UNIVERSITY OF OREGON
INVESTMENT GROUP
March 5, 2010
Consumer Goods
TRUE RELIGION APPAREL, INC.
BUY / HOLD
Stock Data
Price (52 weeks)
Symbol/Exchange
Beta
Shares Outstanding
Average daily volume
(3 month average)
Current market cap
$7.80 – $28.90
TRLG / NASDAQ
1.51
25,350,000
519,547
$649,180,000
Current Price
Dividend
Dividend Yield
$25.63
N/A
N/A
Valuation (per share)
DCF Analysis
Comparables Analysis
Target Price
Current Price
$30.47
$30.92
$30.69
$25.63
Summary Financials
Revenue
Net Income
Operating Cash Flow
2009 Actual
$311,000,000
$46,996,000
$53,590,570
BUSINESS OVERVIEW
True Religion Apparel, Inc. was first incorporated in Nevada in 2001 under the name Gusana Explorations Inc. In
June of 2003, the company acquired Guru Denim, Inc, a private manufacturing and apparel company, specializing in
jean production. Following the acquisition, Gusana Explorations changed its name to True Religion Apparel, Inc. and
reincorporated in Delaware in 2005. True Religion currently designs, markets and sells high end fashion apparel
under the “True Religion Brand Jeans” name to consumers on six continents and in more than 50 countries. The
Covering Analyst: Alexander Leiken
Email: aleiken@uoregon.edu
The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational.
Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be.
Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG’s portfolio. In
addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG’s portfolio.
True Religion Apparel Inc.
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company‟s primary revenue driver is its denim jeans brand, but other products including hoodies, t-shirts, sweats,
jackets, sunglasses and designer bags offer additional sources of revenue. The business is broken down into four
distinct but integrated segments: U.S. Wholesale, International, Consumer Direct and Other, which includes licensing
activity. The business segments share product design, manufacturing and marketing resources. They are described in
greater detail below.
OPERATING SEGMENTS
 U.S. Wholesale Segment
The U.S. Wholesale Segment sells True Religion products to leading nationwide premium retailers and boutiques that
carry both the image and merchandising expertise required for presentation of True Religion products. In 2009
company products were sold in Bloomingdale‟s, Neiman Marcus, Nordstrom, Urban Outfitters and Saks Fifth
Avenue, as well as in 900 specialty retailers and boutiques. The Wholesale segment also sells prior season
merchandise to off-price retailers. For fiscal year ended December 31, 2009, U.S. Wholesale net sales decreased
19.6% to $123.2 million, largely due to the sharp decline in boutique store sales. Deteriorating economic conditions
contributed to a challenging retail environment for boutiques, as they depend largely on external financing. Sales to
major retailers fell 11.6% over the prior year as True Religion customers adopted more conservative inventory
strategies. Sales to off-price retailers including Nordstrom Rack, Sacks off Fifth, and Neiman Marcus Last Call,
increased on a year over year basis. The U.S. wholesale segment is True Religion‟s second largest revenue driver,
contributing 39.6% of total revenue.
 International Segment
True Religion Apparel distributes products internationally through a network of distributors and its wholly owned
subsidiary, True Religion Japan, KK, which was formed in the second quarter of 2008. True Religion products can be
found in major cities throughout Africa, Asia, Australia, Europe, the Middle East, North America and South America.
Apparel is sold internationally much like in the U.S. wholesale segment, through major foreign premium retailers. For
fiscal year ended December 31, 2009, International sales increased 36% to $54.5 million, driven primarily by demand
in Asian and Western European markets. In 2008, 81% of the company‟s international revenue came from sales via
its 5 largest distributors. This segment contributed 17.5% of overall revenue in 2009, up from 14.8% in 2008.
