RET – Divestor

Another clothing retailer bites the dust

The fixed costs of leasing for most of these companies is way too high, so CCAA is the only real escape hatch.

Reitmans (TSX: RET.A) finally pulled the trigger on CCAA today, probably to get out of their onerous leases.

My only comment about them is that their balance sheet is still in reasonably decent shape (they have a lot of cash, relatively speaking – $89 million at the beginning of February 2020) and little in the way of debt other than their lease obligations.

Finally, in what had to be the worst-timed substantial issuer bid in stock market history, on July 29, 2019 they repurchased $43.4 million in stock at $3 a piece. I’ll leave it to the readers to determine the rate of return on this after less than 10 months.

Retailers going belly-up

So far of note: J. Crew (clothing), Neiman Marcus (sort of like HBC – higher end generalized department store), Aldo (shoes).

Pier 1 (homewares) didn’t even need the Coronavirus to take it down.

These are all American, but in Canada some other notables (it’s actually odd how there aren’t a lot of retail companies publicly traded on the TSX – I’m excluding the food-related companies here):

Reitmans (TSX: RET.A) – stock trading at 12 cents – this one isn’t as clear-cut, mainly because at the end of January 2020 they had $89 million in cash in the bank, and the only liabilities were their massive lease payments outstanding. Their business (mid-stream business casual women’s fashions) is a terrible sector. They did caution “the Company estimates that it will need financing to meet its current and future financial obligations”, which is never something you want to be reading, but a bit paradoxical given their still relatively strong cash position. At a market cap of just under $6 million, the market is saying this one is worth way more dead than alive.

Roots (TSX: ROOT) – looks pretty ugly. Debt on the balance sheet combined with an operation that’s not making money, means they’ll have to get more credit in order to continue. Margins are decreasing, expenses are rising, it isn’t looking very pleasant.

Indigo (TSX: IDG) – The only big debt they have is their lease payments, while their retail operation isn’t bleeding THAT much. It’s kind of surprising to think on a normal full-year cycle they do make money. But from March 1, 2018, their stock graph has been a 30-degree ski slope downhill. It’s rare to see declines this smooth. Also, at the end of December 2019, they have $66 million in unredeemed gift card balances. Amazing.

Low price to sales ratios – Tailored Brands

This might sound obvious, but the most amount of income you can generate from a dollar of revenue is one dollar. Eventually taxes will kick in, and that will go down to a net profit margin of around 74%, depending on what province you live in. Then you add in expenses such as salaries, or cost of goods sold, or marketing, and that net margin goes lower. Finally, you have non-operational expenses such as financing which will bring the number even lower.

However, it all starts with revenues – if you can’t bring in anything on the top line, it is guaranteed that you won’t see anything flow to the bottom!

Which is why one of the periodic value screens I typically conduct are companies that have low price to sales ratios.

Most typically they trade that way because they are either in debt/solvency trouble, or in traditionally low margin industries (or both) – if your gross margins are 10%, you better be selling a lot of product in order to cover the other fixed expenses. It is one of the basic premises of my original CMA designation (now merged as CPA) to construct methods to judiciously track the linkage between the top line and the proper allocation of overhead expenses to different divisions.

However, if a company with relatively high top-line sales is not producing good financial results, there are value opportunities if one is lead to believe that management can tweak things to either induce higher profitability or to reduce fixed costs in a manner that will not endanger revenues. These results do not show up in historical financial statements, but when they do appear, the results can be very dramatic.

The most recent example of Francesca’s (Nasdaq: FRAN) fits the definition of dramatic:

FRAN has 3.06 million shares outstanding, so at the end of July they were about a $10 million market capitalization company. I’ll skip the bulk of their corporate history (they were one of those high-flyer retailers that caught tailwinds before they became like the next beanie baby), and their Q1-2020 result (note: their fiscal year ends January) was horrible – $87 million in sales, $9.7 million loss in operations. The trajectory looked like they were going into Chapter 11 (they did have some net cash on the balance sheet but not a ton).

Fast forward to Q2-2020, and a miracle happened – $106 million in sales, $1.4 million income from operations. The stock went haywire as you can see – especially given its low float. It’s very interesting to see when a company with 3 million shares outstanding has a day with 20 million shares traded in volume.

