Description

Maideform Brands is a marketer of intimate women’s apparel sold through major department stores, national chain stores and mass retailers. Coming out of its $17 IPO this past July, it stock has fallen 33% and despite its solid history of revenue growth, it now trades at about 10x next year’s estimates. It hit a snag in its very first quarter out and at about $11.50 per share it looks like a great time to own it.

A Brief History of Maidenform:

After declaring bankruptcy in 1997, it emerged in 1999 under new management and they did the hard work of rationalizing its business model (such as completing the move from being a manufacturer to becoming marketer by steadily shifting to a foreign sourcing model). In May 2004, Maidenform was fully acquired by a private equity fund, Ares Corporate Opportunities Fund LP. Only about one year after the Ares acquisition, Maidenform was taken public this past July at $17 per share. While Ares sold a good portion of its position, it still retains a healthy 35% stake.

For the record, Ares’ remaining unsold shares just recently became available to trade in the open market and they cannot be very happy with the disappointing start of the stock. If they are interested in unloading the rest of their shares at some point, they obviously want to get the stock price back up. However, it is important to note that other shareholders have sometimes very different objectives in mind (for an example, take a look at Overhill Farms (OFI) recent private equity transaction) - so the worry of share overhang is there.

The 3rd Quarter Disappointment:

For the first 9 months of 2005, Maidenform Brands increased total sales by about 15%. It’s wholesale division, which makes up the vast majority of its sales, were up 18% year-to-date. Its most recent quarterly report (its 3rd quarter) was seen as disappointing with sales increasing only 11%. Before I get into the negative stuff with the last quarterly report, a few good things did happen this past quarter. They did continue to pay down another $20m of their debt and they have now moved 100% of their product sourcing to foreign manufacturers in China and various Southeast Asian sources.

The big negative for the last quarter was the hit it experienced to gross margins due to a few issues and mistakes. Their gross margins for this last quarter were only about 36.5% versus a year ago getting gross margins of around 41%. Management did say on the call that the previous year’s 41% was actually a bit higher than they normally would expect due to favorable issues that weren’t likely repeatable, but it 36.5% number was still low. Of that 4.5% difference, about 1.9% of the margin compression was due to its manufacturing inefficiencies in its “cutting” operations in Florida and its “sewing” operations in Mexico. By the end of the 4th quarter, those facilities are closed – thus completing the outsourcing job.

Another 1.5% of the gross margin miss was due to price markdowns and returns on its “full support” bras. The product for full figured women was not met enthusiastically because they looked “too large” on the racks. Further exacerbating the margin hit, they say they took an aggressive stance by facing the issue straight up and decided to just sell off the inventory quickly rather than slowing reducing the inventory over time in order to smooth the margin impact over multiple future quarters. If that is true, that is a good sign of an honest management that cares more about running the business than trying to simply please the public markets. They also said that they aren’t done selling down the inventory of these full support bras and it will likely have an impact in the 4th quarter too.

The remaining 1% of margin miss was blamed on increase costs such as energy and transportation costs. Management’s most recent guidance for 2006 is to hit gross margins of 37.5%.

Getting back to the full support bra product, which the company describes as about a third of its total bra business, they have supposedly re-engineered the product and they feel that heading into 2006 they will have corrected the issue. This obviously remains to be seen but it I think it should be expected that the full support bra issue in 2005 is just a 2005 issue and won’t carry into next year. As is always a worry in the apparel business, it really hurts things when the consumer doesn’t like the product that you put out on shelves. Being able to consistently put the right product and the right style out is what separates strong apparel companies from weak ones. Maidenform has a good history of doing this key task adequately. At today’s stock price, I am giving them the benefit of the doubt on this issue.

A key point regarding sell-through/liquidation of this unwanted inventory was made during the Q3 conference call however. Despite its obvious drag on gross margins in the 4th quarter, management decided to stick with its operating profit guidance which naturally leads you to believe that they probably do have some other things going well enough to absorb the impact. That seems to be a good sign.

