Private Equity is Circling This Jeans Designer

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In November, jeans manufacturer True Religion Apparel (NASDAQ: TRLG) announced that it was looking to go private and take itself out of the public spotlight.  Perhaps as a result of its lower brand name recognition, the company doesn't attract much interest from investors, trading at a low 13 P/E multiple that is below the valuations of larger peers Ralph Lauren (NYSE: RL) and Coach (NYSE: COH).  With billions in annual sales, both of these competitors have done a much better job of creating mass market brands through the licensing of a variety of products.  Investors might be missing the boat here, though, since True Religion has enviable assets, including a loyal customer base, a $200 million cash position, and a consistent record of profitability.

Building a Religion

Founded in 2003, True Religion manufactures fashion jeans and related denim apparel for the premium-priced market, with a pair of its jeans selling for an average price of $255 in FY 2011.  In addition to its signature jeans, the company also sells denim-based shirts, jackets, and sportswear.  True Religion started as a wholesale supplier to the upscale department and specialty stores, but it has increasingly moved into the retail area with its own global store base. 

In its latest fiscal year, the company reported increases in revenues and operating income of 15.4% and 6.7%, respectively, versus the prior year.  Sales growth benefited from an additional 15 stores in operation and a 10.9% increase in comparable sales in the U.S. market.  While True Religion’s gross margin rose due to a greater percentage of sales from company-owned stores, its operating margin was negatively affected by the costs associated with building and maintaining its own stores.

In FY2012, the company has continued on an expansion path, opening an additional 22 stores in the U.S. and select international markets through the end of September.  However, True Religion has generated mixed sales results during the period, with a 12% gain in the U.S. segment and a 1% decline in the international segment.  Its operating margin also continued a multi-year decline, as the overhead costs necessary to manage a global store base have grown faster than sales.  Despite the near term growing pains, though, True Religion is still solidly profitable and maintains a rock-solid balance sheet.

Follow the Brand Leaders

As a standalone entity, True Religion needs to invigorate growth by broadening its brand beyond the premium-priced denim market via the licensing channel.  While the company has engaged in some licensing activities, the segment accounted for less than 1% of total sales during the first nine months of 2012.  This strategy has worked well for both Ralph Lauren and Coach.

Like True Religion, Ralph Lauren was founded by a fashion designer looking to build a brand from a quintessentially American style.  Starting with the sales of ties, Ralph Lauren has become a $7 billion global apparel giant that includes men’s, women’s, and kid’s clothing, fragrances, and home furnishings.  The company also started as a wholesaler to department stores, but has amassed a store base of roughly 900 locations around the world.

In the first six months of FY2012, Ralph Lauren reported flat sales versus the prior-year period, with a fairly even split between the retail and wholesale markets.  Despite the below-average sales growth, the company maintained its operating efficiency and generated substantial excess cash flow, which it used to enhance shareholder value through share repurchases and investments in its core brand.  Ralph Lauren also isn't afraid to close underperforming units, as it closed its Rugby and American Living brands in 2012.

In a similar fashion, Coach’s multibillion-dollar fashion empire started with the sale of a single product, high-quality, premium-priced handbags.  While the bags still account for roughly 65% of total sales, the company has used its loyal customer base to sell a range of accessories and licensed products.  In its latest fiscal year, Coach reported increases in revenues and operating income of 14.5% and 15.9%, respectively, versus the prior year.  Despite near-term profit pressures due to economic weakness in certain international markets, Coach continues to invest in its brand and pursue growth opportunities, especially in the Asia-Pacific region.

The Bottom Line

With a fairly cheap market valuation, True Religion is an interesting story with or without a buyout.  It would make a good portfolio addition to a retail-focused investment firm like Sycamore Partners, which acquired U.S. retailer Talbot’s during 2012.  In the meantime, the company is making some good moves, including pursuing international growth opportunities and initiating a dividend.  If it can successfully extend its brand and products to a wider market, it should significantly increase its market value.  That makes True Religion one for the portfolio.


rghanley owns shares of True Religion Apparel. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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