Tommy Hilfiger, much maligned for its debt and anemic growth merits a closer look if for no other reason than the company is generating reasonable cash flow and has a recognized, established consumer brand. Its prospects depend on your view of the company's brand strength.

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By Tom Jacobs (TMF Tom9)
July 30, 2001

Perhaps with the businesses and stock prices of many companies down 90% from past highs, investors are taking a close look at whether they actually understand what their companies do. Many of them might think, "Optical networking, network attached storage, framuses and whatsits... I never understood them anyway. What was I doing?"

Now, they may say, "Ah, consumer brands, now that's something I can get my hands around!" As in, a cup of Starbucks (NYSE: SBUX), a cold Coca-Cola (NYSE: KO), or a shirt from Tommy Hilfiger (NYSE: TOM). (And they can peruse our helpful InDepth: Retail page for more information!)

But there are risks here, too. Sure, maybe you like the clothes at Chico's FAS (NYSE: CHS) -- Mike Trigg will cover that one in the SmallCap Foolish 8 space tomorrow -- or the Abercrombie & Fitch (NYSE: ANF) catalogue, but don't let superficial familiarity with a product blind you to the need to do research your consumer brand clothing investment as carefully as you would for a company with a more complicated business or product.  

Let's look at Tommy Hilfiger, a clothing designer with a very familiar but somewhat tarnished brand. When a recent Forbes article looked at retailers catering to teens, it said, "This could be a chance to buy Hilfiger on the cheap: The stock sells for nine times 12-month trailing earnings."

I'm not so sure. Hilfiger reported Q1 2002 earnings today. Revenues dropped 11% from $399.9 million last year to $355.7 million, with net income off 7% from $9.7 million to $9 million. However, the company earned $0.10 per share, in line with estimates, and expects to earn $1.60 this year, versus $1.43 last year. At $13.10 a share at Friday's close, sure, it sells for nine times trailing earnings, but there's more to look at:

($ in millions, except EPS)

                 2001   2000   1999   1998  1997
Sales          $1,880 $1,977 $1,637    847   662 
Cash              318    309    242    157   110 
Long-Term Debt    529    579    609      0     1.5
Free Cash Flow    116     79    181    111    68

EPS             $1.43  $1.79  $1.84  $1.49 $2.28   
Flow ratio       2.05   1.73   1.79   3.05  3.96

Stock Price 7/27/01: $13.10

Price to Free Cash Flow (P/FCF): 10
Price to Sales (P/S):             0.62
Price to Earnings (P/E):          9

No, it's nothing to get excited about, but there are positives. The company is paying down its debt and increasing its cash, though the debt load makes it less attractive than debt-free Abercrombie & Fitch, for example. Another positive is its price-to-free cash flow ratio of 10, well below the ratio for the S&P 500 over the last 20 years. But the P/FCF, the P/E, and P/S ratios are only helpful if you think that the company will increase free cash flow, earnings, and sales.

Whether Tommy can pump up its results depends on a number of factors. One red light that must turn green is the company's working capital management. One measure, the Foolish Flow Ratio, is better now than in 1998 and 1997, but trending upward and well beyond the 1.25 we like to see. (Lower is better.)

More importantly, what about Tommy's brand? Some brands are popular for a while, then killed, and Tommy's sales are lackluster for the last year. An interested investor should do some research at department stores, preferably in the company of teens and adults in the target market. Do shoppers finger the Tommy clothes, or disdain them for clothes of other designers? And patrol the bargain bins -- a Ross (Nasdaq: ROST) store is always a good place -- to see how much Tommy stuff ends up there, and how far it is marked down.

Looking at a battered company to see if it can resurrect itself, as opposed to a highly valued company with a top brand that can only fall off its horse, can be a good investment strategy, but many companies -- like would-be equestrians -- stay down for good. Whether Tommy Hilfiger rises again, or ends up like Mossimo, depends on management's success in bringing demand back to the brand.     

Tom Jacobs (TMF Tom9) is not a dedicated follower of fashion. At press time, he owned no shares in companies mentioned in this story. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy.

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