To give a little more background on its operations, about 86% of Maidenform’s revenue is done as a wholesaler. They sell into most of the major department and national chain stores. Its list of department store customers includes Bloomingdale's, Macy's, Lord & Taylor, Marshall Field's and the national chains include Kohl's and J.C. Penney. Also, they sell into the mass merchant retailers such as Target, Costco and Wal-mart and finally they sell private-label products to specialty retailers.

Only 14% of Maidenform’s revenue comes on the retail side via its almost 80 stores of its own. They are moving away from this channel and are selectively shutting down least productive of these stores.

In addition to their multi-channel strategy, Maidenform also follows a multi-branding approach by developing and segmenting its brands specifically one for channel such as its Self Expressions brand at Target, its Sweet Nothings brand for Wal-mart and finally its Bodymates brand at Costco. It exclusively uses its core Maidenform, Flexees and Lilyette brands with its department store and national chain store customers.

To give you a basic breakdown of their sales, approximately 70% comes from its bras segment, 20% in shapeware products and lastly about 10% of its ales are panties. As far as its selling channel mix, about 65% is sold to its department store and national chain store customers, 20% is sold via the mass merchant channel and finally 15% in private-label sales to specialty retailers, off-price retailers and its international distributors.

From 2001 through 2005E, Maidenform will have likely increased its sales from $234m to at least $385m for full year 2005 if it reaches it guidance for 4th quarter. This is over 13% in compounded annual growth in the past 4 years. Going into 2006, management has stated that it should be able to get 7% to 10% in revenue growth next year. So, it is slowing and much of that has to do with its large department store customer base that is troubled really. The mass merchant customers are not yet big enough to get the growth into the teens.

So where are they going to get growth? Essentially in three main areas (1) its mass merchant sales were up nearly 30% in the last quarter and up almost 70% year-to-date (2) it is aiming to gain market share in the department store/national chain store channel where its sales in that area actually increased by 10% for the first 9 months and (3) it is focusing on continuing to grow its international sales which were up nearly 60% year-to-date on a small base.

To give you a bit more detail on how they achieved 18% sales increase in its wholesale division during the first 9 months of year, about 25% of it came from (1) getting a new mass merchant customer this year and (2) by getting a national chain store customer to sell its new Maidenform panty. The remaining 75% of the growth was “organic” so to speak – although I really don’t consider getting new customers to sign up with you or to choose to carry a new product of yours as “non-organic”!

As far as their balance sheet is concerned, they are leveraged with $140m in a term loan carrying a LIBOR + 1.75% rate. As I mentioned, they paid down $20m last quarter and have stated that paying the debt down is a priority with its free cash flow. Another item to point out is their NOL position. As of the start of 2006, they will have about $70m in NOLS that expire between 2006 to 2021. My estimate is that the present value of these NOLs is about $0.75 to $1 per share. It isn’t a significant item, but it deserves some mention nonetheless.

If they are able to get their expected revenue growth in 2006 and have that translate into solid operating margin growth in the mid-teens, it is very likely that they will be able to hit an EPS number reasonably north of $1.00 per share. Maidenform is down 33% from its very recent IPO price, it is committed to its de-leveraging process and it also has nearly $0.75 per share in value for the NOLs on its balance sheet. They have successfully moved 100% to an foreign sourcing model and it is successfully positioning itself into the faster growing and important mass merchant customer. They have done and are doing the right things. With an $11.50 per share stock trading at about 10x its next year’s expected earnings and with it coming off an entirely disappointing 3rd quarter report that was plagued by likely transient issues, Maidenform Brands looks very attractive today.

Catalyst

Getting continued strong growth in 2006 in the mass merchant customer base.
Getting past the full support bra issue
Continuing its de-leveraging process
Fully sourced model of manufacturing in place
Being able show improvement with their gross margins.