 Consumer Direct Segment
The Consumer Direct segment includes True Religion‟s branded retail stores and e-commerce sales. Through year
2008, 27 retail branded stores were added, giving True Religion Apparel a total of 42 stores. For fiscal year ended
December 31, 2009, an additional 28 stores were added, bringing the total to 70. True Religion owns and operates
stores across the United States in upscale shopping areas, including street, mall, and a limited number of outlet
locations. Specifically, 13 stores can be described as off-price outlet stores, while the other 57 sell apparel at full price.
The branded retail stores provide consumers with easy accessibility to all of True Religion‟s products and apparel,
including many of their licensed products. This is in contrast to the larger department stores which focus mainly on
the denim part of the product line. The size of their retail locations range from 1,400 to 2,500 square feet and
emphasize the company‟s unique “Malibu hippy-bohemian chic” image and feel. E-commerce sales are made through
a third-party who receives commission on sales in exchange for operating the „True Religion Brand Jeans‟ website.
They accept and fulfill customer orders from a distribution center, where merchandise is held on consignment. For
fiscal year ended December 31, 2009, sales from the Consumer Direct segment increased 71.3% to $129 million,
which represents 41.5% of company revenue. Same store sales including e-commerce were up 25.3% from their 2008
levels.
 Other /Licensing
True Religion Apparel, Inc. licenses their brand name and logo to be included on products sold by other companies,
thereby enhancing and extending the „True Religion Brand Jeans‟ name. Each licensing partner pays a royalty based
on wholesale sales to use the True Religion name and logo. At year end 2009, True Religion licensed merchandise
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included: footwear, fragrances, eyewear, headwear, and swimwear. Handbags and outerwear were transitioned to inhouse development in 2008. The licensing segment contributed 1.4% of total revenue in 2009.
PRODUCTS & MARKETING
True Religion Apparel, Inc. relies heavily on its ability to market products to affluent, fashion conscious consumers.
Since 2003, they have emphasized styling, fit, wash, and attention to detail in their brand. True Religion is also proud
of the fact that 90% of their denim merchandise is produced and manufactured in the United States. The design
team, which has 26 employees, is led by Chief Executive Officer Jeffrey Lubell. True Religion‟s design team is known
for being on the cutting edge of current fashion trends, constantly developing new washes in reaction to consumer
demand, while maintaining long term product durability by using the highest quality fabric and stitching methods.
Most of True Religion‟s product line can be viewed online at www.TrueReligionBrandJeans.com but generally
includes the following: denim jeans, corduroy pants and jackets, cotton, twill, linen and velvet pants, and jackets,
fleece sweat suits and hooded sweatshirts, skirts, knit shirts, t-shirts, shorts and sportswear for men, women and
children including sunglasses, swimwear, and footwear. For the year ended 2008 sales categorized by gender were
58% to women, 38% to men, and 4% to children.
BUSINESS AND GROWTH STRATEGIES
True Religion is undergoing a major change in their business model. Primary revenue drivers switched in 2009, from
the U.S. wholesale segment, (sales from independent boutiques and major retailers), to the consumer direct segment,
(sales from True Religion Brand Jeans freestanding stores). The economic downturn and high mall vacancy rates have
provided attractive leasing opportunities for True Religion and they‟ve taken advantage, adding 28 stores in 2009. The
company seeks to add another 30 branded retail stores in 2010, 27 of which will be located domestically. The other
three locations will represent the company‟s first international venture in branded retail. The stores will be located in
Tokyo, London, and Toronto and are expected to be fully operational by Q3 2010. True Religion Apparel, Inc. has
no debt and as such, expansions are funded by cash flow from operations.
The company sees an immense opportunity to expand internationally, as currently the vast majority of sales come
from domestic markets. In particular 2009 saw a 36% increase in international sales, with the strongest growth
coming from Germany and Japan. As mentioned above, True Religion has taken the initiative to expand its retail
branded stores to international markets, with the hopes of becoming a globally recognized premium brand. They
have made provisions for significant investments in East Asia, planning to develop networks in Hong Kong, Japan
and Seoul Korea. These initiatives will cause the company to incur a one-time expense of $6.5 million in 2010,
accounting for a new brand manager, sales team, and some incremental advertising. Sales resulting from these
investments will likely be stronger on the back half of 2010 and into 2011 than in early 2010, as building a network of
boutiques and major retailers to carry True Religion Brand Jeans apparel will take time.
