Description

Loehmanns, a leading national specialty retailer of discounted men’s and women’s designer and brand name apparel, is very attractively priced and could appreciate significantly assuming modest multiple expansion and/or a recovery in the retail environment. The Company operates 44 stores in 17 states (12 are in CA; 7 in NY; 5 in NJ) and targets relatively affluent women (between the ages of 30 and 55) that are attracted to designer and other brand name merchandise. Loehmanns sells its merchandise at prices that are typically 30%-65% less than department stores (if you are from New York, think Century 21). All stores are low maintenance, simple and functional facilities designed to maximize selling space and contain overhead costs.

Loehmanns pre-dates the other designer outlets, as it was founded in 1921 and has multiple owners since that time including a number of LBO firms. In 1996, Loehmanns went public and in May of 1999 Loehmanns filed Chapter 11 following an unsuccessful, aggressive expansion into demographic areas that could not support its stores. Prior to its Chapter 11 filing, the Company operated 69 stores, generated EBITDA of approximately $22 million (in the fiscal year ending 1/30/1999) w/ capex exceeding $10 million annually and had approximately $140 million in debt. The Company successfully used the bankruptcy process to shed 25 unprofitable stores (and lease commitments), focus its operations, and reduce debt. In October of 2000, its plan of reorganization was confirmed by the court and the Company emerged with a conservative capital structure, profitable stores and streamlined operations.

The Company has been steadily profitable since its emergence despite the headwinds of the retail downturn. In the nine months ended 11/3/01, the Company generated $16.8 million of EBITDA, and EPS of $1.15. On an LTM basis, the Company generated $22.3 million of EBITDA and EPS of $1.29. The EPS figures include expenses related to the amortization of reorganization value in excess of identifiable assets following the emergence from bankruptcy. As of the first quarter of fiscal 2002 (begins on 2/3/02), the Company will no longer expense this amortization, which will increase EPS by $0.24 on an annualized basis. Below is an outline of the Company’s capital structure as of 11/3/2001:

Price per Share: $11.15
Common Shares Outstanding: 3,333,333
Employee Options: 75,000 @ $5.00 per share for directors; CEO: 131,250 @$15.00 per share; COO/CFO: 131,250 @$15.00 per share

Fully-diluted market cap: $37.6 million
11% Senior Notes due 2005: $26.5 million
Revolver: $3.7 million
Cash Balance: $1.2 million
Net Working Capital: $23.6 million

The revolver is used to fund working capital and should be paid down entirely when the Company reports Q4 (the fourth quarter consists of many inventory clearance sales and has historically represented a decrease in net working capital from the third quarter). Therefore, it is fair to evaluate the Company assuming that the cash and revolver net out to zero adjusting for seasonality. On this basis, the Company has an enterprise value of $64.1 million and trades at an EV/LTM EBITDA multiple of 2.88x. The Company’s trailing P/E multiple is 8.6x, but once you adjust for the reduction of amortization expense, this multiple is reduced to 7.3x. Moreover, the P/E multiple is adversely affected by the Company’s significantly higher than market rate debt. If the $25,000,000 of debt that the Company had emerging from bankruptcy was at 8% (a fair rate for debt of slightly higher than 1x EBITDA), it would add $750K annually to earnings, or $0.23 annually. With a refinanced capital structure and no amortization expense, the Company could have earned $1.76, a trailing P/E multiple of 6.3x. Whether this is the correct way to look at it is academic, since the Company has to live with its capital structure until 2005.

Capex is modest, given that no new stores are being opened. For the first nine months of this fiscal year (ends on 2/3/02), capex was $3.8 million. For the year ending 2/3/01, capex was $2.7 million. For the first nine months of this fiscal year, unlevered free cash flow before working capital was $9.3 million. Therefore it is safe to assume that the Company is trading at less than 6x annualized unlevered free cash flow. Working capital is a net zero investment over the course of the year, and the Company is operating with more net working capital than they did in this quarter last year.