What’s interesting is some very smart people (or insider trading) edged the stock up a few days before the quarterly release. The day after Q2 was announced, the stock doubled and proceeded to wipe out the short sellers (on August 30, 2019 there were 1,163,624 shares that were short!).

Retail fashion is currently an industry that is getting killed because of a confluence of factors. There is the typical Amazon effect – most retailers are in malls, and malls have less traffic these days because people are discovering the experience is a pain in the ass. There are other transient factors, but in general the industry is taking it on the chin.

Reitmans (TSX: RET.A) is a good example. I can get a chart of their stock from October 2016, and place a ruler on my computer screen at a downward 30 degree slope, and it extrapolates to today.

Just because it is cheap doesn’t mean it is a good value – these cases can be classical value traps.

We move onto an interesting case, Tailored Brands:

Tailored Brands initially got on my radar a few months ago because it was on Michael Burry’s 13-F form. Burry is somebody that I have been aware of well before his “Big Short” days, specifically when he wrote on MSN Money at the turn of the millennium (his write-up on American Physician’s Capital was complete genius). Needless to say, I respect his thought process greatly. I was wonder what the heck he was thinking with TLRD, but I guessed the general thesis involved. He eventually explained some of his thinking in a 13-D filing indicating that he has been accumulating shares between $4.30 to $6.00.

Putting a long story short, his letter was that the company still makes money and if management believes in the business, they should scrap the dividend ($36 million a year) and instead buy back shares and increase the EPS materially.

This hype from Burry (who recently went public after a multi-year hiatus with an investment in Gamestop, another retailer, which I do not believe is a good decision because they are truly vulnerable to the Amazon effect) presumably got the short sellers in trouble (in the first week of September, there was an obvious spate of short covering – this is what happens when the stock goes up 40% in a short period of time!). Short interest is VERY high – 23.3 million shares as of August 30. The quarterly report is what got TLRD back down to earth again.

Looking at their financial statements, TLRD does look cheap from a price to sales perspective – annualizing the first 6 months, they sell $62 in revenues for every share outstanding. Operating income is still $91 million for the first half, although definitely going down.

The balance sheet isn’t great, but it is a manageable position – they have a large line of credit that extends out until April 2025 ($884 million outstanding), and a senior note ($229 million) which matures on July 2022. The senior notes trade around 99.5 cents on the dollar with a YTM of 7.2%. Right now the credit market does not look like it is locking out TLRD. Most of this debt acquired in the takeover of Joseph A. Banks (another clothing retailer) which was a total disaster. TLRD also has a large amount of lease liabilities, similar to other retailers, and more visible now due to IFRS 16.

In the last quarterly report, the company also listened to Burry and cut the dividend to zero, and made noise about buying back shares. This was actually a good sign.

When a company reduces its dividend to zero (a brave decision), in addition to the negative psychological sentiment associated with it, there is also the effect of having income funds dump the stock due to the investment policy, not to mention retail people that are deluded into believing the yield statistic they see on the stock is sustainable. There will be the technical effect of a lot of forced selling after the quarter, and I believe we are seeing it presently. The question is how many shares will get force-dumped, and when will the short sellers cover.

It is interesting how at one point the cost to short TLRD went as high as Beyond Meat for a few days – signs that borrowing is getting tougher.

Tailored Brands is mostly associated with the Men’s Warehouse brand, and in Canada it is Moore’s. The question is whether men’s fashions (suits and the like) is still subject to the Amazon steamroller. I would think this segment of retail fashion is less vulnerable than Reitman’s.

So the question is whether management is capable of clotting the bleeding. Guidance for the 3rd quarter was awful (sales down roughly 5%). Operationally management does appear to be getting into a better and more profitable niche (customization), and the question is whether they can pull it off competently.

The risks are pretty obvious. The situation can get worse. The operating income to debt ratio is quite high. Fashion is fickle, and I don’t even want to divulge on this website publicly the last time I bought a suit. That said, I think men’s fashions are less fickle than women’s, but if we get this much-anticipated recession or economic slowdown it will also not help the company’s financial fortunes – a suit is the last thing on the shopping list when one is worried about their employment (note: the Men’s Warehouse still made money during the 2008-2009 economic crisis).

That said, there was a pretty good reason why this thing was trading at $24/share a year ago. It could easily get there again – a couple quarterly reports with stabilization will do this. They set the bar very low for Q3. The CEO also put up $72k of his money into the stock after the quarterly report, which is better than nothing.

