Cherokee's Profitable Brands

Shares of brand licensor and marketer Cherokee Brands (NASDAQ:CHKE) are up almost 30% after hitting a 52-week low in early September but still have a 7% dividend yield. So is it still appealing for investors looking for income from their investments?

Cherokee is a very profitable company. It licenses brands to third parties, leaving licensees the responsibility for manufacturing related apparel, footwear, and accessories. Cherokee offers customers some design assistance, but clients handle most of these decisions to fit their particular merchandise needs. As a result, the business model lends itself to net margins near 40% and jaw-dropping returns on capital that came in close to 80% over the last 12 months.

Top-line growth has been decent too, averaging about 8.6% on average over the past five years. Cherokee released fiscal third-quarter results today and revenue grew only 5.3%, but international growth opportunities, particularly with Tesco and Zellers, are offsetting falling royalties from Target (NYSE:TGT) that account for close to half of total revenue.

Management also looks to grow by purchasing additional brands to go with the already-owned Cherokee, Sideout, and Carole Little names, just to mention a few. In fact, it has detailed that should it find a compelling brand or trademark to bring in-house, it could consider cutting its dividend to free up capital to make a purchase.

As you can see, there are risks to consider when investing in Cherokee. Beside the dependence on Target and uncertain dividend status, Cherokee is a small-cap company and inherently riskier than larger, better capitalized firms. Fortunately, it does have an enviable track record of enhancing its dividend payout and growing over the years, but there's no guarantee its brands will continue to sell well forever.

Other benefits include the fact that Cherokee has no long-term debt outstanding, and nearly all of the cash flow it generates is paid out to shareholders. The appealing business model also leads to strong free cash flow generation that rivals reported net income, demonstrating how little capital expenditure is needed to sustain the business.

Be sure to also check out Iconix Brands (NASDAQ:ICON), as it is one of the only other pure-play brand licensors. However, it is less profitable and carries more debt than Cherokee. Other firms pursue a combination of branding, manufacturing, and retailing, such as VF (NYSE:VFC), Liz Claiborne (NYSE:LIZ), and Warnaco Group (NASDAQ:WRNC). But, as you would imagine, none come close to matching Cherokee's margins.

For related Foolishness:

• The Best Dividend Payers of the Past Decade
• Cherokee's Brand Nation

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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.