment over that period.

BALANCE SHEET

At the end of fiscal 2014, just after the spinoff from Sears, Lands’ End had net debt of $285 million. This amount changed little over the next five years, ending fiscal 2019 at $307 million. But as the new CEO’s initiatives have taken hold, and the company has become both more profitable and more efficient in its use of assets, net debt has been reduced materially over the last two fiscal years, dropping by $93 million to $214 million at the end of fiscal 2021. (Given the seasonal nature of the business, inventory and debt tend to peak at the end of the third quarter, right before the holiday season, but debt trends have been similar during that part of the annual cycle, declining sharply over the last two years.)

The table above shows debt outstanding at the end of each fiscal year, which ends on about January 31 of the following year. In April 2014, at the time of its spinoff, the company had taken a term loan of $515 million, maturing in April 2021, with an interest rate of LIBOR + 3.25%, effectively paying about 5% rates in recent years. [VIC member timp9990 recommended purchasing the term loan at a discount in August 2020.] The loan was refinanced in the early months of the pandemic, in September 2020, and replaced with a $275 million term loan. With markets in turmoil, the new loan was priced at LIBOR + 9.75%, so that the company has effectively been paying well over 10% on this debt. The company can refinance this expensive debt without incurring substantial penalties at its two-year anniversary, which is in September 2022. At the end of April 2022 Lands’ End had $245 million of this term loan outstanding. Management has indicated that they expect the refinancing to happen very soon—i.e., within the next few weeks. Every 1% decrease in the interest rate will save the company $2.5 million annually pre-tax, or more than $0.05 per share after taxes. Total interest expense, which was $34.4 million in 2021, will likely be below $20 million next year. We can expect details of this refinancing shortly, possibly before the next earnings report in early September.

STOCK BUYBACKS

On 6/28/22 the company announced the authorization of a $50MM buyback program. Since then, the stock price has ranged between $10.50 and $18. At average repurchase prices of $16 and $20, this authorization would enable them to buy back 3.1 million and 2.5 million shares respectively, or 7.5% to 9.5% of outstanding shares. I suspect they have begun buying shares, though that will only be confirmed when they release their Q2 earnings in early September. Given that the company is both profitable and non-capital intensive, buybacks at current depressed prices can add tremendous value over some years and increase their likelihood of achieving their $5.00 EPS target within a few years.

VALUATION TODAY

With 33.4 million shares outstanding at the end of May, Lands’ End’s market cap is about $540 million today. Because of the seasonal nature of the business, debt levels at the end of each quarter fluctuate. The average net debt outstanding at the end of the previous four quarters was $271 million, giving EV about $811 million, or about 0.5x sales. EBIT and EBITDA in 2021 were $80 million and $119 million respectively. With the potential to increase to over $200 million and $250 million respectively over the next four years, Lands’ End appears to be compellingly cheap today. Stock buybacks and debt reduction over this period provide further leverage for stock price appreciation.

One reason we get this opportunity is because Lands’ End’s stock is incredibly volatile, fluctuating far more than the results of the underlying business. This volatility arises in part because it is an apparel company, but also because the stock is illiquid. Eddie Lampert owns or controls just over half the outstanding shares. Another 6.3% is owned by Capital Research and 6% by Tom Tisch. This leaves just 36.5%, or 12.2 million shares, in public float. Declines of 50% in the stock price over a few months are routine for this company; the stock is now more than 60% lower than it was in July last year.

RISKS

-Failure to execute on business plan.

-Prolonged economic downturn and lower consumer spending.

-Ongoing supply-chain disruptions.

Catalyst

Long-term: Growth in sales, margin improvement, and higher EPS.

Short-term: Stock buybacks; debt refinancing news. Earnings report in two weeks.