I’m buying shares in the low 4’s. It will not be a large position, but my price target is $20/share.

Normally I do not like these sorts of companies for a few reasons. One is that there are too many eyeballs tracking this, especially now that Burry has made his 13-D filing public. I am not typically a “follow Buffett” type of investor – usually when I read about something from another source, I use it as an exclusionary criterion. However, there is a good chance the market sentiment is so negative that the chances of a less negative outcome are a lot better than the consensus.

If it works out, I’ll buy a cheap suit.

Reitmans / Substantial Issuer Bid / Taxation

Hat tip to Tyler for getting this on my radar. I’ve personally been following Reitmans (TSX: voting stock RET, non-voting stock RET.A) on-and-off for the past decade or so. Not that I’ve been a purchaser of women’s clothing but financially it is a typical story of the decline of a fairly benign women’s fashion retailer facing the steamroller of competitive marketing and the internet.

Fortunately for Reitmans, they are highly un-leveraged. As of May 4, 2019, they have $122 million cash and zero debt. As Tyler pointed out, IFRS 16 had a disproportionate impact on the reporting of their balance sheet – I will point out any accounting system does not change the actual economics of a company’s operations (other than covenants and restrictions that are governed by the stated accounting values!).

On June 3rd, RET announced their quarterly results, which were less than inspiring (sales down, margins down, cash drain increased from the previous year’s quarter) and their stock tanked. There was a panic sale before somebody with larger pockets decided they wanted to accumulate shares in the low 2’s.

On June 17, RET announced a substantial issuer bid (SIB) for CAD$3/share of up to 15 million shares of RET.A stock. There were 49,890,266 shares outstanding, so the 30% SIB is not a trivial amount – and also nearly 40% of the cash on RET’s balance sheet. The voting stock has 13,440,000 shares outstanding and this will be untouched – directors and insiders have 56.9% control of these shares, although if you want to be a muzzled voting partner, the stock does trade a few thousand shares a day on the TSX.

Shareholders have until July 26 to figure out whether to tender.

The SIB was filed on SEDAR, but I will spare you the trouble and attach it here.

I always find these documents interesting to read, specifically the background of the transaction. Merger documents also have to include the timeline of discussion and negotiations. For RET’s SIB, it is as follows:

During the spring of 2019, senior management of the Corporation was approached by a significant unrelated Shareholder indicating its desire to realign its portfolio and to sell all of its Shares. As a result, such members of senior management and the Board of Directors began engaging in preliminary discussions concerning possible strategic activities and opportunities that may be in the best interests of the Corporation and could provide enhanced liquidity for all of the Shareholders. Among the alternatives discussed was the possibility of pursuing a substantial issuer bid to repurchase a portion of the issued and outstanding Shares.

“a significant unrelated Shareholder” is not defined in this document, but my first guess is Fairfax.

I’m sure another alternative was trying to find a buyer for the company, but this would require the control group agreeing to it.

In May 2019, following discussions with senior management of the Corporation, certain independent members of the Board of Directors seriously considered the possibility of pursuing a substantial issuer bid and the alternatives thereto. Given the Corporation’s significant cash on hand and marketable securities portfolio, certain independent members of the Board of Directors and senior management of the Corporation considered that, in light of the trading price of the Shares, the low return from its investment in marketable securities and interest rates earned on the cash balance, a substantial issuer bid would be a good use of the Corporation’s funds and sought preliminary advice from Davies Ward Phillips & Vineberg LLP, legal counsel to the Corporation, in order to further consider and evaluate the possibility of making an offer to repurchase a portion of the Shares.

The key word is “certain” in “certain independent members of the Board of Directors”. Clearly this was not a unanimous decision.

The rest of the document is bureaucracy to adhere to MI 61-101 and is not terribly juicy.

Taxation (hat tip to Fred for this one)

This is for Canadian residents.

A Resident Shareholder who sells Shares to Reitmans pursuant to the Offer will be deemed to receive a taxable dividend on a separate class of shares comprising the Shares so sold equal to the excess, if any, of the amount paid by Reitmans for the Shares over their paid-up capital for income tax purposes. Reitmans estimates that the paid-up capital per Share on the date of take-up under the Offer will be approximately $0.66. As a result, Reitmans expects that a Resident Shareholder who sell Shares under the Offer will be deemed to receive a dividend. The exact quantum of the deemed dividend cannot be guaranteed.

