Throw This Stock Away

The house rules are simple in this weekly column.

I bash a stock that I think is heading lower. I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, True Religion Apparel (Nasdaq: TRLG  ) .

The flight's going to get a bit bumpy
Shares of True Religion opened 23% higher today after the company revealed that it is exploring strategic alternatives after receiving third-party buyout interest.

That's fair. If buyers are willing to pay a healthy premium for a company, it owes it to its shareholders to open up the process.

However, how much can True Religion reasonably expect to fetch in a sale, and are today's investors running ahead of the potential price tags?

I'll be up-front here. I've never bought a single item of True Religion clothing. I can never fathom paying $300 for a pair of jeans or $158 for a plaid lumberjack shirt. However, there are clearly people out there who are more than willing to pay up for designer clothing. The problem is that growth is slowing at True Religion.

Net sales may have soared 15% to $419.8 million last year, but net income only inched 3% higher to $45 million. Through the first half of this fiscal year, net sales climbed 10%, but adjusted gross, operating, and net margins have all contracted.

A big part of the True Religion growth story has been expanding its chain of premium apparel stores. There are now 116 stores in the country, and another 23 locations internationally. This would make it seem as if we're early in True Religion's growth cycle, but we're not. There's a limit to how many stores selling $59 T-shirts and $315 vintage denim a market can take. Before pointing to the upside of growth overseas, keep in mind that international sales were flat last year and declined in its latest quarter.

You didn't think True Religion would be considering a sale if it were actually accelerating its growth, did you?

That's not a statement of opinion. Back in January, True Religion was targeting $450 million to $460 million in net sales for the entire fiscal year. Now its outlook tops off at $455 million.

The climate just isn't right for many premium brands. Fifth & Pacific (NYSE: FNP  ) -- the company behind Lucky, Juicy Couture, and kate spade -- took a hit earlier this month after dramatically hosing down adjusted EBITDA guidance. The culprit was largely Juicy Couture and not the premium denim hotbed that is Lucky, but it still proves that a lot of upscale brands are struggling.

In True Religion's defense, it's a cash-rich and debt-free company that's still growing. No one is arguing that True Religion is going away if a sale doesn't go through. There's a healthy dividend, too. However, today's exuberance glosses over a premium brand with decelerating growth in a niche that hasn't been very forgiving when fickle shoppers move on.

If True Religion is open to a sale, investors should take today's pop and run.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

  • Joe's Jeans (Nasdaq: JOEZ  ) : As a smaller player in premium denim, Joe's Jeans is holding up surprisingly better than True Religion. Net sales rose 16% in its latest quarter, and margins are on the rise. Yes, Joe's Jeans also has its shortcomings, but it still deserves some respect after cranking out profitable results in recent years.
  • lululemon athletica (Nasdaq: LULU  ) : The high-end retailer of yoga apparel may seem to be an odd replacement for True Religion. Value investors will laugh at the suggestion that Lululemon -- fetching 35 times next year's projected profitability -- is a better buy than True Religion, a stock trading at a third of that forward multiple. However, Lululemon has established itself as a true premium brand in fitness apparel with the strong sales growth and spectacular store-level comps to prove it.
  • VF (NYSE: VFC  ) : Fans of more appropriately priced denim may have some of VF's wares in their closets. This is the company behind Lee and Wrangler. VF isn't afraid to go upscale. It's the company behind 7 For All Mankind, and its name may even come up as a potential suitor for True Religion at the right price. I still like VF here given its broad collection of apparel and footwear brands across all price points. VF has also boosted its dividend for 39 consecutive years. That streak should stretch to a round 40 straight years of hikes when VF reports later this month.

If you're looking for some long-term investing ideas -- and you're impressed by VF's long string of dividend increases -- let me invite you to read the Fool's brand-new special report: "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so just click here and get your copy today.

Longtime Fool contributor Rick Aristotle Munarriz has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Lululemon Athletica and True Religion Apparel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 10, 2012, at 3:09 PM, SSFE wrote:

    Hi Rick,

    Wow I can't tell you how wrong I think you are. LuLu @ 54 ttm pe and Joez over true religion?? No where is value more apparent then with true religion. Brand Strength, 200m in cash, no debt, 120+ store built out infrastructure trading @ an after cash PE of 6. You've got to be kidding me. This is at least a mid-30s stock. Manipulation has taken this stock down to the bare bones undervalued and management has to be getting pressure from stockholders to get back value. Why not sell out to maximize value that is a way to do it if the market doesn't recognize it.

  • Report this Comment On October 10, 2012, at 3:14 PM, ElCid16 wrote:

    From an enterprise perspective, TRLG is still pretty cheap, even after today's pop. It's selling at an EV/FCF of 10 or so (at around $26/share). A PE firm looking to buy the company outright really doesn't need too much (or any) growth to see a good return over the next 5-10 years.

    Additionally, I'm not sure that valuing this company from a net income perspective makes sense at this point, anymore. In their analysis, a PE firm would likely exclude stock-based compensation, substantially increasing the net income that would be realized by the prospective buyer. Look at FCF to get a better idea of what PE firms are looking at with this company.

    "how much can True Religion reasonably expect to fetch in a sale?"

    Diana Katz, an analyst at Lazard, thinks the company could fetch $27-31/share. My target price has been $31/share for a while, now. I'm gonna push my luck and wait until a sale is finalized before ditching my shares. I'm only up about 10% or so at $26. I'd like to squeeze an extra couple of bucks per share out of this thing.

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