Investors may have heard of Cherokee
Cherokee is a marketer and licenser of a number of apparel, footwear, and home-furnishing brands such as namesake Cherokee, Sideout, and Carole Little. The company enters into licensing agreements, usually as a percentage of net sales, with clients (in the U.S. and internationally) such as Target
As for first-quarter earnings released today, results were essentially flat. Revenue was largely unchanged from the first quarter of last year, and earnings fell 3%. Overall weakness was attributed to a longstanding brouhaha with Mossimo that caused a $900,000 decrease in a related royalty payment. Back in April, Cherokee had nearly acquired Mossimo before coming to an agreement with Iconix to let that company make the purchase instead. Mossimo has been a client of Cherokee's, and the two have been embroiled in litigation regarding their relationship for at least the past couple of years. Perhaps it's best the marriage didn't work out.
The Mossimo dispute and aborted acquisition have clouded near-term results, but the longer-term picture is one of consistent growth and profitability for Cherokee. Sales growth has been merely decent over the past five years, having averaged just less than 9% annually. Earnings have grown slightly higher, at 10% annually over the same time frame. Yet the company is hugely profitable, with recent operating margins near 70% and net margins around 40%.
Returns on equity and capital, which are the same because of zero long-term debt, are equally impressive -- an astounding 74% over the past year, averaging more than that over the past five years. And net income is a good proxy for free cash flow because of high levels of cash flow from operations and minimal capital expenditure -- and that's possible because the business is primarily built on intellectual property. In other words, the company is very profitable because it leaves the product design, manufacturing, distribution, and selling up to its clients, while focusing on marketing and managing its brands through quality-control inspections.
The primary risk to the company is that Target accounts for almost half of its revenue, but at least Target represents a growing retailer, and the relationship looks stable. There also appears to be occasional licensing disputes and related litigation, as witnessed by the Mossimo debacle. Finally, as management looks to acquire brands, there is always risk in making acquisitions.
Mossimo's brands may not possess enough pizzazz for certain shoppers, my wife included, but they appear to offer mass appeal and a subsequent great investment because of a compelling brand offering to its licensee customers. Plus, Cherokee's business is understandable, very profitable, easy to maintain financially, and it has a good track record. With a current market cap of only $335 million and a 6.4% dividend yield, perhaps this opportunity flies under the radar of most investors.
Fool contributor Ryan Fuhrmann has no financial interest in other company mentioned and welcomes your comments.