Description

TLB is a reasonably priced women’s apparel retailer which generates significant free cash flow currently undergoing a cyclical downturn as scheduled by the market in each of the last several years.

Talbot's a women's retailer with multiple concepts with 1062 stores at the end of Q2 and 1077 stores at the end of Sept. The comp release for Sept gives a breakdown, but the bigger concepts are Misses (531), Petites (290), and Woman (plus sizes - 107). The company also has a sizeable direct catalog (243m in 04) business. Sqft was up 7% last year. Sqft for this year is 3-5%. As of January 29, 2005, the Company had 38% of its stores in malls, 40% in specialty centers, 10% in village locations, 7% as freestanding stores, 2% in outlet locations and 3% in urban locations. Most inventory is sourced internationally, and all merchandise sold is under the TLB brand. The company is majority owned.

Here is why I like the company:

*the stock price reacts in a cyclical fashion to earnings news. When they report good news, the valuation goes up. When they report bad news, the valuation goes down. Right now, the stock price is down due to negative same stores sale in Q3 and a downturn in eps expectations. The stock price has given up 550m in market cap in short order (so far) and it might get even cheaper.

*the balance sheet is clean enough. The only debt on the balance sheet (using year-end for sake of ease) is 100m (not including operating leases) in revolving credit debt at relative low rates. As of Sept, inventory was down 3% on a sqft basis.

*they generate a lot of cash flow. Ni + d/a in the past 12 months equals 183m with 80m in trailing cash flow. The market cap on the stock is currently about 1.33 billion, for a current FCF yield of 7.7%.

*there are some growth vehicles. The Woman division is the obvious opportunity (7% comps in 04, though there could be industry strength as the cause here, something that could reverse), as the company is under-represented in this important area. The Men’s division is less certain, and there could be some opportunities to close some of the underperforming areas like Kids (5% of sales, but it got special mention in the 04 AR).

*they buy shares. They purchased 385m in stock in the past five years and did another 41m thru Q2. The company also pays a dividend (47c this year).

What they have to do to succeed:

*let time go by. A glance at the VL sheet for the company shows that net margins climb and fall here with a peak of 7.9% in 2001 and a low of 0.6%. The 5-6% they will likely make is in line with recent numbers. TLB comps had been strong since Dec last year before falling September by 5.1% (up 3.4% ytd). The company immediately lowered the earnings estimate to 1.67-1.71 (14x) though Q4 could prove this optimistic. If it does, the price will go down some more. Long-term though, this doesn't mean a whole lot. The company has a loyal following and albeit weak niche with its customers and you can make money buying when these things hit a rough patch because invariably business gets better. The catalog in particular has remained a good business, an indicator that TLB still resonates with customers.

*continue to buy shares and keep sqft modest. Comps have been on a downward trend for a while and the company has scaled back growth in response, and it appeared to be working before the latest setback, though note that TLB isn't a high-end type retailer and thus has suffered in the current high energy environment. Less of a focus on growth and more on operations and renovations could help.

Pitfalls/Risks:

*Options. They have averaged 2.5% by grant sized divided by diluted share count with a cancellation rate of 9% over the past 5 years. This obviously offsets shares repurchased

*Maybe the concept has really passed. As noted, comps over the last several years have been uninspiring (down 2.6, 6.6, and 3.8 from 02-04). TLB may have suffered from too many concepts and not enough focus, but this could be corrected in the future.

*No growth. No, this isn’t a growth story, though TLB’s progress is generally rewarded a bit quicker than less followed companies like CTR. Margin expansion will be difficult to achieve without meaningful increase in margins, and concepts like CHS have been eating TLB’s lunch.

*This is a trade stock. Admittedly, this isn’t the sort of company you keep for the long term. If the price goes up 50% in a year, the best choice is usually to sell it, so anyone looking for a buy and hold in this commodity business ought to look elsewhere.

I think the best way to invest in these stocks is using a stair-step allocation as the price goes down, as 20% declines are pretty common and will be generated by nothing more than a bad comp report. This makes companies like ideal trading vehicles, as one good comp report could bump it back it. It happened before and I think it will happen again, but in all fairness I would rank this as a ‘6’ and if you aren’t comfortable in retail then the current price may not be cheap enough for you, but the market could shave off another 5 bucks if it gets irritated enough, especially since apparel retailers are not in favor right now. I own the position and have traded it for years.

Catalyst

One happy comp report