Aside from growing revenue through expansion, they seek to grow internally through increased efficiency. In 2009,
True Religion employed a team to improve employee sales techniques. The results were positive across the board.
The conversion rate, units per transaction, and sales per hour were all higher in 2009. True Religion has also worked
to improve its replenishment capabilities and inventory stocking. By keeping more popular clothing lines and sizes in
stores and filtering out slower selling merchandise, True Religion can improve the bottom line. These factors should
help further increase same store sales in 2010 and going forward.
During the economic downturn and difficult consumer retail market, True Religion has seen a substantial increase in
sales to the off-price wholesale channel. In order to maintain the brand‟s integrity and premium image, management
has decided to cut sales to such retailers by $10 million in 2010 and by a similar amount again in 2011. Ideally, they
want less than 10% of U.S. wholesale sales to be through the off-price channel, and the vast majority of those sales to
be through their own outlet stores. This decision will have a negative impact on earnings, but will likely keep the
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brand sheltered from overexposure long term. The difficult retail environment contributed to lower revenues from
the U.S. wholesale segment, (boutiques and major premium retailers) in 2009, though such retailers have maintained
True Religion shelf space in their stores. True Religion recognizes the need for a more collaborative sales process
with major retailers and is making investments to stimulate revenue growth in the segment going forward. Further
growth opportunities exist in the smaller boutique stores. True Religion Brand Jeans merchandise is available in over
800 boutiques, compared to some competitors who have merchandise in upwards of 1,600 boutiques. By getting sales
people out on the road, True Religion is confident in its ability to expand its brand through partnering with additional
specialty boutiques across the country.
INDUSTRY ANALYSIS
True Religion Apparel, Inc. operates in a sub industry of the apparel and footwear industry known as “Apparel,
Accessories and Luxury Goods.” The general outlook for apparel and footwear is negative, but True Religion‟s
subsector is expected to outperform. True Religion serves a niche market of affluent and fashion conscious
individuals who care about the design and quality of a product far more than its price point. In general, throughout
the economic downturn, this niche group has not suffered to quite the same extent as has the average consumer.
Because of this, sales of luxury goods and accessories have outperformed traditional apparel and footwear. This more
exclusive market segment offers differentiated fashion products, that is, products which stand out in some way from
everyday brands or, “conversation products”. True Religion Brand Jeans, with their superior fit, design, and quality,
satisfy the above condition. Still, going forward True Religion will be susceptible to lack of disposable income from
the consumer, as the “aspirational luxury shopper,” fails to make purchases.
The economic downturn has contributed to lower levels of core consumer price inflation, personal consumption
expenditure, disposable income, employment, housing prices, consumer credit outstanding, consumer sentiment, and
the real wage. Though many of these broad economic indicators remain at depressed levels, a few have shown recent
signs of life. In January, the retail sector added 52,000 jobs, implying that firms expect higher consumer demand
going forward. The chart below is the ICSC-Goldman Sachs Weekly Chain Store Sales Index. A value above zero
represents an expansion. As you can see, store sales have recently been trending upward. On the manufacturing side
the ISM PMI has remained above 50 for 7 straight
months, implying the sector is going through an
expansion. These factors are reflected in the Q4
headline GDP increase of 5.9%. That number
could be a little misleading, as a large portion of the
increase was due to “change in private inventories,”
while only 1.9% of the growth was generated by real
consumer demand. These results might imply only
an inventory bounce, rather than any significant
long term improvement.
Considering the
unemployment rate remains at 9.7% and the 4-week
moving average of weekly unemployment claims is
trending upward, which implies future job losses,
the inventory bounce theory is looking more and
more likely. In other words, firms are acting cautiously given the current economic environment, showing a
reluctance to hire, which further depresses the real wage and thus, consumer spending. In terms of how this affects
True Religion, tentative U.S. wholesalers will hold less inventory, which will lead directly to lower sales.
