TOO is a mall based retailer focusing on the “tween” market of girls between the ages of 7 and 14 that is experiencing temporarily depressed EBIT margins. With $4.44 per share of net cash and building about $1 share of cash per year (not including share repurchase) and currently buying back up to $95mm of stock, it could double over the next three years.
The company recently shifted its marketing dollars away from catazines (a combination catalog-magazine) and direct-mail to a broad-based TV campaign. The strategy did not drive customer traffic this spring and in May TOO reduced Q205 EPS guidance to $0.05 (flat vs. last year, $0.03 below the street). Shares sold off 10% on the announcement. We believe that the market over-reacted for two reasons: (1) Q2 is not important in terms profits for TOO (last year it represented just 3% of profits), (2) the problem is marketing, not merchandising related, which is an easier and less costly problem to fix.
Additional opportunities include the return to 2002 operating margin, 12%, and Justice - the Company's fast-growing off-mall concept that is presently a drag on EBIT margins - breaking even in 2006. TOO also has a unique opportunity to improve lease terms as 35% of leases are up in next 3 years.
The CEO, Michael Rayden, has been running the company since 1996 and TOO spun-off from The Limited in August 1999. Since that time he has done a good job growing revenues, improving operating margins and being disciplined about spending capital to improve stores. He has also tried a few concepts that failed and was disciplined enough to stop the experiments before they consumed too much capital, and he implemented an extensive set of programs to become the country’s experts on tween girls.
At $22.40, TOO trades for 4.4 x 2007 EV/EBIT. We believe that the stock could double over 3 years if management is able to execute its Justice growth plan and improve operating margins.
MVE: 804.6 mm
EV: 594.5 mm
EV 2007 (assuming no share repurchase and stock at $22.40): 494.5 mm
2003 EBIT: 46.4 mm
2004 EBIT: 64.4 mm
LTM EBIT: 67.8 mm
2007 EBIT: 114 mm
Stock trades at 11 x EBIT: $33 per share
Cash: $6.83 per share
Total: $39.83 per share
Revenue will grow from 686 mm to 950 mm
TOO stores will grow from 568 today to 580 in 2007
Justice stores will grow from 47 today to 200 in 2007
EBIT margins will increase from 9.9% today to 12% in 2007
Net cash will grow from 160 mm today to 260 mm in 2007
Fully diluted shares outstanding will grow from 35.9 mm today to 38 mm in 2007
Fashion or marketing missteps, cannibalization of Limited Too by Justice, slowdown in consumer demand.
EBIT margins return to 12%
Justice grows to 200 stores
|Entry||06/22/2005 05:22 PM|
|To get to your assumed 12% margin in 07, does that all come from turning the Justice business from a negative margin to a positive margin or does it also require a rebound in the core business margins? For 07 what are you assuming for the core margin? If you assume it is better than 10-11% (the margin in 00 and 01) what gives you that confidence? Are peak margins of 12.5% for the core biz attainable again?|
|Entry||06/23/2005 11:33 AM|
|We assume positive margins at Justice and a rebound in the core business can bring the combined operating margin to 12%. For the core business, we think that peak margins are attainable again for two reasons: (1) improved sales per square foot from the new concept “It’s a Girl’s World” and (2) improved lease terms. When the “Girl Power” format was rolled out in the late 1990’s, sales per square foot improved dramatically. For Justice, we think the four-wall profit margin will be slightly lower than the core operating margin due to lower sales per square foot, but since corporate expenses will remain relatively fixed, the combined operating margin will be 12%.|