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To really understand a stock, you just have to get down and dirty, break out your pencil, and really weigh the risk versus reward potential of the company you're following. I propose we take a closer look at the good and the bad at True Religion Apparel (Nasdaq: TRLG ) to see if the stock is a good value or a potential money pit.
If a company can persuade consumers to purchase designer jeans for $319 in the midst of a major economic downturn, clearly it's doing something right. True Religion has shown phenomenal growth in an otherwise flat retail environment. The main driver to that growth has been its ability to transform from simply a wholesaler into a bricks-and-mortar luxury denim retailer. Its most recent quarterly filing proves this, as True Religion noted a 9% jump in same-store sales.
It doesn't hurt either that True Religion's balance sheet is ripe with cash. The company is currently debt-free and derives nearly a quarter of its market cap from its cash. This cash should give True Religion significant flexibility to adapt to changing market conditions.
Designer luxury jeans do come with a price, or should I say a rising price. Cotton, the leading cost for True Religion's products, is trading at historic highs, which is beginning to constrict margins. These rising input costs are part of the reason True Religion has missed earnings expectations the past two quarters. It's possible that True Religion will be able to pass along higher cotton costs to consumers, but with its denim prices rising, competitors Joe's Jeans (Nasdaq: JOEZ ) , privately held Diesel, and Polo Ralph Lauren (NYSE: RL ) could take advantage and gain luxury denim market share at True Religion's expense.
Of greater concern might be the amount of shares currently being sold by short-sellers, who will profit if the share price drops. More than 20% of total shares outstanding are bet against True Religion's stock, which is a clear indication that bears may be betting on more pain after two prior quarterly misses. This is no guarantee a stock is heading lower, but it's clearly a yellow flag.
Bulls and bears each have solid evidence backing up their positions, but the pendulum, as I see it, seems to favor the bulls. I find it highly unlikely that cotton will remain at these extremely high prices for a lengthy period of time, making True Religion's margin contraction only temporary. It also seems pretty evident that True Religion's growth plan entails moving toward bricks-and-mortar stores. With such stores now accounting for half of the company's revenue, True Religion is poised to break free from the cyclical nature of the wholesale business and control its own destiny.
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