In the near term, declining housing prices and home sales will cause further deterioration of family balance sheets,
leading to a squeeze on disposable income, and likely a higher savings rate as Americans attempt to rebuild equity in
their homes. The high unemployment gap will depress real wages and cause deflationary pressure on consumer
goods. This is not the type of macroeconomic environment one wants to operate under as a premium retailer. That
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being said, broader industry conditions have yet to adversely affect True Religion‟s bottom line in a meaningful way.
Declines in sales via U.S. wholesalers were more than offset by increases in the higher margin consumer direct and
international segments. Finally, pending the U.S. economy enters into a real recovery phase, high end retail will likely
outperform other industry, as pent up demand from the “aspirational luxury shopper,” will drive both revenue and
margins higher.
MANAGEMENT AND EMPLOYEE RELATIONS
Chief Executive Officer
Jeffrey Lubell founded True Religion Apparel, Inc. in 2002. He has served as Chairman of the Board, Chief Executive
Officer and Chief Merchant since June 2003. He also heads the True Religion Brand Jeans design team. The
company is a reflection of Mr. Lubell‟s creativity, vision, and love for the premium denim business. Before True
Religion, Mr. Lubell was President and Creative Director (Men‟s) of Hippie Jeans based in Commerce, California. Mr.
Lubell has over 30 years of executive experience in the business. From 1978 to 1998 Mr. Lubell was the President
and CEO of Jeffrey Lubell Textiles, based in Los Angeles, California, a textile design and distribution firm that Mr.
Lubell founded.
Director
Marcello Bottoli was recently appointed as Director in March of 2009. He served as CEO of Samsonite Corporation
from March, 2004 through January, 2009. From September, 2001, until March, 2004, Mr. Bottoli served as division
CEO at Louis Vuitton Malletier S.A. Mr. Bottoli‟s past experience in premium retail management makes him a
valuable asset to the True Religion team.
Chief Operating Officer
True Religion Apparel, Inc. recently hired Lynne Koplin as Chief Operating Officer. Ms. Koplin brings over 30 years
of experience in the apparel industry, having worked in operations, product development, manufacturing, and retail.
She came to True Religion after leaving her position as President of the Tommy Bahama women‟s division. Prior to
Tommy Bahama, Ms Koplin served as President and Chief Executive Officer at Apparel Ventures, Inc.
RECENT NEWS
True Religion Opens New Branded Retail Store at Washington Square in Portland, OR – February 23, 2010
(Business Wire) -- “True Religion Apparel, Inc. (Nasdaq: TRLG) today announced the opening of a new branded
retail store at Washington Square in Portland, Oregon. The 1,485 square-foot branded retail store will offer shoppers
the entire True Religion collection for men, women and kids, including its signature jean styles, its expanding denim,
sportswear and handbag collection, and a full range of licensed merchandise.” Washington Square is recognized as
one of Oregon‟s premier shopping destinations, housing the state‟s largest Nordstrom and over 170 specialty shops
and restaurants. Over 400,000 residents with average annual household income exceeding $80,000 live within five
miles of Washington Square. Expanding the branded retail business is an important part of True Religion‟s growth
strategy going forward. The development of new stores, providing exposure and brand accessibility to affluent and
fashion conscious customers, is imperative for future growth of the True Religion brand.
True Religion Spikes on Overseas Growth – February 25, 2010 (TheStreet.com)
“No matter how bad the economy gets it seems shoppers love their denim, and not just the cheap brands. True
Religion, which sells jeans for as much as $300 a pop, is spiking after it topped Wall Street's fourth-quarter forecast
and announced plans to open its first stores overseas.” True Religion Apparel, Inc. came out with better than
expected fourth quarter earnings and guided earnings of $2.00 - $2.10 per share for fiscal year 2010, slightly below
analyst estimates at $2.13. The company expects to incur a few one-time expenses that will adversely affect earnings
in 2010 as they position themselves for future growth opportunities. True Religion expects an $0.11 per share hit for
construction of a Hong Kong office, and other $0.16 per share hit from the hiring of a new Chief Operating Officer.
