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16thMarch

True Religion Coverage Initiated With Strong Buy Rating

True ReligionStrong Buy
12 Month Target $25.00

Following yesterday’s closing bell, True Religion Apparel (TRLG) reported 4th Quarter and full year 2006 financial results. In the most recent quarter, the high-end fashion company achieved revenue of $29.8 million and diluted earnings per share of $0.21. These numbers were in line with expectations, displaying strong year over year growth in both sales and profitability. Following a disappointing 3rd Quarter which made many question the company’s direction and staying power, investors should breath a sigh of relief as True Religion’s business appears to be back on track following a few key senior management hirings and some strategic steps that should give the brand staying power. Among these strategic steps are a ramped up retail build-out, a more diversified product mix, and the signing of licensing deals for footwear and outerwear. All three of these initiatives will lead to greater brand recognition and move the company further away from the one trick pony they have been (with premium denim sales accounting for nearly all of True Religion’s up until this point in their existence).

Despite the fact that True Religion had only 4 retail stores in operation during the quarter, two of which opened just weeks before the end of the period, the opportunity for improved margins that they provide is already quite obvious. Gross margins expanded 300 basis points in the most recent quarter to 54.1%, with the retail platform being cited as the key driver. With gross margins of over 75% being achieved at their retail locations, further margin expansions will be realized as more company branded stores open their doors in 2007. A new Miami Beach location has already opened for business and four new leases for stores have been signed thus far this year.

Management is projecting full year 2007 earnings per share of $1.24-$1.27, on revenue growth of approximately 20%. The market is currently valuing the textile apparel industry at about 20 times earnings. Based on yesterday’s closing price, True Religion is trading at a forward P/E of 13.2. With significantly higher growth rates than the industry average, as well as rapidly expanding gross margins, it is reasonable to assume that True Religion should command a multiple at least equal to that of their peers, if not higher. Further supporting this thesis is the strength of their balance sheet, with over $2 per share in cash and zero debt. Seeing no reason for True Religion to be valued at a price to earnings ratio lower than the average for the industry, I foresee shares appreciating over the course of the next year and achieving fair valuation near $25.00.

Disclosure: Joseph Urgo has a long position in True Religion Apparel.

16 Comments

Chet Morrison says 17th March @ 16:05

I sure hope you are correct as I have been long on this one for some time. Do you think that the departure of Ms Lubell is a net positive or negative for the company?

Joseph Urgo says 17th March @ 19:53

Six months to a year ago, I would have viewed Kym Lubell’s departure as a cause for alarm, given the companies relative immaturity at the time. However, given the talent and experience of the senior management and designer hirings as of late, I feel Ms Lubell’s absence will not result in any noticeable negatives. While her vision helped shape the brand, much more qualified individuals have been brought on board to fill and expand upon her duties.

David Hersh says 17th March @ 23:11

Do you feel that the naked short positions and their obvious ability to illegally manipulate the price of the stock without consequence will continue to impact the stock price going forward?

Dwain Reed says 18th March @ 6:50

I have read over the past 6 months about the possibility of TRLG being purchased by a bigger retailer. Is this a realistic possibility in your view? If so, what would you expect the takeover bid would be?

Joseph Urgo says 18th March @ 6:56

Naked short selling is a problem that pertains to the entire marketplace, adversely impacting the price of many companies. However, naked short selling alone is not enough to depress a stock’s price over the long run, fundamentals should eventually take over and govern price changes. Given True Religion’s small float though, it is possible that naked short selling could continue to depress their short term valuation to a small extent.

Joseph Urgo says 18th March @ 7:10

While not ruling out the possibility of True Religion being acquired, I dont see a major retailer stepping in to make a bid at this stage in the companies existence. Despite the success and potential of their retail platform, they still rely upon their wholesale operations for the majority of their revenues at this point in time. If a major retailer were to purchase True Religion, it would have adverse effects on their relationships with their current wholesale channels. I view them as a more likely acquisition target if they can continue to display momentum and robust growth in their retail platform, to the point where their wholesale operations account for less than 40% of total revenues. I am going to hold out on predicting a takeover bid in such a scenario, as this scenario is not likely in the short term. To be acquired today, I believe a bid would have to come in around at least $28 per share to be considered viable, given their strong balance sheet and financial metrics.

angelo tomeo jr says 18th March @ 11:16

What do you thing of the severance package Kim Lubell received??Myself, I think it was a divorce settlement package. Been buying TRLG since Aug 2004. Consequently I’m not hurting. In it for the long haul.

Joseph Urgo says 18th March @ 15:17

I have read the filings detailing Kym Lubell’s departure. Nothing sticks out as being out of the ordinary, which would be necessary to view this as anything more than a typical corporate severance package. Given the Lubells have a joint net worth of around $100 million, the severance package would need to include far more than $675,000 to viewed as a realistic divorce settlement.

Stephen Chao says 18th March @ 15:35

I’m aware that sales have been falling off at the retail level. Picking up margin with the retail stores is only a bandaid for the overall brand falling off the trend/desire radar. I don’t see much life left here.

Joseph Urgo says 18th March @ 20:18

Sales at the company were up 17% for Q4 2006 and guidance provided by management calls for revenue growth of over 20% for 2007. Not sure were you are getting your information.

Michael Wasilewski says 22nd March @ 12:52

In your view what is the possibility of a significant share purchase by TRLG. It is sitting on more than 50 million. That would make the shorts run for the exit. I am surprised that Goldman has not presented this possibility to the board yet.

Joseph Urgo says 22nd March @ 14:03

I am sure that Goldman has thought through this scenario and presented it as an option. Given their ongoing retail build-out, they have lease obligations and opening costs that are somewhat capital intensive in the short term, so they may be allocating their cash position for reinvestment. However, the longer share prices remain low, I feel chances of seeing a buyback plan increases.

Ade Patton says 28th March @ 14:05

Do you see PE players interested in this company? Despite the inherent fashion and luxury macroeconomic risk in any company like this, the brand looks strong, CFFO is attractive, and CAPEX + inc in working capital is low.

Joseph Urgo says 28th March @ 15:24

I could see private equity being interested in True Religion, given the characteristics that you pointed out. Anytime a company appears to be as undervalued as True Religion currently looks, they are a candidate for a private equity buyout, especially these days with so much cash on the sidelines looking to be put to work.

A. Patton says 28th March @ 16:59

To that point, do you have any idea as to the valuation of Bear Stearns investment in 7 for all Mainkind or Berkshire Partners investment in Citizens for Humanity? I personally think that a PE player could take the company private, roll some mgmt equity over, professionalize mgmt/operations a bit, provide capital to expand to India and other new markets in the next 3 years and turn this company into something on the order of Diesel potentially.

Joseph Urgo says 28th March @ 23:53

I can’t comment on the valuation of either 7 For All Mankind or Citizens For Humanity, as any figure I give wouldn’t be much more than a wild assumption. Undoubtedly, a Private Equity firm could take over True Religion given their clean balance sheet, strong cash flows, and low valuation. Whether or not that occurs remains to be seen.

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