True Religion Apparel: Bargain Buy or Value Trap?

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.

The good
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.

The bad
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.

The takeaway
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.

Do you have an opinion on any of the companies mentioned here? Sound off in the comments section below!

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Fool contributor Sean Williams does not own shares in any companies mentioned in this article. He's never paid more than $40 for a pair of jeans. You can follow him on CAPS under the screen name TMFUltraLong. 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 which is always in fashion.


Read/Post Comments (4) | Recommend This Article (5)

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 February 01, 2011, at 6:44 PM, chou651 wrote:

    Regarding 'the bad,' I disagree with the first one. How much cotton does it need for each blue jean? Cotton price can be a factor for low-price jeans, but not for luxury jeans. The cost of cotton should be immaterial for the margins of all luxury jean manufactures?

  • Report this Comment On February 01, 2011, at 7:03 PM, herbslojewski wrote:

    So JOEZ earnings coming out in a couple of days, anyone seen any sensible forecast? This stock has

    been dreary for a year now, all the promise it had seems to be disappearing. If you want to compare

    notes write me at h.slojewski@gmail.com

    Herb S.

  • Report this Comment On February 01, 2011, at 7:07 PM, TMFUltraLong wrote:

    chou651,

    For luxury jeans up to 99% of the denim can be made of cotton... so it can actually be a BIG problem.

    TMFUltraLong

  • Report this Comment On February 01, 2011, at 9:51 PM, RevelationMan wrote:

    Forget True Religion. I'm surprised that I've not heard a peep from Fool.com regarding Ralph Lauren at their current stock price. The entire staff including Ralph himself have been unloading stock all the way up. Meanwhile RL is still trading at $100+. RL has been recorded saying that they would face increasing profit margin pressure in the second half of the year and the sales and profit margin comparisons with the prior year period would become more challenging and that they anticipated cost of goods inflation will begin to impact their gross profit margin in the third quarter. Additionally, it's been noted that they would be up against intense pressure from higher sourcing costs and a negative exchange rate impact in the back half of the year. This mixed with a falling knife retail sector and sky rocketed cotton and silk prices make RL the perfect short position. In my opinion it's highly unlikely that they could have pulled a profit in Q3 in the US or Europe. Consumer Christmas spending in 2010 was like a fish out of water.

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