As a guy who mostly covers commodities, branding is a concept that doesn't usually enter the value equation. Gas is gas. Corn is corn. The low-cost producer wins. End of story.
In retail, things are radically different. Instead of what economists call perfect competition, in which products are completely undifferentiated, you're dealing with what's known as monopolistic competition. There are many producers selling similar, but not identical, wares. Superiority, real or perceived, wins customer loyalty and can command a higher price. Branding is a big piece of that puzzle.
I jigsaw that coming a mile away
Speaking of puzzles, I would be hard-pressed to calculate the value of a megabrand. Fortunately, I don't have to. The fine folks at Interbrand have already done it.
Perhaps you've seen Interbrand's "Best Global Brands" breakdown in BusinessWeek, a feature that's run annually since 2001. Well, for the first time, the consultancy has placed a dollar value on the 50 top U.S. retail brands.
With these estimates in hand, I return to the question posed at the outset: Where is the value in retail? To suss out an answer, I've taken the enterprise value -- market capitalization plus net debt -- of each retailer in question, and divided that by Interbrand's estimate of brand value. We'll call the resulting metric enterprise value-to-brand value, or EV/Brand.
The results are pretty fascinating.
One brand to rule them all
Wal-Mart Stores (NYSE:WMT) naturally sports the greatest brand value, at $129.8 billion. Tack on $9.5 billion for Sam's Club, and you're looking at an EV/Brand of about 1.7, which sounds reasonable. Given its efficiencies of scale, Wal-Mart's value as a company surely goes beyond its branding.
The next-largest brand value leader may surprise you. It's not Target (NYSE:TGT) or Home Depot (NYSE:HD), but Best Buy (NYSE:BBY) -- a considerably smaller firm. In a brutal environment for consumer electronics that's ushered in the demise of second-fiddle Circuit City, Best Buy's brand value is definitely in evidence.
Mr. Market may be giving the retailer short shrift. With an EV/Brand a bit below 0.7, Best Buy is one of the most undervalued firms on the list. J. Crew, which is counting on its in-house labeled "heritage classics" to outlast the big-name designer fad, is in the same ballpark. They make a fine pair of khakis, I've got to say.
Lap of luxury, or lack of luxury?
Meanwhile, Coach (NYSE:COH) and Abercrombie & Fitch (NYSE:ANF) are the most heavily discounted, at less than 0.5 times EV/Brand each. Coach has long been on my radar because of its world-class returns on invested capital. All is not rosy for the hawker of handbags and other luxury items, however. Interbrand notes that "[d]espite its exclusive lines, brand differentiation may be on the wane." Coach's middle- and upper-middle-class clientele are less willing to pay up for those purses in today's economic climate, so you have to wonder about the persistence of brand loyalty here. Still, at such a steep discount to Interbrand's estimated $9 billion brand value, this all may be priced into the stock -- and then some.
Similar concerns weigh on youth-oriented Abercrombie, whose Hollister brand alone is estimated to top $900 million in value. Interbrand offers up the warning that "if the recession brings frugality into vogue it may hasten the brand's lifecycle."
Fair enough. This is a retail name that I had not really considered before, but I'm going to go ahead and pick it to outperform over in Motley Fool CAPS.
A Foolish final word
I know the foregoing approach to hunting for retail value is unconventional and unscientific and all that, but here's something to think about. As we saw with Wal-Mart, there are plenty of reasons that a business might be worth multiples of its brand value. Whole Foods Market (NASDAQ:WFMI), the most richly valued, may even be worth its 5 times EV/Brand multiple -- though I doubt it, and am red-thumbing that one.
An EV/Brand below 1.0, however, is another story. It assigns no value to other elements of the business, whether that's inventory management, a history of profitable growth and growing dividends, or what have you. As long as the balance sheet is clean, though, I'm quite a bit more inclined to perceive a mispriced security.
