High Growth Prospects for This Fashion Icon

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Founded in 1982, Vera Bradley (NASDAQ: VRA) has become an iconic brand in the U.S. and abroad. It has a distribution network of over 3,300 independent retailers and is in the early stages of rolling out its own retail stores. If everything goes as planned, then the company's stock is severely undervalued. However, the many obstacles that could derail its growth are a legitimate cause for concern.

High-Quality Products for Everyone

Vera Bradley's products are popular among a diverse set of customers. Unlike Coach (NYSE: COH), Vera Bradley offers an array of products at price points that attract customers across the income spectrum. For instance, its handbags range in price from $25 to $130 and its luggage/travel accessories range from $15 to $340. Meanwhile, Coach's products are targeted at a more affluent customer base. Most of its handbags are priced above $250, some much higher. As a result, Coach earns much higher gross margins than Vera Bradley.

Vera Bradley's gross margins are more similar to that of Fifth & Pacific Companies (NYSE: FNP), which owns brands that cater to high spenders as well as brands that cater to lower spenders. FNP's Juicy Couture brand has price points similar to that of Vera Bradley, but its Kate Spade line has higher price points. Still, Vera Bradley routinely earns a slightly higher gross margin on its products than FNP.

<img src="/media/images/user_13490/vra-gross-margin_large.png" />

However, operational superiority allows Vera Bradley and Coach to earn strong operating margins, whereas FNP struggles to turn a profit. As a result, Vera Bradley can safely occupy the mid-tier price point without being preoccupied about rapid expansion from FNP.

Long Runway for Growth?

Vera Bradley's price point diversity positions it for high growth. Revenue grew 27% and 26% in 2010 and 2011, respectively. Sales are expected to continue growing at a double-digit pace as the company rolls out its own retail stores, a departure from its traditional channel of going through independent retailers. The company has also opened retail stores overseas, most notably in Japan.

However, with products in over 3,300 stores already, some investors are concerned that adding its own retail stores will only cannibalize sales. However, a slide from the company's recent investor presentation shows that many U.S. markets remain under-penetrated.

<img src="/media/images/user_13490/vra-market-penetration_large.png" />

There remains, however, the risk that over-expansion leads to a tarnished brand due to its wide availability, not to mention the risk of losing established retail partners who become dissatisfied with having to compete with Vera Bradley retail stores. Brand image risk and retail partner risk are the two biggest causes of concern that could derail the company's growth, but it is near impossible to have reliable insight into the outcome until Vera Bradley is further along in its expansion.

Valuation

Valuing a company with a short history of public filings and high growth prospects is not an easy task. First, let's look at the company's trading multiples. VRA trades at 25x last year's earnings, 14x EV/EBITDA, and 45x last year's free cash flow. Clearly, the market is pricing in a great deal of growth.

The company earned a 20.62% pre-tax margin in 2011. Assuming sales grew 15% in 2012 and the margin holds, the company will earn $109 million before tax in 2012. The company currently trades at about $968 million, which is 8.9x 2012 pre-tax earnings if our assumptions are correct.

The Big Picture

It is possible to continue making assumptions and plugging in values in a spreadsheet to come up with a range of values for Vera Bradley's stock, but the important consideration is a lot more simple than an exact valuation. It is clear that the market has priced in a fair degree of growth, but not too much. The market is hedging its bet; the stock sits between the value of the company if its expansion efforts are successful and its value if expansion is a flop. The prospective investor's task is to decide if expanding its retail presence will ultimately help the brand while not inciting anger from its existing retail channel relationships, or if the company will fall flat on its face.

So, Vera Bradley is either wildly undervalued or wildly overvalued; you decide.


titans8904 has no position in any stocks mentioned. 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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