Jones Apparel Group
/ (JNY-NYSE) / $33.70Note: All new material since last report has been highlighted.
Overview
Jones Apparel Group, Inc. (JNY)is a leading designer, marketer and retailer of branded apparel, footwear and accessories. The company’s nationally recognized brands include Jones New York, Barneys New York, Anne Klein, Albert Nipon, Kasper, Gloria Vanderbilt, Norton Mcnaughton, Erika, Lesuit, Evan Picone, l.e.i., Energie, Nine West, Easy Spirit, Enzo Angiolini, Bandolino, Joan & David, Mootsies Tootsies, Sam & Libby, Napier and Judith Jack. The company also markets apparel under the Polo Jeans Company brand licensed from Polo Ralph Lauren Corporation, costume jewelry under the Tommy Hilfiger brand licensed from Tommy Hilfiger Licensing Inc. and the Givenchy brand licensed from Givenchy Corporation. For reporting purposes, JNY has five revenue segments: Wholesale Better Apparel, Wholesale Moderate Apparel, Wholesale Footwear and Accessories, Retail and Other.
JNY has grown through a series of acquisitions over past years, all of which have been made possible by the company’s strong balance sheet and free cash flow and most of which have allowed JNY to continue to execute on its multi-brand, multi-channel business strategy. Subsequent to the end of the quarter JNY announced the acquisition of luxury retailer, Barney’sNew York.
JNY reported a strong 3Q with all segments showing sales gains of 6 – 8%, except Wholesale Moderate Apparel, which declined 2%. Management pointed out that the third quarter was more challenging than the first two quarters of 2004 because consumer traffic during the period was negatively impacted by higher gasoline prices, hurricanes in the southeast and an unseasonably warm September in the northeast (which hurt the sale of winter boots). Jones ended the 3Q with 961 stores and intends to end the year with 989 stores. Management stated that JNY’s strong financial position has allowed them to endure and absorb various market inconsistencies throughout the year and they are maintaining a conservative outlook through fiscal year end.
Analysts have identified the following issues as critical to an evaluation of the investment merits of JNY:
Strengths/Opportunities / Weaknesses/ThreatsNew Products: JNY is planning to launch new products thatare expected to boost near-term sales. / Weaker margins: A tough selling environment has placed margins under tremendous pressure.
Better performance by Signature, Nine West and Anne Klein: The better performance by Signature, Nine West and Anne Klein will boost gross margins. / Tough sales environment:A higher level of off-price merchandise and a lower recovery rate make the operating environment very difficult.
Strategic acquisition of Barney: Barney’s New Yorkacquisition will broaden JNY’s retailing exposure into the luxury area. / Risky acquisition: Jones lacksluxury retail experience. Therefore, Barney’s New York could end up being a risky acquisition for JNY.
Strong Balance sheet and Free cash flow: JNY’s strong balance sheet and free cash flow will enable further acquisitions and share repurchase. / Disappointing Acquisitions: The acquisitions made by JNY over the past few years have been disappointing in that they failed to give sufficient impetus to growth.
Additional information is available from the company’s website,
JNY’s fiscal year ends December 31.
Sales
Jones Apparel Inc.reported net revenue of $1.296 billion in its fiscal third quarter (ended September 30), a record 9.8% increase, compared to $1.181 billion year-over-year. The acquisitions of Maxwell, Kasper and Anne Klein, as well as the successful launch of Jones New York Signature, contributed significantly to the increase in revenue. Net sales in Wholesale Better Apparel were $435.4, up by 6%. Sales in Wholesale Moderate Apparel declined by 1.7%. Wholesale Footwear and Accessories were up by 32.6%, Retail by 8.1% and Other increased by 52.1%.
Wholesale Better Apparel revenues increased primarily due to shipments in the new Jones New York Signature product line($57.8 million) and in product lines added as a result of the Kasper acquisition ($101.6 million). These increases were offset by the discontinuation of the some of the Ralph Lauren licensed businesses. Increased shipments of Jones New York Sport, Polo Jeans Company and Nine West were offset by the discontinuation of the Rena Rowan product line in Better department stores.
Wholesale Moderate Apparel revenues decreased primarily as a result of lower shipments of Norton McNaughton, Erika, Evan-Picone, Nine and Company and private-label denim businesses, partially offset by increased shipping in Energie, Gloria Vanderbilt and Bandolino, as well as initial shipments of A-Line.
Wholesale Footwear and Accessories revenues increased primarily due to the product lines added as a result of the Maxwell acquisition ($65.9 million) as well as higher shipments of Nine West footwear and accessories product lines, the introduction of Bandolino accessories, and the inclusion of the Anne Klein accessories product line obtained in the Kasper acquisition. These increases were partially offset by a reduction in shipments of Easy Spirit and Enzo Angiolinifootwear products.
Retail revenues increased primarily as the result of $17.7 million in sales from locations added from the Kasper acquisition, partially offset by a 1.1% decrease in comparable store sales.
