I will begin this post by saying I don’t understand the shopping mall experience. Perhaps because of my gender, I just don’t understand why people, usually women, like to “go shopping”.
However, I can understand what goes before my eyes, and that is people shop. I might not understand fashion retail, but I understand the economics of it – something about the marketing works. It gets people to pay more for a product that inherently has very low marginal cost to purchase. The embedded marketing costs, however, are huge.
Earlier this year, I invested in some corporate debt of Limited Brands (NYSE: LTD) – the 2033 series of debentures, which has a coupon of 6.95%. Investors back then assumed that retail was going to get thrown out the window along with the rest of the economy and especially for a discretionary retail shop like Limited Brands (their primary brand name is Victoria’s Secret), droves of people would be not shopping for lingerie. Or will they? According to their last quarterly report, they are on track to bringing in about $500-600M in free cash flow, depending on how the Christmas season works out.
For 35 cents on the dollar, I figured that the debt would be a good buy. It was tough to rationalize how being rewarded 20% interest a year (plus another 4% capital appreciation) under the assumption that Limited Brands would not blow up could lose money. And indeed, it has not lost capital – the same debt is trading for around 71 cents if you shop around carefully. This will still net you 10% a year in coupon payments, and about 1.5% a year capital appreciation compounded over the next 23.8 years.
If you look at their balance sheet, they have about $2.9 billion in debt, covered by $968M in cash, and positive earnings. Although I have no idea whether the retail chain over the next 23.8 years will survive, at least right now it is looking quite good. The following is the debt maturity schedule from the Q2-2009 SEC filing, which shows they have staggered out their debt financing fairly well:
15. Long-term Debt
|Term Loan due August 2012. Variable Interest Rate of 5.18% as of May 2, 2009||$||750||$||750||$||750|
|$700 million, 6.90% Fixed Interest Rate Notes due July 2017, Less Unamortized Discount||698||698||698|
|$500 million, 5.25% Fixed Interest Rate Notes due November 2014, Less Unamortized Discount||499||499||499|
|$350 million, 6.95% Fixed Interest Rate Debentures due March 2033, Less Unamortized Discount||350||350||350|
|$300 million, 7.60% Fixed Interest Rate Notes due July 2037, Less Unamortized Discount||299||299||299|
|$300 million, 6.125% Fixed Interest Rate Notes due December 2012, Less Unamortized Discount||299||299||299|
|Credit Facility due January 2010||—||—||15|
|5.30% Mortgage due August 2010||2||2||2|
|Current Portion of Long-term Debt||—||—||(7||)|
|Total Long-term Debt, Net of Current Portion||$||2,897||$||2,897||$||2,905|
Another similar corporation that is debt-free is Abercrombie and Fitch (NYSE: ANF), which seems to defy everybody’s expectations during recessions by coming back from the financial netherworld to make insane amounts of money. I can see the appeal of Victoria’s Secret – sex sells – but Abercrombie? When walking into the two stores to do some ‘consumer research’, I just don’t understand what keeps these names afloat in the retail fashion world.
However, I can at least invest and make some cash off of it while the going is good. Will I know when it is time to liquidate? Who knows.