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Movado Investment Thesis

Movado Investment Thesis

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Published by benclaremon
This is my updated research on Movado Group (MOV). After a recent pullback the stock now trades at about 47% of tangible book and 67% of current assets minus total liabilities, thus making it a Ben Graham net-net. What is unusual is that it is rare to see a company with such a strong brand trading at these levels.
This is my updated research on Movado Group (MOV). After a recent pullback the stock now trades at about 47% of tangible book and 67% of current assets minus total liabilities, thus making it a Ben Graham net-net. What is unusual is that it is rare to see a company with such a strong brand trading at these levels.

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Published by: benclaremon on May 13, 2009
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The Inoculated Investor 
Movado Group (MOV): 5/13/2009- $7.61Investment Thesis
MOV is a well recognized luxury watch and jewelry company whose shares have recently been trading atextremely depressed levels. From a 52 week high of $26.17 in late September 2008, shares of MOV plunged all the way down to a 52 week low of $4.65. However, they have recently rebounded to around$7.60 per share. As a result of declining demand for luxury items all over the world and a recent breach of acertain debt covenant, MOV now trades at about 47% of listed book value (and tangible book value as thecompany has no goodwill or other intangibles). Even given the global consumer slump, concerns about thecompany’s debt situation, and the potential lasting effects of the current crisis, the fact that a company withsuch a strong global brand is trading at or near liquidation value may be indicative of an irrationalmispricing. The following analysis is an intentionally brief summary of the risk and potential rewards of  buying shares of MOV at the current levels. The conclusion at the end of the analysis provides the rationalfor monitoring this stock but recommends holding off on buying shares until some realistic catalystsemerge. For much more detailed information on margins, valuation, and industry comparisons please refer to the appendix.
Company Background
MOV is a US-based company that designs, markets and distributes watches and jewelry. The company wasfounded in 1967 and has a portfolio of 9 watch brands (including licensing agreements): Movado, Ebel,Concord, Coach Watches, HUGO BOSS Watches, Tommy Hilfiger Watches, Juicy Couture Watches andLacoste Watches. The company also sells Movado-branded jewelry at its 29 retail boutique and 32 outletlocations in the US. However, the company’s main revenue source is the wholesale distribution of watchesto retailers throughout the world. Traditionally, the wholesale segment has made up about 80% of revenuesand 90%+ of operating profits. In terms of geographic breakdown, in the most recent year ended January31, 2009 (fiscal year 2009) approximately 55% of sales were to customers in the US and 45% were toforeign customers.
Concerns/Risks
1.Debt covenant breach
Movado has $65M of total debt on its balance sheet, all of which is now classified as current due to the breach of an interest coverage ratio covenant upon reporting full year fiscal 2009 earnings.Specifically, all three of MOV’s debt facilities/instruments require the company to maintain an interestcoverage ratio (Trailing 12-month GAAP EBIT/Cash Interest Paid) above 3.50x. However, as a resultof $15.6M of non-cash charges for FY 2009, MOV’s reported interest coverage ratio dropped to only2.45x. While none of its lenders have made any attempt to force MOV to pay off all the debt, thecompany is concerned about the covenant breach and is actively looking to negotiate new facilities to pay off the currently outstanding debt.
Debt BreakdownQ4 2009RateMaturity
US Revolving Credit Facility$40LIBOR+ .5%-.875%Dec-10Series A Notes106.90%Oct-10Senior Series A-2004 Notes154.79%Oct-11Total$65
According to the recently filed 10-K, MOV is in the process of trying to obtain a new $110M, 3 year asset-backed facility to be used to retire all $65M of the current debt. The company has indicated thatits interest costs are likely to rise as a result of higher rates and that there will be some restrictions ondividends, share buybacks and additional debt. However, the company anticipates the financialcovenants to be less onerous. This facility is expected to be complete by May 2009, but even if it is notthe company has already received commitment from Bank of America for a 3 year $50M asset backedcredit facility. It should be noted that the company also has $86.6M in cash ($20M+ in net cash) on the balance sheet that could also potentially be used to pay off some of the debt. The company alsoeliminated the dividend and has stopped buying back shares in order to bolster liquidity.
 
