Friday, August 6, 2010

True Religion 2010 Q2 Results - More Detailed Analysis

So, did you read the True Religion Q2 press release and call transcript like I suggested?  No?  That's ok.  I'm going to give you some highlights in this post.

First off, TRLG missed analysts' estimates for quarterly earnings.  They came in at $0.30/share compared to analysts' estimate of $0.46/share.  This is how the market gauges the stock, and as you can see, the stock dropped an easy 6% the day after earnings were reported.  That's ok.  We don't need to sweat it yet.  So, let's look at  the relevant details.

Earnings Per Share
In Q2 of 2009, TRLG earned $0.45/share.  In 2010, it earned $0.30/share.  What happened?  At the top of the press release, a separation cost of $0.12/share was stated.  What the heck is that?  Well, the former president of the company, Michael Buckley, decided to quit to "pursue other interests".  Lucky guy, 'cause he negotiated a $4.5 million deal if he were to quit the company!  What?  I'd quit too if I were him.  That is simply ridiculous.  You get paid because you decide to quit??  Unfortunately, these deals are ubiquitous for many company executives.  It is a way to attract talent, if you will.  I absolutely do not agree with it though.  It's like me going to my boss and saying, "OK, I give me $100K for it."

Anyway, taking out this "one-time item", the EPS was $0.42.  Therefore, there was a decline of $0.03/share.  We typically want to see an increase in EPS.  This is a cause for concern.  Let's dig deeper.

Revenue / Top Line Growth
If you read the press release, you can't actually find the word, "revenue", as it is more commonly used.  What you do find a lot is the term, "net sales".  It is essentially the same thing.  Net sales is simply revenue minus any discounts or returns.  For Q2, net sales increased 14% over the same quarter last year, from $72.1 million to $82.2 million.  More importantly, we want to note that net sales for the U.S. Consumer Direct segment saw increased sales of 47.2%.  This is very significant.  True Religion splits its sales into 4 segments.  First, there is the US consumer direct segment, where it sells its products through its own True Religion branded stores and its website.  Second, there is the wholesale route, where the company sells its products to department stores, boutiques, etc.  Third, all sales outside the US are labeled as "International" where the sales may come from a True Religion branded store or through other venues.  Lastly, there is the "Other" segment, which is the money it makes through licensing its products.

The US Consumer Direct segment is performing the best out of all 4 segments.  If you scroll down to the "Q2 2010 Segment Results", you will see a table that shows the net sales of the 4 segments.  US Wholesale saw a decrease of 16.7% and the International and Other segments saw an increase of 14.1% and 16.6%, respectively.  So, the US Consumer Direct segment absolutely blew away all of the other segments.  Why is this important, you ask?  For one, US Consumer Direct makes up about 50% of total sales.  Second, this is reflective of the success of True Religion's expansion plan, that is, opening up stores all around the US.  Third, the efficiency of their sales has increased.  In the call transcript, Jeff Lubell (CEO) tells us that in Q2, there were 82 stores compared to 59 stores last year.  That is a 39% increase in number of stores, and yet, the net sales grew by 47%.  This was helped by increased same store sales of 6.7%.  This means that wherever True Religion opened up stores, they were able to generate increased revenues.  The market has not been saturated yet.

The US Wholesale segment was disappointing in that it actually decreased.  Lubell blamed this on the major department stores.  While it is not an excuse, it is easy to understand why large department stores would buy less of True Religion's products.  In a relatively weak consumer market, the more expensive and luxurious items would be the first to go.  This is not because people do not want True Religion products (the US Consumer Direct segment performance disproves this), it is simply the decision of the department stores to buy less.

All in all, the top line growth was not bad.  The strength of the US Consumer Direct segment shows the strength of True Religion's brand moat.

Why Did Profits Go Down Then?
Since EPS did decrease by $0.03, the money must have gone somewhere.  Was it because True Religion had to sell their jeans and products at a discount to attract consumers?  Let's take a look.  The best way is to look at the gross profit.  It came in at $52.7 million, or 64.1% of net sales (this is the gross margin).  Gross margin actually increased from last year's 62.1%.  Gross profit is simply the revenue generated minus the cost to produce the goods.  Therefore, True Religion actually made more money per pair of jeans.

What happened was that the operating margin had decreased, and it was significant.  Operating costs includes the cost to Sell the product, other General and Administrative costs (SG&A), and other operating expenses such as capital expense and costs to open up new stores.  Operating margins fell from 24.9% in 2009 to 20.1% in 2010 (if we include the separation cost, the operating margin would have been 14.6%).

So, in the end, is this a cause for concern?  I would say, yes, it is, but only slightly.  Management should have done a better job in controlling costs.  However, as a young company in its fast growth phase, I would say it is acceptable.  I would keep my eyes on their margins in the future quarters to see how well management deals with the company's growing pains.

The Future
I believe True Religion will have no problem expanding in the US.  The brand has reached the point of critical mass where it is no longer a fad.  The company plans to open up 12 more stores in the US in 2010, which is 15% more stores in 6 months.  That is an encouraging number.

The more important development is over in Europe (see Michael Egeck's comments in the call transcript).  True Religion, together with UNIFA Premium, has started a joint venture in Germany.  This is a great move.  As we saw above, much of the operating margin decrease resulted from increased operating costs, i.e. expansion costs.  UNIFA Premium is True Religion's international distributor, and therefore, is well entrenched in Europe.  They would be able to expand in Europe much more efficiently than if True Religion did it all by themselves.  There are plans to open a few more retail stores in the Germany region.

The stores in London and Japan are both performing above expectations.  This is another good sign.  These are the frontiers in the international market, and if the products are well received here, it is likely that expansion into these areas will be successful.  The Toronto store will open later this year, and I hope to be able to check it out personally.  For those of you living in Toronto, it's opening up in Yorkdale mall in the Fall.

The Technicals

Is there concern over the short term of where the stock is going?  Yes.  TRLG is forming what is called a descending triangle.  In general, this is a bearish sign, and if the stock breaks through the support of $21.50, the stock will likely head lower.

The Stock is Down...Buy More!
So, is this a concern for us?  NO!  After my long-winded post, I hope I have shown you that True Religion's fundamentals are still intact and it is a great growth story.  We don't know if the price will break through the support, but if it does, we want to buy more!  This is the strategy that Phil Town outlined in his second book, Payback Time.  Because we know the company has solid fundamentals, we know the value of the stock is higher than its current price.  The lower the stock goes, the happier we are.  Who would not buy a $10 bill at $5, right?

Will it happen?  I'm not so sure.  At $22, the P/E ratio is less than 12.  Analysts estimate that the company will grow at 22.5% per year in the next 5 years.  Do the math and you will figure out that the earnings will accumulate to the market capitalization of the company in less than 6 years (this is Phil Town's "payback time").  It is literally screaming, "BUY!!"  And so, I leave you with that!