DESTINATION MATERNITY CORP DEST
January 09, 2010 - 3:33pm EST by
gocanucks97
2010 2011
Price: 17.70 EPS $1.77 $3.15
Shares Out. (in M): 6 P/E 10.0x 6.0x
Market Cap (in $M): 110 P/FCF 3.7x 4.7x
Net Debt (in $M): 37 EBIT 23 36
TEV ($): 147 TEV/EBIT 6.3x 4.0x

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  • Retail

Description

Destination Maternity (DEST) is a cheap retailer with decent business fundamentals. It is an under-the-radar micro-cap with no sell side coverage - stock actually traded down last week after the company raised guidance. Company has beat its own guidance in the last 2 quarters, but stock is down from 6 months ago. I believe the company will destroy the current quarter yet again in 2 weeks, which may act as a catalyst. Even though DEST is not the highest-quality/most stable retailer around, I think stock is too cheap at 0.3x EV/sales, 6x current year fully-taxed EPS, 3x EV/EBITDA at below-peak margin. Trading under $18, I see upside to $30 based on 10x earnings or 4.5x EV/EBITDA. CEO bought $300K worth of stock on open market 2 months ago at a price slightly above current price.

Company background: DEST sells maternity clothing and operates 724 retail stores and 360 leased departments. Overall maternity clothing sales is about $1B annually, and DEST has ~50% of the market with over $500M in sales. Key competitors include Old Navy, JCP, WMT and TGT. Mgmt will have you believe that maternity apparel is a steady business with stable birth rates and low fashion risk, and DEST is differentiated from its competitors with more comprehensive offerings and SKUs. I have no such illusion. Eye-balling the stock charts over the last 10 years will show two plunges from $40+ to sub $10. The reason behind the first dive in 2004 was due to competitors such as Old Navy and JCP increasing offerings. The result was a bloodbath for everybody in 2005 with bloated inventory. Big players retreated, and DEST roared back in 2006 as SSS and margin recovered and stock 5x'd in one year. Then came the recession and an unfavorable fashion trend of baby-doll and trapeze tops, which pregnant women can also wear. This drove the stock down to $5 at the bottom.

While DEST is far from a stable business, I think the stock movement is more extreme than the underlying fundamentals. In last 10 years, worst-ever SSS was -5%, and the company usually bounces back after a negative year. Gross margins are generally respectable at low 50's and average op margin over the same period was 5% and the company never lost money on an operating basis.

 

Income Statement Sep 01 A Sep 02 A Sep 03 A Sep 04 A Sep 05 A Sep 06 A Sep 07 A Sep 08 A Sep 09 A Sep 10 E

                   
SSS       -5.0% -2.5% 4.3% -4.8% 0.2% -4.3%  
Revenue $388.3 $453.2 $492.5 $518.1 $561.6 $602.7 $581.4 $564.6 $531.3 $548.0
        YoY Growth               -2.9% -5.9% 3.1%
        Inv Change YoY       0.0% 14.3% -11.0% 6.6% -12.3% -20.5%  
Gross Profit $194.0 $241.5 $267.3 $278.4 $284.2 $314.7 $300.2 $283.0 $282.8 $295.9
        Gross Margin 50.0% 53.3% 54.3% 53.8% 50.6% 52.2% 51.6% 50.1% 53.2% 54.0%
        change YoY in bps



(315) 160 (56) (151) 310 77
 - Selling, General & Admin Expense $172.8 $207.7 $230.1 $253.9 $269.9 $284.3 $281.5 $271.6 $259.6 $260.0
        YoY Growth               -5.7% -0.1%  
        SG&A as % Sales 44.5% 45.8% 46.7% 49.0% 48.1% 47.2% 48.4% 48.1% 48.9% 47.4%
Operating Income $21.2 $33.7 $37.2 $24.6 $14.2 $30.3 $18.7 $11.5 $23.3 $35.9
        Op Margin 5.5% 7.4% 7.5% 4.7% 2.5% 5.0% 3.2% 2.0% 4.4% 6.6%
EBITDA $33.1 $43.2 $47.0 $34.8 $29.7 $46.5 $38.6 $25.5 $40.0 $49.6
        EBITDA Margin





