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.
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.
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.
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!