The Inoculated Investor 
http://inoculatedinvestor.blogspot.com/
2.
 Lasting concerns regrinding demand for luxury goods
MOV sells watches and jewelry that range in price from $165 (Lacasote Watches) to $37,700 (Ebelwatches) aimed at wealthy and aspirational consumers. As a result of this focus, the recent pullback inconsumer spending has taken a toll on MOV’s income statement. This was especially true in Q4 2009(typically the company’s best quarter due to holiday gift giving) when sales fell off a cliff. Year over year sales were down 35%, with US wholesale down an amazing 60.5% and international wholesaledown 33.5%. For the full year 2009 wholesale revenue was down 17.5% and retail same stores boutique sales were down 17.3%. The company has averaged about 56% of sales in the 2
nd
half of theyear but many of these sales did not materialize as a result of the rapid financial meltdown at the end of calendar year 2008. The only bright spot was the outlet stores, which had positive comparable storesales of 6.9%. Unfortunately for the company, higher outlet sales lead to a negative margin mix shift.The aforementioned plunge in sales when combined with the non-cash charges led to an operating lossin Q4 2009 and a full year net income figure of only $2.3M, down from $60.9M in FY 2008. When theone time items are stripped out, D&A are added back, and CAPEX is subtracted from net income, thecompany produced owner’s earnings (Net income+D&A-CAPEX +/- Extra Items) of $12M for FY2009. In terms of unlevered free cash flow, the company lost $12.2M dollars but this figure wasskewed by the effect on net working capital of reclassifying all of the company’s debt as current.Without the change the company would have been decidedly cash positive for the full year. The factthat the company did not burn cash in an extremely difficult retail environment is actually veryimportant. Assuming this downturn is going to last multiple quarters it is crucial for MOV to be able tocut costs and maintain positive cash flow in order to pay down debt and have sufficient liquidity.The question going forward is what the lasting impact of the current crisis will be on MOV’s long termsales and margins. After being somewhat blindsided at the end of FY 2009, the company has takencertain measures to attempt to right size expenses for the anticipated continued lackluster demand for watches and jewelry. In FY 2009 the company initiated some cost saving measures that the companyhas guided will reduce operating expenses by $50-60M in FY 2010 and beyond. These measuresinclude inventory reduction, reduced staffing, and decreased marketing expense. When these initiativeswere first announced on the Q3 conference call, the management team indicated that it believed thecompany could eventually achieve a 15% operating margin as a result of cost cutting. To put that intocontext, the average operating margin from FY 2005-2009 was 7.6% and the FY 2009 operatingmargin was only .7%. While the recent circumstances make a 15% operating margin look veryoptimistic, the company has started cutting costs and expects the majority of the savings to berecognized in the second half of 2010. Accordingly, the company expects to lose as much as a $1 per share over the first half of the year but achieve a small profit for the full year (excluding one timeitems) as a result of cost savings and retailers restocking for the holiday season. Investors should beaware that a prolonged recession in the US and abroad may limit the amount of restocking and shouldnot base an investment decision on the potential for a second half recovery.
3.
 Lackluster Retail and US Margins
FY 2008FY 20095 YR AVGSegment Operating MarginProfitMarginProfitMarginMargin
US($18.1)-5.5%($31.3)-12.3%-2.5%International68.8 29.7%34.7 16.9%25.3%Total$50.79.1%$3.40.7%7.6%
Operating MarginFY 2005FY 2006FY 2007FY 2008FY 20095 YR AVG
Wholesale9.6%11.0%10.8%10.8%2.3%8.9%Retail2.7%6.7%4.8%0.6%-5.9%1.8%Total8.4%10.2%9.8%9.1%0.7%7.6%
 