JNY forecasts 4Q net revenue to range from$1.035 billion to $1.045 billion. For the FY04, the projected net revenue is $4.65 billion. For the FY05, JNY forecasts total revenues to range from $5.3 billion to $5.4 billion. Jones now projects that Retail will account for 24% of 2005 sales against previous expectations of 17%,because of the pending acquisition of retailer Barney’s New York.
One analyst (AG Edwards) expressed concern over the Footwear and Moderate Apparel segments. Its long-term revenue outlook projects only mid-single digit organic growth. Another analyst (Banc of America) opines that new product launches and continued brand extensions should support top line growth for a moderate FY05. The analyst believes that the Moderate group could increase market share from approximately 30% to a range of 30% and 40%.
Margins
JNY’s total gross margin decreased 68 bps to 35.6%. This included a 90 bps decline from the mix shift in the “Better” business and a 45 bps decline from non-cash purchase accounting adjustments related to Maxwell acquisition. Operating profit margin for 3Q was down by 121 bps to 12.7%, compared to 13.9% year-over-year. The decrease includes $16.9 million of non-cash purchase accounting adjustments associated with the acquisition of Maxwell Shoe Company.
Wholesale Better Apparel gross margins were 33.9% compared to 36.5% year-over-year, decreasing because of product discontinuations and the addition of the acquired Kasper business which generated lower margins than the historical segment average.
Wholesale Footwear and Accessories gross profit margins were 32.7% compared to 33.8% year-over-year. Margin improvement in wholesale accessories and costume jewelry businesses was offset by $6.0 million in accounting adjustments required to write up acquired Maxwell inventories to market value.
Retail gross profit margins were 51.9% and 53.1% for the third fiscal quarters of 2004 and 2003, respectively,due to a more promotional selling environment in retail footwear stores and lower margins in Canadian retail operations. Margins were negatively impacted by the addition of the acquired Kasper apparel retail outlets, which generate lower margins than the historical segment average.
SG&A expenses of $297.2 million in 3Q04 represented an increase of $32.8 million from the prior year quarter. Kasper added $25.2 million to the Wholesale Better Apparel segment and $6.5 million to the Retail segment while Maxwell added $19.0 million to the Wholesale Footwear and Accessories segment. SG&A expenses related to retail operations also increased because of additional store openings. These increases were partially offset by a $16.7 million reduction in royalty and advertising expenses.
One analyst (Banc of America) expects Moderate’s margins to expand in 2005. Also solid performance from Signature, Nine West and Anne Klein are expected which will contribute to better margins. The analyst expects operating margins to be in the 14% - 15% range. Another analyst (Merrill) thinks that several factors are negatively affecting operating margins. Excluding non-cash purchase accounting charges, margins in the Better segment will be 14.2%. The analyst thinks that JNY has seen some margin recovery in the Moderate segment. Another analyst (TD&Co.) estimates that operating margin will improve 8.6% or 50 bps.
Earnings per Share
JNY reported a 3Q EPS of $0.77, a penny below consensus, compared to $0.71, up by 8.5% year-over-year. During 3Q, the company repurchased 2.15 million shares of common stock in the open market at an aggregate cost of $79 million.
Subsequent to the third quarter, JNYpre-announced and issued guidance for the fourth quarter, FY 2004 and FY2005. Management expects EPS to range from $0.28 to $0.30, down from previous guidance of $0.40 to $0.45, for 4Q. For FY04 EPS are expected to range from $2.39 to $2.41, lowered from $2.51 to $2.56. For 2005, the company projects growth of 15 - 21% or a range of $2.75-$2.90 EPS.
Digest EPS ranges from $0.40 to $0.45 for 4Q and from $2.51 to $2.56 for FY04. For FY05the range is $3.00 to $3.17. Two analysts (SG Cowen, Tradition Asiel) raised their EPS.
Table-2 – Earnings Per Share
FY ending December / 2003 / 1Q04A / 2Q04A / 3Q04A / 4Q04E / FY2004 / FY2005Zacks Consensus / NF / NF / NF / NF / NF / $2.41 / $2.78
Digest High / $2.48 / $0.73 / $0.61 / $0.77 / $0.44 / $2.55 / $3.17
Digest Low / $2.48 / $0.73 / $0.61 / $0.77 / $0.29 / $2.39 / $2.70
Digest Average / $2.48 / $0.73 / $0.61 / $0.77 / $0.34 / $2.45 / $2.89
Digest YOY growth / -12.7% / -18.9% / 13.0% / 8.5% / 3.0% / -1.2% / 18.0%
Management Guidance / NF / NF / NF / NF / $0.28-$0.30 / $2.39-$2.41 / $2.75-$2.90
Target Price/Valuation
Of the 12 analysts that cover JNY, 4 have a positive rating, 6 have a neutral rating, and 1 has a negative rating. One analyst (SG Cowen) did not provide any rating.
Research analysts have set 12-month target prices that range from $30 (CSFB) to $43 (UBS). The digest average price target is $37.86. The majority of the analysts are using P/E multiples of EPS that range from 12 to 14 times. One analyst (TD&Co) is taking 12 times 2005 EPS to calculate its low-end target price while another analyst (UBS) is using 14 times of 2005 EPS for the same.