6.6% 4.5% 7.5%
Interest Expenses ($14.9) ($16.5) ($14.5) ($14.8) ($15.3) ($14.6) ($10.2) ($7.0) ($4.7) ($3.4)
Net Income $3.5 $10.8 $14.0 $5.9 -$0.2 $9.1 -$0.4 -$1.4 $11.1 $19.5
Shares 6.01 6.01 6.01 6.01 6.01 6.01 6.01 6.01 6.01 6.2
EPS $0.58 $1.80 $2.32 $0.98 -$0.03 $1.63 $0.87 -$0.23 $1.77 $3.15











D&A $11.9 $9.5 $9.9 $10.2 $15.5 $16.1 $16.4 $16.0 $15.0 $13.7
OCF $19.5 $28.5 $30.0 $11.4 $7.3 $42.4 $27.4 $27.8 $42.5 $33.2
Capex ($12.2) ($9.8) ($19.2) ($14.7) ($17.6) ($13.9) ($15.4) ($15.7) -$12.6 -$10.0
FCF $7.3 $18.6 $10.8 -$3.3 -$10.3 $28.5 $12.0 $12.1 $29.9 $23.2

Current Fundamentals: DEST's fundamentals resemble most retailers -- weak SSS but decent margins thanks to good inventory control and SG&A cuts. With just about every retailer cutting SKUs and controlling inventory, competitive landscape should remain benign - I doubt Glen Murphy at GPS will suddenly decide maternity clothing will be the new focus to drive SSS at Old Navy. Indeed, DEST saw Sears/Kmart came back as a customer after just one year. Mgmt also noted current fashion trends are mostly neutral - I am no fashion expert, but it will be hard for pregnant women to put on skinny jeans.

SSS remains negative, but unlike most other retailers, compares will get progressively easier in the next few quarters, and DEST historically demonstrated a mean-reversion in SSS. Last month DEST reported a -1% SSS, and I hope the trend will continue.

FY Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan
1Q 2Q 3Q 4Q Year
2001 -3.4% -1.5% -0.3% -6.0% 1.0% -6.5% -1.6% -9.3% -6.3% -2.0% 0.3% -1.5%





2002 5.0% 7.6% 2.1% 4.5% 6.3% 6.8% 9.1% 2.6% 7.4% 7.9% 3.4% -2.7%





2003 -5.0% 1.3% -4.5% 4.7% -0.6% 2.9% -1.7% -4.7% -5.5% -3.7% -5.4% 4.7%
5.1% 0.2% -0.4% -1.4% 0.3%
2004 7.8% -6.3% -0.4% -3.0% -10.9% -2.6% -13.0% -8.9% 1.0% -11.6% -1.9% 2.0%
-5.0% 0.2% -5.0% -8.3% -4.9%
2005 -2.3% -3.0% 3.1% -8.1% -0.5% -4.3% -0.5% 1.9% 1.7% 4.0% 3.5% -3.7%
-4.2% -3.0% -1.9% -1.0% -2.5%
2006 4.8% 2.2% 7.1% 5.5% 6.2% 3.9% 5.0% 10.6% -5.2% -1.0% -0.3% 3.9%
3.1% 1.4% 6.4% 6.5% 4.3%
2007 -4.7% 3.6% -14.8% -3.6% -5.4% -9.4% -3.7% -7.0% -3.9% 0.0% -7.6% -6.0%
-2.1% -1.6% -8.2% -6.8% -4.8%
2008 4.8% -6.0% 2.3% 4.3% 0.8% 2.8% 7.2% -1.3% 6.0% 0.6% -6.9% -2.1%
-4.1% -1.7% 2.4% 2.8% 0.2%
2009 -3.5% -7.6% -1.2% -5.7% -10.1% -9.0% -10.6% -7.0% -5.2% -11.6% -1.2% 5.1%
-0.5% -2.8% -5.5% -8.7% -4.3%
2010












-5.9%



Inventory remains well-controlled down double digit on a per store basis and is expected to remain down, even as mgmt implicitly expected a positive SSS in 2H '10. Mgmt has also cut SG&A to '04 level despite a higher sales base.

Earnings: Mgmt had guided 11-29c ex-charges for the current quarter, but noted last week that EPS would come in higher. While guessing EPS is virtually impossible considering the low margin and tiny share base (DEST has just 6m shares, so $90 sales/share vs. a $18 stock price), I think 50c+ is quite likely. Mgmt had guided full-year EPS of $2.05 to $2.58, and my estimate is $3.10. If SSS can come in positive/higher than mgmt guidance, I think $4 EPS is not out of the woods. Note DEST did $2.30 peak EPS back in '03, but lower interest expense alone ($12M reduction) is almost $1.5 EPS/share.

