Can Lands’ End Right Its Ship?

LE_a_revSummary:

  • Lands’ End (LE) has under-performed and is facing declining sales. But there aren’t very many billion dollar single apparel brands and even fewer brands that generate over a billion dollars thru a direct/e-commerce channel. With over $1.4 billion in total sales and $1.2 billion from its direct channel, LE is one of them.
  • In my opinion, the decline in sales is due in part to the last decade of being owned by Sears and its ongoing relationship with Sears since its spin-off in 2014. However, an end to the Sears burden is in sight as the contractual retail lease commitments with its former parent are scheduled to wind down completely by January 2020.
  • The Lands’ End’s direct-to-consumer business model makes it the opposite of a traditional apparel retailer. With over 85% of its annual revenue from direct-to-consumer sales, Lands’ End is uniquely positioned and ahead of the curve in the industry’s acceleration towards e-commerce and away from brick-and-mortar retailing.
  • LE is a prime acquisition candidate because of its billion dollar size, its “only sold here” exclusivity, and its plug-n-play integration due to its 85% direct channel model. Unlike traditional apparel wholesalers and retailers whose products are sold in many other physical stores, LE sells directly to its consumers, so the brand can be easily transferred, both exclusively and in its entirety, to another entity with very limited downside impact to the overall value of its current business.
  • Due to its financial under-performance, LE is currently trading at a Price to Sales ratio of only 0.4x, which is well below the industry’s 1.0x and with potential upside from an acquisition premium.

Lands’ End Business and Financial Overview

I’ve embedded a financial analysis that I made in Tableau. Click the arrows “< and >” to go from slide to slide. You can also click here to open a new tab with the overview on the Tableau Public website. The overview describes Lands’ End’s financial performance including details on its Direct and Retail sales segments from 2011-2015.

Source: Lands’ End Annual Reports.

Key highlights from the overview on Tableau:

  • Lands’ End generated over $1.4 billion in sales and $108 million in EBITDA during 2015 (FYE 1/31/16) with over $1.2 billion from the Direct segment and only $205 million from the Retail segment.
  • The Direct segment generated $1.2 billion in sales (85%) and $142 million in EBITDA in 2015.
  • The Retail segment generated $205 million in sales (15%) and lost $(1) million in EBITDA in 2015. The Retail segment includes 227 Shops at Sears and 19 Other (non-Sears) inlet stores. The Retail segment (primarily Shops at Sears) has been declining over time due to store closures and declining sales per store. 63 Shops at Sears locations have been closed between 2011 and 2015 (faster than the Sears master lease closure schedule).

There Is an End to the Sears Relationship in Sight

The master lease agreement Lands’ End entered into with its former parent for the spin-off shows that there is in end sight to the relationship with Sears. According to the master lease agreement, the last stores leases are scheduled to expire on January 31, 2020.

($ in millions)

Date Stores Rent
1/31/2015 253 $27.0
1/31/2016 239 $25.4
1/31/2017 225 $25.0
1/31/2018 216 $24.9
1/31/2019 167 $17.1
1/31/2020 102 $10.9
1/31/2021 0 $0.0

Looking at the schedule, there would be a fairly minimal cost for Lands’ End or potential suitor to pay to exit the Shops at Sears business early. After this current fiscal year (ending 1/31/2017), Lands’ End will have less than $53 million in future lease obligations to Sears.

From a labor standpoint, Sears provides a dedicated Shops at Sears salesperson in its stores for Lands’ End (LE pays for it). So staffing and labor exit costs would also appear to be fairly straightforward and limited.

Again, the Retail segment lost $1 million in EBITDA during 2015, so shuttering that business does not significantly impact the overall profitability of the company.

Lands’ End is the Opposite of a Traditional Retailer

With over 85% of sales made directly with consumers (e-commerce and catalogs), Lands’ End is really an e-commerce company with ancillary physical retail shops. This is the complete opposite model of a traditional retailer that derives most of its sales through physical store fronts with ancillary e-commerce operations. Thus, traditional retailers are still grappling with the cannibalization between and integration of their channels.

There are only six apparel companies on this list that have over $1 billion in direct-to-consumer/e-commerce sales and Lands’ End is one of them. LE ranks #20 in total sales among these major public apparel companies, but ranks #4 based on direct-to-consumer sales–higher than even the likes of Nike, Under Armour, and Ralph Lauren.