The Inoculated Investor 
http://inoculatedinvestor.blogspot.com/The two above tables highlight the main concerns regarding MOV’s overall strategy. The first tableillustrates the discrepancy in margins between the US division, which includes the retail stores, and theinternational division, which only consists of wholesale operations. The company does not break downad spending between the US and international divisions, but the sense an investor gets from listening toconference calls and reading company filings is that the company’s profligate use of celebrityendorsements and expensive advertising impacts the US margins to meaningful degree. The secondtable shows that the retail margins for the boutiques and outlet stores have been slightly positive tonegative over the last five years and have dragged down the company wide operating margin.According to management the stores are profitable on a “four wall basis” but when the advertisingrequired to support those locations is added the margins shrink meaningfully. The retail locations alsorequire a significant amount of capital expenditures to maintain and grow the store base. In FY 2009the company spent $22.7M on CAPEX and has averaged over $20M over the past 5 years. Prudently,in response to the slowdown in sales management has indicated that it expects CAPEX to be no morethan $10M in FY 2010.The most important thing for investors to consider is whether or not the retail strategy is working at all.The CAPEX and advertising required to support and promote the retail base drag down earnings, freecash flow and margins. The retail margins also appear to be the main driver of the US segment’s feebleoperating margins. While the outlets seem to be performing well as consumers become more costconscious, the boutiques have been hit hard by the consumer retrenchment. The outlets also provide away for the company to get rid of discontinued inventory at higher margins than in liquidation.Accordingly, the outlet strategy seems to make sense on multiple fronts. However, the troubles of the boutiques versus the outlets are one reason an activist shareholder could be interested in MOV. Basedon the recent data and the expectation that consumer spending might not get back to 2007-2008 levelsfor years, there could be an opportunity to eliminate stores and decrease marketing spendingsubstantially to improve margins. As of the filing of the 10-K, MOV had about $85.7M in total leaseobligations, with more than 25% of the total obligation owed more than 5 years from now. There is noway to know exactly what ability MOV has to get out of these leases so while it may be prudent to exitsome of these leases there is no question lease terminations could be costly. At a very minimum thedata indicates that the company would be well served to limit the number of new store openings untilthe retail margins can be improved. It is worth noting that the retail strategy could benefit from morescale, but with only about 60 stores focused on very high end consumer it seems unlikely that thecompany will be able to achieve economies of scale without building more stores than the market canlegitimately support.
Margin and Expense Comparison
MOVMOVFOSLBULUH
(Data from most recent filings)
FY 20095 YR Avg.5 YR Avg.5 YR Avg.5 YR Avg.Gross Margin
62.4%60.7%51.9%64.2%80.4%
Operating Margin
0.7%7.6%12.2%14.5%19.3%
Net Income Margin
0.5%6.5%8.1%12.1%15.4%
ROE
0.5%9.3%16.5%17.0%15.7%
SG&A Margin
61.7%53.1%39.7%48.7%29.8%
Marketing/Ad Expense %
17.4%16.0%7.0%11.5%15.7%
Lease Expense %
3.8%3.1%3.3%5.6%6.3%
This table simultaneously illustrates a major concern and major opportunity for MOV for the future.Assuming the world will eventually get out of its current economic malaise, addressing thediscrepancy when it comes to important return metrics between MOV and its competitors couldincrease shareholder value significantly. As indicated above, before the dramatic reduction in sales themanagement team at MOV suggested that it believed the company could achieve a 15% operatingmargin by reducing costs. With just a brief glance at the table it looks as though the company has a lotof work to do in order to accomplish that goal. However, a closer look at the percentage of sales thatMOV spends on advertising and marketing each year fleshes out what appears to be the main reasonfor operating and net income margins that lag those of the rest of the group. The data shows that MOV

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