Op Margin EPS Power
2.0% $0.73
3.0% $1.26
4.0% $1.79
4.5% $2.06
5.0% $2.32
5.5% $2.59
6.0% $2.85
6.5% $3.12
8.0% $3.91

 

Valuation: Any way you slice it, the stock is cheap under 10x trailing, 7-8x mgmt guidance, 6x my estimate, 3x EV/EBITDA, 0.2x P/sales. Specialty retail peers trade at low-mid teen PE and 4-7x EBITDA. Balance sheet is not great with almost $37M net debt, but company is paying down debt with all the FCF (capex is lower than D&A), and I expect the company to be close to net-debt free by year end. One thing I like about the company is that despite a seemingly flaky business model, DEST paid down $90M of debt with FCF over the last 4 years, vs. current market cap of $110M. While some of that is from inventory reduction, this is still pretty remarkable considering the last 4 years were far from ideal for retailers and certainly for DEST.

Stock  $       17.7
Shares 6.2
Mkt Cap  $        110
EV  $        147
EV/Sales 0.28
EV/EBIT 4.1
EV/EBITDA 3.0
FCF  $         23
FCFE % 21%
FCFF % 16%
P/E 5.6

Under-the-radar: DEST has no sell-side coverage, and recent conference calls have largely become sad stand-up solo-shows for the CEO, who kept lamenting the stock is cheap on EV/EBITDA (his bonus is based on EBITDA). It is certainly encouraging that he backed up his words with action, buying close to $300K worth of stock on open market recently. The stock also has an interesting holder list - Crescendo Partners, an activist fund, Mill Road Capital, which has made a number of acquisitions in consumer space (Kona Grill, Cossette, and an unsuccessful bid at old VIC-favorite DFZ), Stadium Capital (sharp investing record in retail space), and Michael Price, the noted value investor.

Risks:

  • SSS remains weak and gross margin starts to contract with tougher comparisons: Certainly a legit risk with any retailer. Clean inventory and SG&A cuts should provide some downside protection.
  • Founder couple retiring: The Matthias couple built the company from organic growth and acquisitions, but current CEO Ed Krell has been a long time CFO, and I think he has done a decent job managing the business through the recent downturn.

 

Catalyst

Catalyst:

  • Earning in 2 weeks.

 

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    Description

    Destination Maternity (DEST) is a cheap retailer with decent business fundamentals. It is an under-the-radar micro-cap with no sell side coverage - stock actually traded down last week after the company raised guidance. Company has beat its own guidance in the last 2 quarters, but stock is down from 6 months ago. I believe the company will destroy the current quarter yet again in 2 weeks, which may act as a catalyst. Even though DEST is not the highest-quality/most stable retailer around, I think stock is too cheap at 0.3x EV/sales, 6x current year fully-taxed EPS, 3x EV/EBITDA at below-peak margin. Trading under $18, I see upside to $30 based on 10x earnings or 4.5x EV/EBITDA. CEO bought $300K worth of stock on open market 2 months ago at a price slightly above current price.

    Company background: DEST sells maternity clothing and operates 724 retail stores and 360 leased departments. Overall maternity clothing sales is about $1B annually, and DEST has ~50% of the market with over $500M in sales. Key competitors include Old Navy, JCP, WMT and TGT. Mgmt will have you believe that maternity apparel is a steady business with stable birth rates and low fashion risk, and DEST is differentiated from its competitors with more comprehensive offerings and SKUs. I have no such illusion. Eye-balling the stock charts over the last 10 years will show two plunges from $40+ to sub $10. The reason behind the first dive in 2004 was due to competitors such as Old Navy and JCP increasing offerings. The result was a bloodbath for everybody in 2005 with bloated inventory. Big players retreated, and DEST roared back in 2006 as SSS and margin recovered and stock 5x'd in one year. Then came the recession and an unfavorable fashion trend of baby-doll and trapeze tops, which pregnant women can also wear. This drove the stock down to $5 at the bottom.

