Description

TOO is a mall based retailer focusing on the “tween” market of girls between the ages of 7 and 14 that is experiencing temporarily depressed EBIT margins. With $4.44 per share of net cash and building about $1 share of cash per year (not including share repurchase) and currently buying back up to $95mm of stock, it could double over the next three years.

The company recently shifted its marketing dollars away from catazines (a combination catalog-magazine) and direct-mail to a broad-based TV campaign. The strategy did not drive customer traffic this spring and in May TOO reduced Q205 EPS guidance to $0.05 (flat vs. last year, $0.03 below the street). Shares sold off 10% on the announcement. We believe that the market over-reacted for two reasons: (1) Q2 is not important in terms profits for TOO (last year it represented just 3% of profits), (2) the problem is marketing, not merchandising related, which is an easier and less costly problem to fix.

Additional opportunities include the return to 2002 operating margin, 12%, and Justice - the Company's fast-growing off-mall concept that is presently a drag on EBIT margins - breaking even in 2006. TOO also has a unique opportunity to improve lease terms as 35% of leases are up in next 3 years.

The CEO, Michael Rayden, has been running the company since 1996 and TOO spun-off from The Limited in August 1999. Since that time he has done a good job growing revenues, improving operating margins and being disciplined about spending capital to improve stores. He has also tried a few concepts that failed and was disciplined enough to stop the experiments before they consumed too much capital, and he implemented an extensive set of programs to become the country’s experts on tween girls.

At $22.40, TOO trades for 4.4 x 2007 EV/EBIT. We believe that the stock could double over 3 years if management is able to execute its Justice growth plan and improve operating margins.


Valuation:

MVE: 804.6 mm
EV: 594.5 mm
EV 2007 (assuming no share repurchase and stock at $22.40): 494.5 mm

2003 EBIT: 46.4 mm
2004 EBIT: 64.4 mm
LTM EBIT: 67.8 mm
2007 EBIT: 114 mm

2007 Estimates:

Stock trades at 11 x EBIT: $33 per share
Cash: $6.83 per share
Total: $39.83 per share

Assumptions:

Revenue will grow from 686 mm to 950 mm
TOO stores will grow from 568 today to 580 in 2007
Justice stores will grow from 47 today to 200 in 2007
EBIT margins will increase from 9.9% today to 12% in 2007
Net cash will grow from 160 mm today to 260 mm in 2007
Fully diluted shares outstanding will grow from 35.9 mm today to 38 mm in 2007

Risks:

Fashion or marketing missteps, cannibalization of Limited Too by Justice, slowdown in consumer demand.

Catalyst

EBIT margins return to 12%
Justice grows to 200 stores
Share repurchase