The hottest stock in retail today is undoubtedly Lululemon (Nasdaq:LULU), whose share price is ready to vault into triple digits. I've written extensively about the company and while I don't agree with its valuation, you can't argue with its success. Sometimes, investors are willing to throw the rulebook out the window and that's OK, because it gives a great comparative for making a case for True Religion (Nasdaq:TRLG) instead. Here are three reasons why I think this stock will outshine Lululemon some day soon. (To analyze retail stocks, investors need to be aware of the most common metrics used as well as the company-specific and macroeconomic factors. See Analyzing Retail Stocks.)
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True Religion's Financials
For me, investing is always about relativity. In the trailing 12 months, True Religion's revenues were $364 million, compared to $712 million for Lululemon. Based on sales alone, common sense suggests that investors will pay the same amount for $1 in revenue. Not so. In this instance, True Religion investors will pay $1.85 per dollar in revenue while Lululemon investors are willing to pay $9.20, or 5.4 times as much. Supporters of the yoga brand will counter that P/S is heavily influenced by earnings, so let's look at profitability. In the trailing 12 months, Lululemon made $180 million in operating income compared to $70 million for True Religion. Therefore, I'd reason this justifies a price-to-sales multiple 2.5 times that of True Religion, or a share price of $43.17, although its current prices is about 1.5 times higher. I can already hear the LULU fanatics crying foul. If I'm wrong and the LULU valuation is reasonable, then an equally strong argument can be made by both groups that True Religion's valuation is woefully low. So the million-dollar question is: Just how low is it?
Consolidation Continues at TRLG
More than a year ago, I wrote about how the denim market was consolidating. Since then, Rock and Republic went bankrupt and was picked up in March for $57 million by VF (NYSE:VFC); it should do nicely alongside its other premium brand, 7 For All Mankind. This is only the beginning in my estimation. There are too many brands chasing business in a fickle market once big on skinny jeans and now moving back toward bell bottoms. Only the strongest businesses will survive this many gyrations, and this puts True Religion in a wonderful position.
Lucky Brand Jeans, part of Liz Claiborne (NYSE:LIZ), is struggling to find its way despite bringing in a new CEO (in 2010) with stints at Williams-Sonoma (NYSE:WSM) and Gap (NYSE:GPS) on his resume. Lucky finished 2010 with revenues of $387 million, 12% less than in 2009. Same-store sales and sales per square foot declined by 13.5% and 13.3% respectively. Liz Claiborne will tell you it was a period of retrenchment and that's OK except that this turnaround is in its sixth year. Lucky should be sold before it becomes irrelevant or worse, dead and buried. True Religion, on the other hand, saw revenues increase by 16.9% in 2010, and more importantly, same-store sales at its own retail stores increased 9.6%. As the potential that other jean makers will fade away increases, companies such as True Religion and VF stand to benefit the most.
Motley Fool contributor Sean Williams makes the argument that True Religion's cash position relative to debt is better than many of its peers. This can be attributed to the company's strong gross margins and excellent inventory management. According to Williams, TRLG's retail inventory per square foot increased 1% in 2010 compared to a 9.6% increase in same-store sales. That's outstanding. By comparison, Lululemon's retail inventory per square foot increased 8.9% in 2010 with a 37% same-store sales increase. To put this in perspective, LULU's same-store sales would have needed to grow something like 85% in 2010 to equal True Religion's inventory management. In addition, this past year saw revenues for True Religion's direct-to-consumer segment surpass those of its wholesale segment for the first time ever. With 72.4% gross margins in the direct-to-consumer segment, cash is going to accumulate even faster than it already has. Unless it hits a hiccup, there's little evidence that TRLG will ever need to take on any substantial debt loads - and that's always a good thing.
The Bottom Line
The denim market hit a bit of a lull in 2010, but it appears to be doing well so far in 2011. By year's end, I see True Religion's stock price testing its 52-week high of $34.17.
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