Careful – if you tender your shares, you will receive a deemed dividend of $2.34/share! Fortunately your capital gain will be reduced (in most cases, one exception is if you just bought the shares before/after 30 days of the final disposition) by said amount, which will lessen the tax bill somewhat. Unfortunately, almost all shareholders of RET are sitting on loss situations – so in order to take full tax advantage of the situation you would need to be able to offset 3 years’ prior capital gains, or future capital gains. Otherwise, you are taking a very large tax hit to tender your shares.

Putting on my individual CPA tax advisory hat, in general, if your desire is to dispose your shares of RET, you should ask yourself whether taking a dividend with a relatively large capital loss (the tender route) or a relatively small capital loss with no dividend (sell in the open market) is better for your personal taxes. RET.A shares are trading at around $2.85 presently so going through the open market approach will involve surrendering a potential 15 cents per share, offset with the tender route uncertainty that at a minimum, only 30% of your shares will be tendered.

Buying and selling retail fashion stocks

I’ve been reviewing a bunch of miscellaneous stocks today (both new and things that I’ve researched well into the past) and I will just write a bunch of short thoughts, on a topic that I don’t give much attention to, and that is fashion.

The last time I wrote about Vancouver, BC-operated Lululemon (Nasdaq: LULU) was about five years ago. I was mentioning how a $9 billion market capitalization is mind-puzzling. I’ve checked today and they’re up to $17 billion. Lest an investor think that this increase in capitalization was due to equity issuances and dilution, an investor over the past 5 years would have doubled their money. All of the price appreciation, however, was in the last year. No positions, never had any, but always curious as to the drivers that make these fashion stocks tick.

I also remember writing about Coach, and Kate Spade. Clearly I don’t frequent these two stores enough since I just checked and Coach bought out KATE for $18.50/share and changed its name to Tapestry (NYSE: TPR). I remember Coach was running into the issue of too much expansion and their main handbag products were simply not reaching that level of exclusivity that once made it a special brand. KATE investors did not do well as their brand appeal fell off faster and Coach was probably trying to consolidate that “mid-to-upper” segment.

Finally, two more Canadian companies. Roots (TSX: ROOT) has continued to dither since its initial public offering. Financially they’re still trying to figure out how to ramp up their profitability (they are modestly profitable on a yearly basis, although when it isn’t Christmas, they bleed cash).

Canada Goose (TSX: GOOS) continues to “wow” me and reminds me of Lululemon in the old days – something trading with a P/E of a bazillion. Their FAANG-styled valuation, however, is well deserved – looking at their last three fiscal years, revenues have ramped up nearly at 50% growth and gross profits have also increased percentage-wise – so more revenues, and at a higher rate of gross profit. If you can extrapolate that for the next 10 years, they’ll be able to pay of Canada’s national debt with the amount of corporate income taxes they will be paying. The question becomes a matter of whether they can pivot when suddenly seeing everybody dressed up in warm parkas with the circle patch no longer becomes fashionable.

I remember Guess? (NYSE: GES) was on my value radar screen when doing some research in this area last year. Their stock was around US$10/share at the time and I was mighty surprised to open up the quote screen and see it at US$22/share today. I have no idea whether they are fashionable again or not. You don’t see it in their financial statements, however – they’re basically a break-even operation. But Guess has always been unusual compared to some other fashion companies in that their balance sheet is debt-light and cash-heavy, which gives them a lot of time to figure out how to turn their $2+ billion in revenues into $2+ billion in profitable revenues.

Likewise, looking at Abercrombie & Fitch (NYSE: ANF), they seem to be in a similar position as Guess – the revenue drain has stopped, but profit levels are still relatively low.

In the latter two, small changes in profitability percentages will have substantial impacts on the bottom line, which gives their equity inherent leverage to a change in market environment. It’s pretty clear the market is betting on this happening to some degree.

A company that has been cited by various value Canadian investors everywhere but still receives not a lot of respect from the market is Reitmans (TSX: RET / RET.A) – people cite their strong balance sheet (it is indeed, about $150 million cash and no debt) but the entity is marginally profitable and it isn’t entirely clear how they can increase profitability. This probably is an issue facing most fashion retailers without brain-share in the consumer space. Commodity retailing, to put it mildly, it is a horrible area to be in.