Description

SUMMARY

I believe that Lands’ End stock, at its current price of $15.76, can appreciate by 200% or more over the next three to five years. This analysis explores the potential of this happening if a few things go right. The probability of this has increased under a new CEO. Founded more than 50 years ago, the company thrived and grew profitably through the 1980s and 1990s. However, for most of the last fifteen plus years, since being acquired by Sears in 2002, it was undermanaged by its parent, so that the size today (by revenues) is still at about the same level as it was then. It was spun-off by Sears in April 2014. The current CEO, who appears very competent, took over in March 2017. He has refocused the business on the core customer, and there is a new sense of urgency and clear signs of improvement in both revenues and profit margins since then. As his actions take hold over the next few quarters and years, sales should grow and profit margins should increase dramatically. If this happens, the stock is likely to provide a good return from this level.

INVESTMENT THESIS

My argument is summed up in the points below. I will elaborate on these later in the report:

(1)   Lands’ End is a strong, well-established brand, with a reputation for good products and great service and a long history of profitability.

(2)   The underlying business has excellent economics, with low capital requirements, and if managed well can generate significant free cash flow.

(3)   The company was undermanaged and mismanaged for well over a decade. Sears milked the company during its twelve-year ownership and underinvested in the business. One year after the spinoff from Sears, a former Dolce & Gabbana and Ferrari executive was named CEO. Her misguided vision was to transform Lands’ End into a high-fashion lifestyle brand. She lasted about 18 months.

(4)   New capable management was brought in almost two years ago.

(5)   There are clear indicators that the strategy of the new CEO is producing results.

(6)   There is potential for top-line growth and significantly higher margins.

(7)   This should result in a much higher stock price over the next few years.

A BRIEF HISTORY

Most VIC members are probably familiar with Lands’ End, and I won’t spend much time on the company’s history or its products. There is much information on the company’s website and in SEC filings. Founded by Gary Comer in 1963 to sell sailboat hardware and accessories, it only went into apparel in the following decade. The stated guiding principle of the company from its founding was: “Take care of the customer, take care of the employee and the rest will take care of itself.” This principle served the company well: it grew fairly consistently and profitably over the decades, went public in 1986, and continued its profitable growth until its acquisition by Sears in 2002. An important part of my thesis is that new management is returning the now-independent company to the principles which made it successful, and this will increasingly show in the company’s financial performance in coming years.

Lands’ End was posted on VIC by TheEnterprisingInvestor a year ago, when the price was $18.30. The author timed it well, recommending exit less than five months later, when the price was about $30, for a more than 60% gain. The fundamentals of the company have improved over the last year, but the stock is down 14% from the time it was previously posted, and down 50% from its 2018 high of over $31.

I encourage anyone interested in LE to read the January 2018 VIC report. My writeup will focus more on the quantitative aspects of the business, highlighting the favorable economics of the business, as demonstrated by both recent and longer-term financial performance, and quantifying the magnitude of margin improvements and revenue growth I consider possible and necessary for this investment to be successful.

HISTORICAL FINANCIAL PERFORMANCE

The table below summarizes the financial performance in the decade prior to the Sears purchase:

(For the purpose of this report, my preference is to focus on EBIT margins rather than EBITDA. For more recent years, D&A information is provided in the table below. With recent stepped-up capex spending, D&A has increased over the last two years, and is now running at about 1.8% to 2.0% of annual revenues.)

Revenue was $1.45 billion in 2001, prior to Sears taking over. Fast-forward to the last decade. Sales increased to $1.66 billion in 2008, $1.73 billion in 2011, and then declined for five consecutive years as Sears largely ignored Lands’ End while struggling with its own problems. And yet, the company continued to be profitable from operations, at the EBIT level:

Operating margins in 2016 and 2017 were the lowest in decades, as a new CEO (now former CEO) brought in in 2015 put the company on a misguided path to becoming a fashion-forward company. She was ousted in late 2016, and the current CEO joined in March 2017.

ECONOMICS OF BUSINESS

An important part of my investment thesis is that Lands’ End has attractive economic characteristics. This can be seen in the fact that the company continued to generate operating profits even under Sears. One way to quantify this is by using a crude measure of “Capital Employed,” which I assume to be the sum of PP&E, inventory, receivables, and other assets, less payables and other liabilities: