Description

Wilson’s the Leather Expert (WLSN) is the leading retailer of high-quality leather outerwear, apparel, accessories and travel products. Formed through a series of acquisitions, the company employs multiple store formats and operates over 720 stores (mall stores, outlet stores and airport locations) in the United States, Canada and the United Kingdom.

I argue that WLSN is grossly undervalued on a cash flow and comparable company basis and have a target price of $ 30 representing appreciation potential of 100%.

FINANCIAL FOOTPRINT
Amount Trend
Revenue $ 636.9 4% comparable store growth
79% of YOYgrowth from new stores
Operating Profit 75.1 3 yr avg margin gain of 1% a yr
Net Income 41.9

Revenue Growth (3 yr avg) 16.5% Driven by acquisitions & new store
ROA (3 yr avg) 7.8%
ROE (3 yr avg) 18.9%

Working Capital(2/2001) 48.5
Working Capital (5/2001) 93.3

Total Debt (2/2001) 30.6
Total Debt (5/2001) 58.7

Total Equity (2/2001) 176.2
Total Equity (5/2001) 174.2

2/2000 2/2001
Working Capital/Sales 0.4% 7.6%
(Cap E + Acquisitions)/Sales 4.3% 8.2%

Operating cash flow has declined from $64.5 million in 1999 to $4.9 million in the past year largely as a result of a significant increase in working capital driven by store opening and acquisition activities. Free cash flow (operating cash flow less capital expenditures) similarly declined from $41.3 million to ($27.6) million. Despite this the company has substantial financial flexibility with low year end debt capitalization ratios (though these figures rise as working capital is built prior to the peak season) and ample borrowing capacity to fund continued aggressive growth.

BUSINESS DYNAMICS
2000 2000 Pro Forma
Apparel (leather jackets and other) 70.5% 57.9%
Accessories 28.0% 30.0%
Travel Products 1.5% 12.1%

As a result of the assortments carried at its stores, the business is seasonal with peak sales occurring in the later part of the calendar year (October- December).Consequently the company looses money during the first three quarters of its fiscal year (fixed costs of leasing and operating stores during the seasonally weak period) and makes all of its profit during the peak period. This high level of operating leverage serves to rightly (though excessively) depress earning multiples.

Nonetheless, the company’s positioning in the marketplace as the source for reasonably priced, fashionable leather goods, and its broad assortment of store formats and products positions it well to capture its share of the market for leather goods. The company is clearly differentiated from higher priced leather retailers like Coach and has mass/multi- market appeal. If you’re in the market for leather apparel chances are that you’ll visit a Wilson’s store.

Business acquisitions have played a large part in the company’s growth. Last year the company acquired El Portal and Bentley’s Luggage, two travel products and accessory chain retailers, both accounted for as purchases. Additionally, WLSN opened 46 new stores in 2000 and anticipates opening 70-100 net additional stores annually during the 2001-2003 period.

Operationally, the company sources product worldwide and offers both brand names and in-house designs. Approximately 80% of its goods are manufactured by independently owned manufacturing facilities in China.

Current Valuation

Share Price $15.14
Shares (millions) 17.24
Equity Market Cap $261.0
Net Book Debt $ 58.1
Enterprise Value $319.1

P/E (2000) 6.3X
P/E (2001E) 5.1X
P/B (2000) 1.5X

For a growing business generating reasonable returns on equity, even considering the operating leverage caused by business seasonality, the stock is cheap. H&R Block, admittedly a more solid and better entrenched business, has lived with a similar earnings profile and slower growth for many years. During the last five years the low P/E on that stock was 12X.

Coach (COH),a slower growing though more profitable business, trades at a forward P/E of roughly 27X.

Target Valuation
Using a straight forward discounted cash flows, and plugging in the assumptions below, I estimate a value for the business in $27-30 range.


Sales Growth 8-10%
Operating Margins 9-10%
Cash Tax Rate 40%
Incremental W/C 25% (increase in working capital/increase in sales)
Incremental CapEx 35-40% (increase in Cap Ex/increase in sales)
Discount Rate 10%
Perpetuity Growth Rate 3%

Trading Issues
A fair number of shares have been registered for sale by insiders, including a block held by an officer named Morris Goldfarb. Mr. Goldfard is the managing partner of an outfit called G-III holdings and is the largest single shareholder of the company.

Catalyst

1) As we move into the peak selling season I expect investors will will take a closer look and drive up the share price on any favorable news concerning company performance.

2) Shares expected to be unloaded by Goldfarb will be absorbed by institutional investors and demand stoked by increased Wall Street analyst coverage. Currently rated strong buy/buy by five, primarily regional firms.


3) Multiples on WLSN and Coach (COH) converge over time.