($ in millions)

DTC Sales Rank Total Sales Rank Company Sales 2015 Direct to Consumer Sales % Direct to Consumer Sales Category
1 4 QVC Group 9,989 9,989 100.00% Catalog
2 16 Wayfair Inc. 2,250 2,041 90.70% Catalog
3 3 L Brands, Inc. 12,154 1,920 15.80% Retailer
4 20 Lands’ End 1,420 1,216 85.60% Catalog
5 10 Under Armour, Inc. 3,963 1,189 30.00% Wholesaler
6 1 Nike, Inc. 30,601 1,010 3.30% Wholesaler
7 6 Ralph Lauren Corporation 7,405 889 12.00% Wholesaler
8 9 Coach, Inc. 4,192 629 15.00% Shoes & Accessories
9 2 V.F. Corporation 12,377 532 4.30% Wholesaler
10 11 Urban Outfitters, Inc. 3,445 482 14.00% Shoes & Accessories
11 18 Lululemon Athletica Canada Inc 2,061 402 19.50% Retailer
12 7 Hanesbrands Inc. 5,732 401 7.00% Wholesaler
13 14 Express, Inc. 2,350 392 16.70% Retailer
14 8 Michael Kors Holdings Ltd. 4,712 330 7.00% Retailer
15 22 Kate Spade & Company 1,243 249 20.00% Shoes & Accessories
16 21 Steven Madden, Ltd. 1,405 240 17.10% Shoes & Accessories
17 19 Deckers Outdoor Corporation 1,875 240 12.80% Shoes & Accessories
18 5 Luxottica Group SpA 9,599 192 2.00% Shoes & Accessories
19 15 Columbia Sportswear 2,326 179 7.70% Wholesaler
20 25 Oxford Industries, Inc. 969 165 17.00% Wholesaler
21 27 Vera Bradley, Inc. 503 140 27.90% Shoes & Accessories
22 13 Chicos Fas, Inc. 2,642 132 5.00% Retailer
23 17 Guess, Inc. 2,204 110 5.00% Retailer
24 23 The Buckle Inc 1,120 105 9.40% Retailer
25 26 Perry Ellis International Inc. 900 99 11.00% Wholesaler
26 12 Skechers U.S.A., Inc. 3,159 28 0.90% Shoes & Accessories
27 24 The Cato Corporation 1,011 20 2.00% Retailer

Here’s an interesting article on this subject: Apparel Retailers and Ecommerce: Direct Marketers Dominate.

Why Would Somebody Want to Acquire Lands’ End?

Lands’ End brings several strong capabilities and benefits especially to an online retailer, but also to a traditional retailer as well. In my opinion, these are the main selling points:

  • Lands’ End possesses a “single” billion dollar brand, which is in contrast to many other large apparel companies that are amalgamations of smaller brands. Some examples:
    • PVH Inc. (PVH) generated over $8 billion in sales in 2015. This came from $2.9 billion from Calvin Klein, $3.4 billion from Tommy Hilfiger, and the remaining $1.7 billion from its Heritage division, which includes Van Heusen IZOD, ARROW, Warner’s, Olga, Speedo, and other brands. So while Calvin and Tommy are legitimate billion dollar brands, the other brands it owns are not.
    • Hanesbrand (HBI) generated over $5.7 billion in sales in 2015 from a laundry list of brands. From its corporate profile, “It provides its products primarily under the Maidenform, Bali, Playtex, Hanes, JMS/Just My Size, Lilyette, Wonderbra, Donna Karan, DKNY, Champion, Polo Ralph Lauren, L’eggs, Hanes Beefy-T, Gear for Sports, Duofold, DIM, Nur Die/Nur Der, Lovable, Shock Absorber, Abanderado, Zorba, Rinbros, Kendall, Sol y Oro, Fila, Bellinda, Edoo, and Track N Field brand names.” There are some good brands there, but how many of them are billion dollar brands in their own right?
    • Oxford Industries (OXM) generated just under $969 million in annual sales, but this came from its main Tommy Bahama and Lilly Pulitzer brands as well as licensed brands from Kenneth Cole, Dockers, Geoffrey Beene, and Nick Graham.
  • Lands’ End possesses an “exclusive” brand. Not exclusive from a Tiffany’s standpoint, but exclusive from an “only sold here” standpoint. While there are plenty of larger brands, their products are non-exclusive and sold by many different retailers. A purchase of a non-exclusive apparel brand by a large retailer would have significant fallout amongst its other large retail customers who would be direct competitors. How much would PVH lose in sales if it was acquired by Amazon or Macy’s?
  • Lands’ End also possesses apparel expertise. This would be valuable to an online retailer looking to expand its business into the fashion and apparel market. Instead of building the knowledge and infrastructure from scratch, an acquiror could purchase LE as an existing platform from which to expand.
  • With over 85% of product sold direct to consumers, Lands’ End is set up as a virtual apparel retailer. This makes LE a “plug-and-play” brand with limited sales cannibalization or fallout.

