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August 6, 2015

Lands End (LE) Fashion at Clearance Prices

Lands End ticker symbol (LE) has been selling clothes for decades. I remember distinctly the catalogs they mailed out in the 90s. I may have even had a jacket or shirt I got from Lands End back then. Not long ago the company was spun off from Sears. The apparel industry is a highly competitive industry. They have been around in one form or another since the 1960s no less. The company was founded in 1963 by Gary Comer in Chicago. They started out selling sailboat equipment. I imagine they will be around in another decade.

The first thing I noticed about Lands End currently is the price to earnings multiple is pretty low. The PE is 15. The very next thing I did is look at the yearly cash flow statement. There was $211 million in cash flow from operating activities. There was $16 million in capital expenditures.  I take 211 minus 16 and we get $195 million in free cash flow. Free cash flow is the money the company has left over after it pays bills. They can either re-invest it in the business or return money to shareholders.  It is always good to see robust free cash flow numbers. I'm about to run one more calculation and we are about to discover just how cheap Lands End really is.

The market cap of the company currently is $762 million. That number divided by the $195 in free cash flow give us a price to free cash flow multiple of 3.9. So the price to free cash flow of Lands End is about 4. Wow! Just wow. That is a super low multiple for a company like this. A lot of investors will actually put a lot more weight on cash flow figures. Some people run extensive spreadsheets that do discount free cash flow projections. With these kind of low valuations I wouldn't be surprised if a Lands End file isn't being emailed around the office of some private equity or one of Lands Ends competitors. I'm not saying there is or will be I just could imagine it.

So I saw this valuation and kept looking around the financials expecting to see a company on the brink of destruction. Earnings are down recently and earnings guidance is down from $2.00 to $1.46 per share. Pretty bad but how bad? I looked at the income statement again. I looked at sales over the past couple years. The past couple of years had flat sales growth. Sales were almost exactly the same as last year. Net income is flat too. This isn't great but they are holding in there. It's almost a billion dollar company too. It's harder to grow sales fast at giant companies.

I read about their customer base. "We believe our customer base consists primarily of affluent, college-educated, professional and style-conscious women and men. In fiscal 2014 our customers had average household income of $105,000 and approximately 42% of our customers were within the 35-54 age group. "

Looking at more valuations and ratios we have a price to sales ratio of .48. Obsurd. We have return on equity of 17%. A return on equity over 10% is very good. Pushing 20% we have a one of a kind golden business. If they can do 17% ROE in a mediocre year they can do 19-20%. A solid return on equity is meaningless, however, if low debt levels are not maintained. You will see high ROE numbers in a lot of industries like auto's and manufacturing but they blow up huge debt bubbles. Lands End's liabilities are stable. Long-term debt is actually down some even this quarter. Long-term debt is down $4 million since Aug 2014. They do carry a lot of debt with debt to equity around 1 but this debt is manageable. Lands End also has $181 million in cash on the balance sheet.

Trying to do a relative valuation is a little pointless. Some companies in this industry do well and have high valuations. Some do poorly and have low valuations. The industry is so competitive I'm not sure looking at other companies helps. I looked at a few though. Companies doing well like Under Armour (UA) has a PE ratio of 90! It has a price to sales ratio of 6. I think Columbia Sportswear (COLM) is pretty apples to apples with Lands End. Columbia has a price to sales ratio of 2 and PE ratio of 30.

The bottom line is will these bad results Lands End has been experiencing lately with sales continue? I don't think the valuation makes since. If sales improve just marginally the valuation could be 20,25 times earnings easily. This is the kind of company that can fetch a 20 PE in a bull market easily. So the way I look at it is over the next few years if things are going well for the company earnings could be $2.00 a share. The stock could be $40 to $50 a share and the compounded yearly return from the current stock price of $23 to $40 or $50 is worth it. There is a brand "moat" in this one and I see them defending the castle through this battle.