    While DEST is far from a stable business, I think the stock movement is more extreme than the underlying fundamentals. In last 10 years, worst-ever SSS was -5%, and the company usually bounces back after a negative year. Gross margins are generally respectable at low 50's and average op margin over the same period was 5% and the company never lost money on an operating basis.

     

    Income Statement Sep 01 A Sep 02 A Sep 03 A Sep 04 A Sep 05 A Sep 06 A Sep 07 A Sep 08 A Sep 09 A Sep 10 E

                       
    SSS       -5.0% -2.5% 4.3% -4.8% 0.2% -4.3%  
    Revenue $388.3 $453.2 $492.5 $518.1 $561.6 $602.7 $581.4 $564.6 $531.3 $548.0
            YoY Growth               -2.9% -5.9% 3.1%
            Inv Change YoY       0.0% 14.3% -11.0% 6.6% -12.3% -20.5%  
    Gross Profit $194.0 $241.5 $267.3 $278.4 $284.2 $314.7 $300.2 $283.0 $282.8 $295.9
            Gross Margin 50.0% 53.3% 54.3% 53.8% 50.6% 52.2% 51.6% 50.1% 53.2% 54.0%
            change YoY in bps



    (315) 160 (56) (151) 310 77
     - Selling, General & Admin Expense $172.8 $207.7 $230.1 $253.9 $269.9 $284.3 $281.5 $271.6 $259.6 $260.0
            YoY Growth               -5.7% -0.1%  
            SG&A as % Sales 44.5% 45.8% 46.7% 49.0% 48.1% 47.2% 48.4% 48.1% 48.9% 47.4%
    Operating Income $21.2 $33.7 $37.2 $24.6 $14.2 $30.3 $18.7 $11.5 $23.3 $35.9
            Op Margin 5.5% 7.4% 7.5% 4.7% 2.5% 5.0% 3.2% 2.0% 4.4% 6.6%
    EBITDA $33.1 $43.2 $47.0 $34.8 $29.7 $46.5 $38.6 $25.5 $40.0 $49.6
            EBITDA Margin





    6.6% 4.5% 7.5%
    Interest Expenses ($14.9) ($16.5) ($14.5) ($14.8) ($15.3) ($14.6) ($10.2) ($7.0) ($4.7) ($3.4)
    Net Income $3.5 $10.8 $14.0 $5.9 -$0.2 $9.1 -$0.4 -$1.4 $11.1 $19.5
    Shares 6.01 6.01 6.01 6.01 6.01 6.01 6.01 6.01 6.01 6.2
    EPS $0.58 $1.80 $2.32 $0.98 -$0.03 $1.63 $0.87 -$0.23 $1.77 $3.15











    D&A $11.9 $9.5 $9.9 $10.2 $15.5 $16.1 $16.4 $16.0 $15.0 $13.7
    OCF $19.5 $28.5 $30.0 $11.4 $7.3 $42.4 $27.4 $27.8 $42.5 $33.2
    Capex ($12.2) ($9.8) ($19.2) ($14.7) ($17.6) ($13.9) ($15.4) ($15.7) -$12.6 -$10.0
    FCF $7.3 $18.6 $10.8 -$3.3 -$10.3 $28.5 $12.0 $12.1 $29.9 $23.2

    Current Fundamentals: DEST's fundamentals resemble most retailers -- weak SSS but decent margins thanks to good inventory control and SG&A cuts. With just about every retailer cutting SKUs and controlling inventory, competitive landscape should remain benign - I doubt Glen Murphy at GPS will suddenly decide maternity clothing will be the new focus to drive SSS at Old Navy. Indeed, DEST saw Sears/Kmart came back as a customer after just one year. Mgmt also noted current fashion trends are mostly neutral - I am no fashion expert, but it will be hard for pregnant women to put on skinny jeans.

    SSS remains negative, but unlike most other retailers, compares will get progressively easier in the next few quarters, and DEST historically demonstrated a mean-reversion in SSS. Last month DEST reported a -1% SSS, and I hope the trend will continue.