There are only a few such brands with the same characteristics as Lands’ End. The only ones I can think of are L.L. Bean (essentially its twin without a Shop at Sears retail arm) and Eddie Bauer (more heavily invested in standalone retail stores), both of which are private companies.

Who Are the Likely Suitors?

The most obvious acquiror is Amazon. This article pretty much states my case for me by pointing out all of the gaps that Amazon still needs to fill to operate successfully in the apparel business. Will Amazon’s own-brand labels revolutionise its fashion business?

  • The desire is there. For years, Amazon has been trying to make a push into the fashion and apparel market, but it has struggled. Recently, Amazon began to offer seven of its own private label apparel brands.
  • Private label is not a draw. Here’s a quote from the article cited above. “Are people going to go there [to Amazon] to look for own label product?” says Westnedge. “I would say the answer is no unless they are given an enjoyable shopping experience with easy browsing, all the product shots should be on models and have 360 degree display, there should be outfit building and recommendation tools and there should be editorial content.” Right now, I suspect that consumers go to Amazon to buy other products, but may end up buying Amazon private label apparel while they are there. 
  • However, a brand like Lands’ End would flip this for Amazon and would be a draw, not only due to its billion dollar size, but also the “only sold here” exclusivity of the brand. That clearly fits in the Amazon’s strategy to bring customers to Amazon to buy a product (e.g., Lands’ end school uniform or khakis), and also buy other products offered on Amazon’s site. That’s the real benefit. Amazon might be able to increase the sales of Lands’ End product from the traffic Amazon gets, but I believe that Amazon’s sales would also increase due to the traffic drawn to Amazon seeking to buy Lands’ End product.
  • Lands’ End design, sourcing, and other apparel expertise would be a great platform from which to manage and expand its private label apparel business.
  • Lands’ End experience and management would be a great resource to Amazon’s overall apparel business.
  • In addition, one of the challenges with selling clothing online is the problems with sizing, fit and quality. I believe that the Lands’ End consumer has a firm understanding for its product sizing, fit and quality. I don’t think that this would be a stretch to transfer that same sense of understanding of Amazon’s private label brands, especially if product design and sourcing crosses over between LE and Amazon.

The same rationale would apply for other online retailers, such as eBay or Alibaba. The additional benefit for Alibaba is that Lands’ End would also provide a strong U.S.-based brand for its expansion out of China and into the U.S. market.

An upscale department like Nordstrom would also benefit for many of the same reasons. Nordstrom would be a much better fit with LE than Sears has been on a consumer, culture and brand quality basis–similar customer base (higher income, conservative, and family based), culture of high customer service and quality products. Again, Lands’ End brings an exclusive brand to the retailer, but it also brings an immediate size, scale, and infrastructure to the online ecosystem to any traditional brick-and-mortar retailer.

Lands’ End would bring similar benefits to an upscale mass merchandiser like Tar-jay…I mean, Target. LE would bring an exclusive brand to the retailer that fits with the family and home, as well as the size and scale to the online ecosystem.

Public Market and M&A Valuations

The Enterprise Value (EV) to Sales ratios vary for different segments of the apparel industry and companies that are growing tend to receive premium multiples. The EV to Sales averages are: Apparel Retailers 0.8x, Apparel Wholesalers 2.1x, and Footwear & Accessories 1.2x. The valuations have come down by 20% over the past year. Click here for the details to a public company analysis by Intrepid Investment Bankers.

Note: EV to Sales is similar to Price to Sales. Enterprise Value is the total of the market cap and the company’s net debt, which is the combined capital of the company.

EV/Sales

I’m using a subset of these companies that I feel are more comparable based on their overall sales, sales growth and type of company. The average Price to Sales ratio of these are 1.0x. The average Price to Sales ratio for M&A activity in the apparel industry is also 1.0x. Click here to see a spreadsheet of the public and M&A  comps.

