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Be Skeptical of This Retailer

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As a value investor, I often search for mispriced securities, which are trading well below its estimated intrinsic value. The business should have a high return on equity with low price/book and single digit P/E valuations. However, the screening should only be the very beginning of the investment process. Investors should look further to see whether it’s a real bargain or not. 

That is the case for Casual Male (NASDAQ: DXLG). At first glance, it is debt-free company with a return on equity of 25%, return on assets of 16.2%, and trades at only 6x trailing P/E. Is it really cheap? Or is there a reason it is that cheap? Let’s dig deeper.

CMRG is a multi-channel retailer with two primary retail brands: Casual MaleXL and Rochester Clothing. It is estimated that the company accounts for around 11% of the market share in men’s big & tall apparel industry. Currently, it has 360 Casual MaleXL retail stores, 60 Casual MaleXL outlet stores, 16 DestinationXL stores, and 14 Rochester Clothing stores.

For any retailers, comparable sales are an important figure. It is a measurement of productivity used to compare sales of retail stores that have been open for at least a year. CMRG has increased comparable sales in the last two years. In addition, the gross and operating margins (excluding impairment) have increased as well.

<table> <tbody> <tr> <td> <p><em>%</em></p> </td> <td> <p><strong>2011</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2008</strong></p> </td> </tr> <tr> <td> <p><strong>Comparable sales</strong></p> </td> <td> <p>2.1</p> </td> <td> <p>1.5</p> </td> <td> <p>-10.8</p> </td> <td> <p>-4.3</p> </td> </tr> <tr> <td> <p><strong>Gross profit margin</strong></p> </td> <td> <p>46.2</p> </td> <td> <p>45.8</p> </td> <td> <p>44.2</p> </td> <td> <p>42.7</p> </td> </tr> <tr> <td> <p><strong>Operating margin (before impairment)</strong></p> </td> <td> <p>4.1</p> </td> <td> <p>4.1</p> </td> <td> <p>2</p> </td> <td> <p>1.3</p> </td> </tr> </tbody> </table>

 Furthermore, CMRG has a history of generating positive cash flows.   

<table> <tbody> <tr> <td> <p><em>USD million</em></p> </td> <td> <p><strong>2002</strong></p> </td> <td> <p><strong>2003</strong></p> </td> <td> <p><strong>2004</strong></p> </td> <td> <p><strong>2005</strong></p> </td> <td> <p><strong>2006</strong></p> </td> <td> <p><strong>2007</strong></p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> </tr> <tr> <td> <p><strong>CFO</strong></p> </td> <td> <p>21</p> </td> <td> <p>12</p> </td> <td> <p>13</p> </td> <td> <p>17</p> </td> <td> <p>12</p> </td> <td> <p>12</p> </td> <td> <p>23</p> </td> <td> <p>31</p> </td> <td> <p>19</p> </td> <td> <p>23</p> </td> </tr> <tr> <td> <p><strong><span><span><span><span>Capex</span></span></span></span></strong></p> </td> <td> <p>-14</p> </td> <td> <p>-12</p> </td> <td> <p>-21</p> </td> <td> <p>-16</p> </td> <td> <p>-23</p> </td> <td> <p>-21</p> </td> <td> <p>-13</p> </td> <td> <p>-5</p> </td> <td> <p>-9</p> </td> <td> <p>-18</p> </td> </tr> <tr> <td> <p><strong>FCF</strong></p> </td> <td> <p>6</p> </td> <td> <p>0</p> </td> <td> <p>-7</p> </td> <td> <p>1</p> </td> <td> <p>-11</p> </td> <td> <p>-10</p> </td> <td> <p>11</p> </td> <td> <p>26</p> </td> <td> <p>10</p> </td> <td> <p>5</p> </td> </tr> </tbody> </table>

Cash flow from operations has been positive, but fluctuating for the last 10 years. And because of the large capital expenditure in 2004, 2006, and 2007, free cash flow turned out to be negative in those years. The average 10 years free cash flow is only $3.1 million.

Since 2003, there were 3 years that the company had net losses. Last year, it had $43 million in profit with 32% return on equity. But that interestingly high return is quite misleading. In fact, $43 million profit was largely contributed by $50 million benefit for income taxes. Actually, CMRG had $7 million operating loss last year. The $7 million operating loss was mainly due to $23.1 million provision for trademark impairment.

Retailers’ operating efficiency reflects in the cash conversion cycle, which equals days sales outstanding + days inventory – payables period. For CMRG, it seems to deteriorate over time. It is mainly due to the increasing trend in days inventory.