Additional Discussion
On December 20, 2004 JNY purchased Barney’s New York for what is deemed by the Street to be a fair price. The merger is expected to generate some EPS accretion but may simultaneously have questionable overall return. The deal was an all-cash transaction with total consideration of around $400 million, including $294 million in equity and $106 million for the repurchase of Barney’s senior notes, implying a deal valuation broadly in line with norms. JNY does not anticipate immediate cost cutting synergies from the transaction although over time, Barney’s could benefit from the back office capabilities of JNY, especially as it expands its store base.
The purchase of Barney’s New York brings JNY’s Retail segment to 24% of its revenue, up from 17% of its revenue now. While the acquisition of a luxury retailer plugs a long time hole in JNY’s product line some analysts express concern that the company may experience integration and execution difficulties as it attempts to grow an entity as complex as Barneys.
Long-Term Growth
Analysts’ long term growth rates range from 8% (Banc of America) to 15% (Lehman). One analyst (UBS) opines that Jones is improving its production to meet individual retailer needs and offer differentiated products faster, which will ultimately propel top line growth.
In the coming year Jones will take more steps to boost sales. First, Comfort Squared technology is finally available for its Easy Spirit line. The Jones New York brand will expand to a three-category lifestyle encapsulating Signature, Collection and Sport. Jones has also scheduled several new moderate channel product launches for 1Q05, including Rena Rowan career, Pappagallo sportswear, Dresses and Denim, Bandolino casual sportswear and Nine & Co. casual sportswear.
JNY plans to work with retailers to reduce sudden and dramatic merchandising shifts between seasons, which create the supply/demand imbalances in key categories.
Individual Analyst Opinions
POSITIVE RATINGS
Banc of America –Buy ($42): report date1/24/2005
Analyst has recently lowered price target to $42. The analyst believes that the company is well positioned to benefit from signs that Moderate is at the beginning of a cyclical upturn and that Better and Footwear will benefit from easy comparisons. Lowered guidance comes from higher than expected promotions in Footwear and Better Apparel and lower recovery rate on off-price shipments than anticipated.
J.P. Morgan – Overweight: report date 1/24/2005
The analyst has an Overweight rating to the stock. The analyst is upbeat about the Barney’s acquisition and believes that near term growth will be strong. However, analyst expresses concerns about long term execution and growth opportunities. Notes that the negative pre-release was occasioned by better apparel and footwear suffering the weakest performance relative to plan of JNY’s segments. Therefore, they were subject to the greatest promotions and cancellations. Specifically, this means that the weather was hot in the early fall and boot sales never materialized.
Tradition Asiel – Buy ($39): report date 1/21/2005
The analyst maintains its Buy rating with a price target of $39. The analyst believes that Jones is wellpositioned in the apparel and footwear arena and that the stock has been overly punished for the weakness in boots this fall.
UBS –Buy1 ($43): report date 1/21/2005
Analyst views several opportunities for JNY and notes that the fundamental story is intact despite recent disappointments. Notes that stock weakness in the past has provided a good buy opportunity. JNY’s inventory pipeline is very clean and management stays conservative, indicating that there could be upside when things improve.
NEUTRAL RATINGS
A.G.Edwards- Hold/Aggressive: report date 1/18/2005
The analyst rates the stock Hold. The analyst is concerned about Footwear and Moderate apparel segments. It also fears that management is focusing too much on Barney’s acquisition.
Goldman –In-Line: report date 11/14/2004
Given JNY’s lack of expertise in luxury, analyst does not see the addition of Barney as lucrative for Jones. This latest negative pre-announcement was the company’s third straight disappointment.
Lehman –Equal Weight ($40): report date 11/11/2004
Analyst blames the difficult retail environment not JNY for the latest earnings disappointment. Analyst is encouraged by company’s commitment to inventory management. Notes that the balance sheet remains strong. While EPS for 4Q and FY04 and FY05 were lowered cash flow estimates were not.
Merrill – Neutral: report date 10/27/2004
The analyst rates the stock Neutral. The analyst thinks that Jones is facing some secular margin pressure. The analyst is cautious over the stock due to tough year-over-year comparisons.
Prudential –Neutral Weight($35): report date 1/21/2004
Analyst has reduced price target to $35 on negative earnings pre-announcement. The analyst thinks that the estimates have bottomed and near-term upside is possible.
TD&Co. - Hold ($36): report date 12/13/2004
The analyst initiates coverage with a hold rating and a target price of $36. The analyst believes that Jones long-term prospects are bright due to growth in sales and earnings combined with strong free cash flow, which should support its ongoing acquisition, share repurchase and dividend priorities.
NEGATIVE RATINGS
CSFB – Underperform ($30): report date 11/11/04
The analyst is providing an Underperform rating with a target price of $30. Given Jones poor record of acquisitions, lack of experience in luxury retail, and the reticence of established luxury retailers to bid up for Barney’s, the analyst believes that Jones acquisition of Barney is significantly risky.