Merrill Lynch can't seem to make up its mind about what investors should do about Too
The curious thing was that this analyst recommended investors sell that stock less than a month ago. He cited a good mix of products but wondered whether enough sales and margin would be generated. As a result, he lowered his earnings estimate for the year.
But with the change in the rating yesterday, Mr. Friedman seems to think everything will work out just fine. Like last month, he praised the good product selection. But this month, he thinks that the promotions will in fact bring customers through the doors in order to clear out old inventory as well as sell the latest spring fashions. In fact, he is now comfortable that Limited Too will meet its Q2 estimates and thinks the good news is already priced into the stock. The market did not seem to agree with that.
Should investors be concerned with product selection and promotion? Absolutely. Should they be bipolar about it on a month-to-month basis? No way. Product selection and promotion decisions are made using judgment by management. Clearly, the analyst was concerned with management's tactics. But should that have warranted a sell rating? Could it have been identified as a risk instead? I think that would have been more prudent than whipsawing investors from neutral to sell and back to neutral. I'd say that's too much short-term focus.
What about the state of the business? It has been making improvements. Free cash flow (FCF) has improved since 2002. Retailers require lots of working capital (defined as current assets minus current liabilities). FCF has varying definitions, but for a retailer, I'd define it as net income + depreciation - changes in working capital - capital expenditures. Limited Too created FCF of $23.8 million in 2002, $19.4 million in 2003, and $53.5 million in 2004. It's a bit lumpy as we might expect, but it's moving in the right direction.
Is Too a buy today? That's a much tougher question. There are a number of great competitors in the teenage fashion industry. TheGap
Don't worry, my feelings will be the same next month as well unless something very drastic changes. Prices can change quickly and fashions can change quickly. Business strategies and tactics take time.