<table> <tbody> <tr> <td> <p><em>Efficiency</em></p> </td> <td> <p><strong>2002</strong></p> </td> <td> <p><strong>2003</strong></p> </td> <td> <p><strong>2004</strong></p> </td> <td> <p><strong>2005</strong></p> </td> <td> <p><strong>2006</strong></p> </td> <td> <p><strong>2007</strong></p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> </tr> <tr> <td> <p><strong>DSO</strong></p> </td> <td> <p>3.4</p> </td> <td> <p>5.3</p> </td> <td> <p>4.9</p> </td> <td> <p>4.0</p> </td> <td> <p>3.4</p> </td> <td> <p>2.6</p> </td> <td> <p>2.0</p> </td> <td> <p>2.1</p> </td> <td> <p>2.8</p> </td> <td> <p>3.3</p> </td> </tr> <tr> <td> <p><strong>Days Inventory</strong></p> </td> <td> <p>107.5</p> </td> <td> <p>137.3</p> </td> <td> <p>151.8</p> </td> <td> <p>130.8</p> </td> <td> <p>147.5</p> </td> <td> <p>164.2</p> </td> <td> <p>155.1</p> </td> <td> <p>156.0</p> </td> <td> <p>156.5</p> </td> <td> <p>168.2</p> </td> </tr> <tr> <td> <p><strong>Payables Period</strong></p> </td> <td> <p>27.4</p> </td> <td> <p>44.9</p> </td> <td> <p>50.4</p> </td> <td> <p>42.2</p> </td> <td> <p>45.5</p> </td> <td> <p>49.2</p> </td> <td> <p>41.7</p> </td> <td> <p>36.2</p> </td> <td> <p>31.9</p> </td> <td> <p>36.0</p> </td> </tr> <tr> <td> <p><strong>CCC</strong></p> </td> <td> <p>83.5</p> </td> <td> <p>97.7</p> </td> <td> <p>106.3</p> </td> <td> <p>92.6</p> </td> <td> <p>105.5</p> </td> <td> <p>117.7</p> </td> <td> <p>115.5</p> </td> <td> <p>122.0</p> </td> <td> <p>127.4</p> </td> <td> <p>135.5</p> </td> </tr> </tbody> </table>

It appears that CMGR’s inventory management has weakened over time, leading to the increase in the cash conversion cycle, from 83.5 days in 2002 to 135.5 days in 2011.

In the apparel industry, CMRG seems to underperform its peers, including Urban Outfitters (NASDAQ: URBN), Abercrombie & Fitch (NYSE: ANF) and American Eagle Outfitters (NYSE: AEO). Out of the four, CMRG is the smallest company, with more than $210 million market capitalization, whereas the rest is more than $2.5 billion market cap. In addition, CMRG is the only one, which has a negative operating margin, whereas the operating margin of URBN, ANF and AEO are 11.09%, 3.21% and 8.48% respectively. How about its operating efficiency, measured by cash conversion cycle?

<table> <tbody> <tr> <td> <p><em>Days</em></p> </td> <td> <p><strong>CMRG</strong></p> </td> <td> <p><strong>URBN</strong></p> </td> <td> <p><strong>ANF</strong></p> </td> <td> <p><strong>AEO</strong></p> </td> </tr> <tr> <td> <p><strong>CCC</strong></p> </td> <td> <p>132.54</p> </td> <td> <p>51.26</p> </td> <td> <p>85.96</p> </td> <td> <p>53.11</p> </td> </tr> </tbody> </table>

For the previous twelve months, CMRG takes the longest to convert its sales, inventories and payables into cash flow. As indicated in the table, it takes more than 132 days. CCC of URBN, ANF and AEO are all below 90 days. URBN seems to be most efficient. It has the lowest CCC, of nearly 52 days. 

Looking forward, CMRG expected its EPS for fiscal 2012 to be between $0.22-$0.25 per share, lower than the previous guidance of $0.22-$0.27 on comparable sales of 3-4%. Currently, CMRG is trading at $4.45 per share; the total market capitalization is $213 million.  The market is valuing the company at 6x P/E, 1.4x P/B and 13.4x P/CF on a historical basis. However, if its EPS is as the company expected for fiscal 2012, the P/E will be as high as 17x.

For insider trading issue, in the last 2 months, Holtzman Seymour, the chairman of the board, has been exercising his options at $3.15 per share and disposing his shares in the non-open market for $4.1-$4.5 per share at the same time. Since August, he has sold out his shares with the total value of $$1.25 million. Now he still owns 8.6% of the company, and his holding is worth $18.6 million.

My take: Even though CMGR looks great in stock screening, but I would avoid it for now because of the following:

  • A good profit in 2011 is mainly due to benefits for income tax, which is not recurring.  In fact, as mentioned above, CMGR produced an operating loss in fiscal 2011.
  • Operating efficiency weakened, indicated by increasing cash conversion cycle over time.
  • Forward P/E is high at 17x.
  • The chairman exercising options at a lower price and simultaneously selling those shares for more than $1.2 million in value in non-open market.

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