The house rules are simple in this weekly column.
I bash a stock that I think is heading lower. I offset the sting by recommending three stocks as portfolio replacements.
Who gets tossed out this week? Come on down, True Religion Apparel (NASDAQ:TRLG).
The flight's going to get a bit bumpy
Shares of True Religion opened 23% higher today after the company revealed that it is exploring strategic alternatives after receiving third-party buyout interest.
That's fair. If buyers are willing to pay a healthy premium for a company, it owes it to its shareholders to open up the process.
However, how much can True Religion reasonably expect to fetch in a sale, and are today's investors running ahead of the potential price tags?
I'll be up-front here. I've never bought a single item of True Religion clothing. I can never fathom paying $300 for a pair of jeans or $158 for a plaid lumberjack shirt. However, there are clearly people out there who are more than willing to pay up for designer clothing. The problem is that growth is slowing at True Religion.
Net sales may have soared 15% to $419.8 million last year, but net income only inched 3% higher to $45 million. Through the first half of this fiscal year, net sales climbed 10%, but adjusted gross, operating, and net margins have all contracted.
A big part of the True Religion growth story has been expanding its chain of premium apparel stores. There are now 116 stores in the country, and another 23 locations internationally. This would make it seem as if we're early in True Religion's growth cycle, but we're not. There's a limit to how many stores selling $59 T-shirts and $315 vintage denim a market can take. Before pointing to the upside of growth overseas, keep in mind that international sales were flat last year and declined in its latest quarter.
You didn't think True Religion would be considering a sale if it were actually accelerating its growth, did you?
That's not a statement of opinion. Back in January, True Religion was targeting $450 million to $460 million in net sales for the entire fiscal year. Now its outlook tops off at $455 million.
The climate just isn't right for many premium brands. Fifth & Pacific (NYSE:KATE) -- the company behind Lucky, Juicy Couture, and kate spade -- took a hit earlier this month after dramatically hosing down adjusted EBITDA guidance. The culprit was largely Juicy Couture and not the premium denim hotbed that is Lucky, but it still proves that a lot of upscale brands are struggling.
In True Religion's defense, it's a cash-rich and debt-free company that's still growing. No one is arguing that True Religion is going away if a sale doesn't go through. There's a healthy dividend, too. However, today's exuberance glosses over a premium brand with decelerating growth in a niche that hasn't been very forgiving when fickle shoppers move on.
If True Religion is open to a sale, investors should take today's pop and run.
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.
- Joe's Jeans (NASDAQ:JOEZ): As a smaller player in premium denim, Joe's Jeans is holding up surprisingly better than True Religion. Net sales rose 16% in its latest quarter, and margins are on the rise. Yes, Joe's Jeans also has its shortcomings, but it still deserves some respect after cranking out profitable results in recent years.
- lululemon athletica (NASDAQ:LULU): The high-end retailer of yoga apparel may seem to be an odd replacement for True Religion. Value investors will laugh at the suggestion that Lululemon -- fetching 35 times next year's projected profitability -- is a better buy than True Religion, a stock trading at a third of that forward multiple. However, Lululemon has established itself as a true premium brand in fitness apparel with the strong sales growth and spectacular store-level comps to prove it.
- VF (NYSE:VFC): Fans of more appropriately priced denim may have some of VF's wares in their closets. This is the company behind Lee and Wrangler. VF isn't afraid to go upscale. It's the company behind 7 For All Mankind, and its name may even come up as a potential suitor for True Religion at the right price. I still like VF here given its broad collection of apparel and footwear brands across all price points. VF has also boosted its dividend for 39 consecutive years. That streak should stretch to a round 40 straight years of hikes when VF reports later this month.
Longtime Fool contributor Rick Aristotle Munarriz has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Lululemon Athletica and True Religion Apparel. 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.