I feel that the 1.0x Price to Sales value is a good benchmark for the fair value of Lands’ End. At 1.0x sales, the market cap for Lands’ End would be $1.4 billion versus the current value of $535 million, which indicates that LE is undervalued by almost $900 million.

Personally, I believe that Lands’ End is being valued, rightfully so, at a lower multiple because of its negative sales growth rate. However, I also do believe that it is being punished unduly with such a low multiple in part because it is a spin-off of Sears. All of the other Sears retailer spin-offs are floundering or have failed. Sears Canada (SRSC) is trading at $2.79 per share, Sears Hometown and Outlet Stores (SHOS) is at $6.84 and Orchard Supply Hardware went bankrupt in 2013. All of these spin-offs are traditional retailers and, in the case of SRSC and SHOS, are just alternative/smaller versions of the floundering Sears format selling similar product offerings. Lands’ End is vastly different in that it really is a brand in and of itself. In my opinion, it is the opposite of Sears.

Key Risks

I have two main concerns about Lands’ End:

  1. Eddie Lampert owns/controls a controlling interest in both Sears and Lands’ End. Will Eddie allow Lands’ End’s “independent” management do what’s best for the company irrespective of Sears or will Eddie’s self-motivations override them to the detriment of LE?
  2. Is the Lands’ End brand and style no longer relevant or is the decline in sales fixable (is it due to its negative association with the Sears brand and experience, as well as the lack of investment and resources while it was under the Sears umbrella)?

In the case of Eddie Lampert, it will be hard to predict. But for point #2, Lands’ End new management team headed by Federica Marchionni (previously with Dolce & Gabbana and VP of marketing at Victoria’s Secret Direct) is working on expanding Lands’ End “into new markets and channels over time while remaining true to the brand’s core values and customer base.” We will have to monitor the company–successful results should appear in positive sales growth.

Catalysts for the Stock:

I’m looking at three catalysts:
1. I’m looking for sales growth for its Direct segment to turn positive. I believe this is their core value of the brand. If sales stabilize and start to grow again, then we know that the brand still has appeal to the consumer (i.e., not a dying brand). I believe they are doing some good things–specifically they are strong in school uniform sales, which drives a steady demand and multi-generational connection (with kids and their parents) for their product.
2. I’m looking for Lands’ End to initiate moves to distance itself from Sears and/or for Sears to initiate moves away from Lands’ End. Some moves can be more obvious (e.g., faster closing of Sears stores; Sears exercising rights to reclaim leases from Lands’ End; switching out directors tied to Eddie Lampert and ESL). Other might be more subtle and harder to see (e.g., Lands’ End reducing the product offerings at Sears).
3. Increased M&A activity in the apparel space. Specifically, I’m looking for acquisitions of apparel brands rather than retailers with physical stores as well as increased buy activity/expansion in the apparel space from online retailers.

The Trade

Lands End closed at $15.39 per share on Friday, July 15 (price to sales multiple of 0.4x). My time horizon is potentially out to 2020 when LE’s contractual lease commitments with Sears expire. My target price of $40-45 assumes that LE sheds the burden of Sears, delivers revenue growth and returns to the industry average of 1.0x sales.

Conclusion

I believe that Lands’ End is currently undervalued at 0.4x sales. I believe that the market is undervaluing Lands’ End in part because it is a spin-off of Sears and it is being lumped in with the failure of the other recent Sears retail spin-offs, which were nothing more than alternative forms of the failing Sears business model.

However, I believe that Lands’ End is fundamentally different from Sears and those other spin-offs and, thus, is not doomed for failure. I believe that the unique nature of Lands’ End brand (it is a big single brand that still retains its “only sold here” exclusivity) and the business model (it is a direct-to-consumer catalog/e-commerce company, not a brick-and-mortar retailer) position the company for success if it is able to shed itself from the weight of Sears, which has been hurting the brand for years. To me, this is not a turnaround situation (of which I’m not a proponent in  investing), but rather the unshackling of a burden allowing LE to return back to its roots. I believe the ship can be righted by separating and further distancing itself from Sears. In addition, I believe that there is additional upside from a possible acquisition. Again, I am not a proponent of investing in a company based purely on a speculative acquisition, but I do like having the upside.

Other great articles and sources:

Lessons to my kids: Always do your homework and formulate your point of view before making an investment. This article is about finding undervalued companies. Note–I don’t actually teach my kids this stuff yet. I just have this as a ready example in case it comes up in the future.

Disclosure: The author is recently initiated a position in LE. Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation. The views expressed in the article are the author and the author’s alone.

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