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They‟re also planning to lower sales to off-price wholesalers by $10 million, instead, focusing on their higher margin
consumer direct segment, and selling year end excess inventory through their own off-price factory outlet stores.
True Religion Apparel: Is It Worth Being a Slave to Fashion? – February 26, 2010 (Seeking Alpha)
“I tend to be a skeptic by nature. So at a time when the economy is weak, employment numbers are terrible,
consumer credit is contracting, and foreclosures are rising, I am particularly skeptical of high flying stocks whose
fortunes depend on spendthrift consumers.” The industry fundamentals certainly don‟t look good. Retail sales have
seen an upward trend but remain at relatively depressed levels, personal consumption expenditure is expanding, but
slowly, consumer confidence is both low and volatile, and home prices and sales continue to fall. The combination of
all these factors should, in theory, lead to the tightening of household balance sheets, that is, less disposable income,
which would adversely affect premium retail sales going forward. Contrary to what the fundamentals are telling us,
True Religion‟s margins hold steady, and they keep selling $250 jeans.
S.W.O.T. ANALYSIS
Strengths
 True Religion is in a strong financial position with no outstanding debt and a large cash position.
 The company manufactures 90% of its denim products in the United States, assuring that its factory workers
are paid a decent wage, a point of issue for many of True Religion‟s customers.
 True Religion posted strong year over year growth with large margins, despite the difficult premium retail
market and trying economic times.
 The company trademarks, intellectual property, and marketing have allowed True Religion to position itself as
the premier premium denim retailer.
Weaknesses
 True Religion operates in a niche market and earnings rely heavily on the ability of design and management
teams to predict future fashion trends.
 True Religion faces intense competition in their market from other premium denim brands, some of which
are backed by larger corporations with greater resources.
Opportunities
 International expansion will yield opportunities for revenue growth going forward, as most foreign markets
are relatively unsaturated.
 Transition from U.S. wholesale to Consumer Direct will yield lower SG&A and thus higher overall profit
margins.
 Further expansion into specialty boutiques can be a source of future revenue growth. True Religion apparel
is sold in roughly 800 specialty boutiques while some of its competitors hold shelf space in up to 1,600.
Threats
 Though it hasn‟t yet had a strong affect on revenue growth or operating margins, a prolonged global
recession will squeeze disposable income and make operations more difficult.
 True Religion, if it continues to expand at its current pace, will run the risk of over saturating the market.
The Washington Square location could be an example. They‟ve opened a store within 500 feet of two other
locations selling True Religion Brand Jeans.
COMPARABLES ANALYSIS
True Religion Apparel, Inc. operates in the high end retail and apparel manufacturing industry, with the largest
portion of its revenue coming from premium denim. As such, it competes directly with other premium denim brands:
Rock & Republic, Seven for all Mankind, Lucky Brand, and Hudson, all of which are either privately held, or part of
larger corporations. The lack of publicly traded pure play competitors for True Religion, with the exception of Joe‟s
Jeans, led me toward other premium lifestyle and apparel companies. Such companies were selected based on several
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criteria: (1) the company‟s served market. I wanted all of my comparables to be high end retailers. Companies in the
same sector operate under similar macro based constraints and are subjected to the same market risks. (2) I looked for
companies with similar capital structure. True Religion finances all of its investing activities from operating cash flow
and has no outstanding long term debt. I didn‟t want leverage to play a big role in the operations of my comparables
for that reason. (3) Finally, I sought companies with a similar business model, that is, companies whose revenue
streams can be broken down into segments similar to True Religion‟s. Based on the above criteria, I found 5 solid
comparable companies: Coach Inc. (COH), Joe‟s Jeans Inc. (JOEZ), Polo Ralph Lauren Corp. (RL), Guess ? Inc.