    FY Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan
    1Q 2Q 3Q 4Q Year
    2001 -3.4% -1.5% -0.3% -6.0% 1.0% -6.5% -1.6% -9.3% -6.3% -2.0% 0.3% -1.5%





    2002 5.0% 7.6% 2.1% 4.5% 6.3% 6.8% 9.1% 2.6% 7.4% 7.9% 3.4% -2.7%





    2003 -5.0% 1.3% -4.5% 4.7% -0.6% 2.9% -1.7% -4.7% -5.5% -3.7% -5.4% 4.7%
    5.1% 0.2% -0.4% -1.4% 0.3%
    2004 7.8% -6.3% -0.4% -3.0% -10.9% -2.6% -13.0% -8.9% 1.0% -11.6% -1.9% 2.0%
    -5.0% 0.2% -5.0% -8.3% -4.9%
    2005 -2.3% -3.0% 3.1% -8.1% -0.5% -4.3% -0.5% 1.9% 1.7% 4.0% 3.5% -3.7%
    -4.2% -3.0% -1.9% -1.0% -2.5%
    2006 4.8% 2.2% 7.1% 5.5% 6.2% 3.9% 5.0% 10.6% -5.2% -1.0% -0.3% 3.9%
    3.1% 1.4% 6.4% 6.5% 4.3%
    2007 -4.7% 3.6% -14.8% -3.6% -5.4% -9.4% -3.7% -7.0% -3.9% 0.0% -7.6% -6.0%
    -2.1% -1.6% -8.2% -6.8% -4.8%
    2008 4.8% -6.0% 2.3% 4.3% 0.8% 2.8% 7.2% -1.3% 6.0% 0.6% -6.9% -2.1%
    -4.1% -1.7% 2.4% 2.8% 0.2%
    2009 -3.5% -7.6% -1.2% -5.7% -10.1% -9.0% -10.6% -7.0% -5.2% -11.6% -1.2% 5.1%
    -0.5% -2.8% -5.5% -8.7% -4.3%
    2010












    -5.9%



    Inventory remains well-controlled down double digit on a per store basis and is expected to remain down, even as mgmt implicitly expected a positive SSS in 2H '10. Mgmt has also cut SG&A to '04 level despite a higher sales base.

    Earnings: Mgmt had guided 11-29c ex-charges for the current quarter, but noted last week that EPS would come in higher. While guessing EPS is virtually impossible considering the low margin and tiny share base (DEST has just 6m shares, so $90 sales/share vs. a $18 stock price), I think 50c+ is quite likely. Mgmt had guided full-year EPS of $2.05 to $2.58, and my estimate is $3.10. If SSS can come in positive/higher than mgmt guidance, I think $4 EPS is not out of the woods. Note DEST did $2.30 peak EPS back in '03, but lower interest expense alone ($12M reduction) is almost $1.5 EPS/share.

    Op Margin EPS Power
    2.0% $0.73
    3.0% $1.26
    4.0% $1.79
    4.5% $2.06
    5.0% $2.32
    5.5% $2.59
    6.0% $2.85
    6.5% $3.12
    8.0% $3.91

     

    Valuation: Any way you slice it, the stock is cheap under 10x trailing, 7-8x mgmt guidance, 6x my estimate, 3x EV/EBITDA, 0.2x P/sales. Specialty retail peers trade at low-mid teen PE and 4-7x EBITDA. Balance sheet is not great with almost $37M net debt, but company is paying down debt with all the FCF (capex is lower than D&A), and I expect the company to be close to net-debt free by year end. One thing I like about the company is that despite a seemingly flaky business model, DEST paid down $90M of debt with FCF over the last 4 years, vs. current market cap of $110M. While some of that is from inventory reduction, this is still pretty remarkable considering the last 4 years were far from ideal for retailers and certainly for DEST.

    Stock  $       17.7
    Shares 6.2
    Mkt Cap  $        110
    EV  $        147
    EV/Sales 0.28
    EV/EBIT 4.1
    EV/EBITDA 3.0
    FCF  $         23
    FCFE % 21%
    FCFF % 16%
    P/E 5.6

    Under-the-radar: DEST has no sell-side coverage, and recent conference calls have largely become sad stand-up solo-shows for the CEO, who kept lamenting the stock is cheap on EV/EBITDA (his bonus is based on EBITDA). It is certainly encouraging that he backed up his words with action, buying close to $300K worth of stock on open market recently. The stock also has an interesting holder list - Crescendo Partners, an activist fund, Mill Road Capital, which has made a number of acquisitions in consumer space (Kona Grill, Cossette, and an unsuccessful bid at old VIC-favorite DFZ), Stadium Capital (sharp investing record in retail space), and Michael Price, the noted value investor.

    Risks:

     

    Catalyst

    Catalyst:

     

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