These multiples are low—definitely too low. But let’s face it, this Company has a history that should raise skepticism and translate into a deflated multiple. Even so, mgmt. has been doing a solid job since emerging from bankruptcy. Management has not opened any new stores and has improved the profitability of existing stores. In the future, the Company plans to focus on three main markets: New York Metro/Mid-Atlantic, Florida & California.

During the bankruptcy process, the Company focused on improving and expanding its “Back Room” inventory. The Company's stores are divided into two shopping areas: a large, open selling area with wall-to-wall merchandise and a smaller, separate, and more intimate area called The Back Room. The Back Room has more exclusive, high-end merchandise. Although the Back Room typically only accounts for approximately 10% to 15% of a store’s selling space, it has historically generated approximately 33% of women's apparel revenues. Sales of Back Room merchandise have increased substantially. The Company also shifted promotional strategies: as opposed to promotional events and point-of-sale markdowns, the Company is now offering permanent markdowns. This allows the Company to promote its positioning as offering the best everyday low prices and better control inventory and gross margins. Moreover, mgmt. reduced corporate expenses by $5.0 million annually during the bankruptcy process.

Same store sales for the first nine months of this fiscal year were down 2.9%, but this is the case for most clothing retailers, especially those that sell designer goods. For the most recent quarter, same store sales were down 5.5%. Margins, however, have shown marked improvement. Gross margins for the nine months were 37.9% vs. 35.7% for the same period in the prior year, an increase that resulted in $5.2 million of added profit. Management attributes this increase to a favorable change in the merchandise mix. This compares to gross margins in the high 20s and low 30s for most of the 1990s. Despite lower same store sales growth, the Company EBITDA of $16.8 million for the first nine months compares favorably to $15.8 million of EBITDA for the same period last year. It should be noted, however, that EBITDA for the third quarter was $8.1 million compared to $9.8 million in the same period last year. Assuming that the declining same store sales trend continues, one could conservatively expect EBITDA of $4.0 million in the fourth quarter, resulting in approximately $21.0 million of EBITDA for the year.

I believe that the stock price provides minimal downside risk at these levels and significant appreciation could come from multiple expansion and/or sales growth (as the economy improves). A multiple of 4x EBITDA, which I think is justifiable, would result in stock price of approximately $17.00 (>50% upside). Improved profitability resulting from a better retail environment should have a similar, if not more pronounced effect.

I believe that the most important risk to consider is the Company’s history. While the Company added two new Chairmen upon emerging from bankruptcy, the CEO, Robert Friedman, and the COO/CFO, Robert Glass, have held their positions since 1992 and 1994, respectively. I can not vouch for either of them, but I believe that they have been successful since emerging from bankruptcy and have been doing the right things, including focusing on profitability of existing operations. I have been told by reliable sources that the buying department at the Company, which is arguably the most important function, is impressive. Other risks to consider include further economic deterioration, the fact that 13 of the Company’s store leases are up for renewal between 2002 and 2004, and the risk that management starts expanding irrationally again.

Offsetting these risks are the fact that the Company is a leader in its retail category and there are natural barriers to entry. Most of the Company’s active suppliers have been selling merchandise to the Company for at least ten years. Because of these long standing relationships and its ability to sell large quantities of goods, the Company has access to a wide selection of merchandise. Most designers are very wary of letting their merchandise be sold in channels that could hurt their brand or image. Loehmanns has proven that it can serve as a profitable channel for excess inventory without any risk of harming the brand. Inventory risk is minimized by the fact that the Company does not engage in forward purchasing and a large portion of its purchasing requirements in any given month intentionally remain unfulfilled at the beginning of the month. This strategy enables the Company to react to fashion trends and changing customer preferences. Loehmanns also maintains a core group of loyal shoppers. A significant portion of the Company’s advertising involves direct mail announcements to members of the Insider’s Club, a free membership program. Members receive notification of special events and a 15% discount on their birthdays. The list of members now includes approximately one million active customers (those who have shopped at Loehmanns within the past 12 months).

The stock has appreciated considerably off of its 52 week low of $3.75. The most important shareholder is Alpine Associates (maybe I should be familiar with them, but I am not), which held approximately 28% of the outstanding shares as of last filing (in November).

Catalyst

improved retail environment and/or multiple expansion (currently undervalued).