(GES), and Liz Claiborne Inc. (LIZ).
Coach, Inc. (20%)
“Coach, Inc. engages in the design and marketing of fine accessories and gifts for
men and women in the United States and internationally. The company’s primary
products include handbags, women’s and men’s accessories, footwear, jewelry,
wearables, business cases, sunwear, travel bags, fragrance, and watches,” (yahoo
finance). I chose Coach as a comparable because both the company‟s structure and
business model are very similar to True Religion‟s, albeit on a much larger scale.
Coach has a U.S. and International Wholesale segment, in which they partner with
major premium retailers like Saks and Nordstrom. They have over 400 branded retail stores located throughout the
United States, Europe, and East Asia, as well as over 100 factory outlet stores. Coach Inc. carries almost no long term
debt on its balance sheet and maintains a relatively similar cash position to True Religion‟s. Beyond the structural
similarities, Coach and True Religion are comparable based on their susceptibility to similar market risks, as they both
operate in the highly competitive premium retail market. For these reasons Coach, Inc. was given a weight of 20%.
Liz Claiborne Inc. (15%)
“Liz Claiborne, Inc. engages in the design and marketing of a range of apparel and
accessories worldwide. It offers men’s, women’s, and children’s contemporary apparel,
denim and casual sportswear, fashion apparel, business-casual apparel, career
sportswear, intimate apparel, activewear, and jeans.” (Yahoo Finance) Liz Claiborne
Inc. offers products under a number of different brands: Juicy Couture, Kate Spade,
Lucky Brand Jeans, DKNY Jeans, Claiborne, Liz Claiborne New York, and more. I
chose Liz Claiborne as a comparable because their position in the premium retail market
is similar to True Religion‟s. Both have a market cap of roughly $650 million, though Liz has over $500 million in
outstanding long term debt. With regards to specific brands and apparel, Liz Claiborne is close to a pure play
competitor, deriving a majority of its revenue from its Juicy Couture and Lucky Brand Jeans, brands. Both companies
target affluent fashion conscious consumers to generate sales. I weighted Liz Claiborne only 15% because of their
reliance on leverage to conduct every day operations and their recent inability to maintain positive profit margins.
Joe’s Jeans Inc. (22%)
“Joe's Jeans Inc. engages in the design, development, and marketing of apparel
products worldwide. Its product line comprises women's, men's, and children's
denim jeans, pants, shirts, sweaters, jackets, and other apparel products under the
Joe's brand.” (Yahoo Finance) Joe‟s is True Religion‟s best publicly traded pure
play competitor. Both companies earn the vast majority of their revenue from sales of premium denim apparel. Both
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companies enjoy strong cash positions and zero long term debt. The only major difference is where the companies
are in terms of their respective development. True Religion is in the middle of a transition from generating revenue
via its indirect wholesale segment, to focusing on its own, higher margin, branded retail stores. Joe‟s still generates
revenue almost explicitly through major retailers. Currently, Joe‟s has only 2 full price branded retail stores in
operation and has no concrete plans to open more. Joe‟s is weighted 22% because of their comparable target markets
and market risks, their similar product line, and the similar capital structure.
Guess ? Inc. (23%)
“Guess?, Inc. designs, markets, distributes, and licenses lifestyle collections of
apparel and accessories for men, women, and children. The company‟s products
include collections of denim and cotton clothing, such as jeans, pants, overalls,
skirts, dresses, shorts, blouses, shirts, jackets, and knitwear. It also grants licenses to
manufacture and distribute a range of products, which comprise eyewear, watches,
handbags, footwear, kids' and infants' apparel, leather apparel, swimwear, fragrance,
jewelry, and other fashion accessories.” (Yahoo Finance) Guess was chosen as a
comparable because their position in the premium retail market leaves them susceptible to market risks similar to
those of True Religion. Guess‟ operating segments are also similar to True Religion‟s, as they sell and distribute
through major premium wholesalers, as well as own, manage and maintain a number of their own branded retail
stores. Guess has a negligible amount of long term debt and a low debt to equity ratio of 4.97% and like True
Religion a strong cash position. For these reasons, I gave Guess Inc. the highest weighting in my comparables at
23%.
Polo Ralph Lauren Corp. (20%)
“Polo Ralph Lauren Corporation, together with its subsidiaries, engages in the design,
marketing, and distribution of lifestyle products worldwide. It offers men’s, women’s, and
children’s clothing; and accessories comprising footwear, eyewear, watches, jewelry, hats, and
belts, as well as leather goods, including handbags and luggage.” (Yahoo Finance) The
company sells its products indirectly through department stores, specialty stores, and golf and
pro shops. They have a full-price direct segment in which they operate 163 branded retail
stores in addition to their 163 off-price factory outlet stores. Ralph Lauren has a debt to
equity ratio under 10% and a strong cash position, just like True Religion. They also have
comparable betas, at 1.59 and 1.51 respectively. The above factors contributed to weighting
Polo Ralph Lauren Corp. at 20%.
Valuation Multiples
In order to test True Religion‟s true market valuation with regards to its competitors, I used four different multiples:
EV/Revenue, EV/Gross Profit, EV/EBIT, and EV/OCF. EV/Revenue gives an indication of a company‟s ability
to generate revenue, controlling for its size, and taking into account leverage from debt along with its cash position. I
used EV/Gross Profit as a way to measure how efficiently the company generates profit compared to its peers. I
used EV/EBIT to show the profitability of the company, accounting for all of its expenses, as well as investments in
long term capital. Finally, I used EV/OCF to show how well the company generates cash flow after covering its
expenses. Each of these multiples values a slightly different set of operations within the company and were weighted
at 25% each.
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DISCOUNTED CASH FLOW ANALYSIS
For my DCF analysis I used the percent of revenue method to better estimate future segment revenues, cost of sales
and free cash flows. I then discounted the free cash flows to calculate the net present value of the company, and
finally its implied stock price. A summary of the line items are below:
Revenue
In order to project revenues forward I built a revenue model based on several key economic factors affecting the
apparel, accessories, and luxury goods industry. I went through a process of forecasting these variables, including CPI
apparel, e-commerce sales, retail sales, consumer sentiment, year-over-year consumer credit outstanding change and
GDP using various auto regressive integrated moving average (ARIMA) models. When forecasting these separate
variables I looked for a good residual structure, a high R2 and a low AIC. I then back tested my forecasts against the
actual data in order to better interpret the efficiency of each model. Once I had the forward looking data based on my
forecasts I built a model, with True Religion‟s revenue acting as the dependent variable. Several models were tried,
and one had some notaable problems. The results of the different models are in the graph below.
I used quarterly data throughout, and adjusted for seasonality using dummy variables. You can see a clear seasonal
pattern in these projected trends, (as well as the raw data, though not shown here). Forecasts 1 and 2 differ based on
the addition of a recession probability statistic. Forecast 3 had some significant issues resulting from the addition of
the consumer credit change variable. Substantial and sudden swings in the series skewed the model downward
significantly. I felt that forecast 3 was unrealistic based on both my own research as well as analyst expectations. For
my revenue projections, I decided to use forecast 1, the blue line, with some manual changes to Q1-Q3 of 2010 due to
the one-time company expenses mentioned in previous sections.
U.S Wholesale
I projected the U.S. wholesale segment to shrink substantially as a percentage of revenue from 36.5% in 2009 to a
long run state of about 15.7% by 2015. The company has made clear its intention to invest in its higher margin
consumer direct segment, as well as expand its brand internationally. I used Coach and Liz Claiborne‟s Lucky Brand
Jeans as a benchmark for what the percentage of revenue structure looks like for more developed brands. Both
Coach and Lucky derive percentage of revenue in the mid teens from U.S. wholesalers.
International
True Religion plans on further developing its presence in international markets and will build its first three full price
international consumer direct stores in fiscal 2010. For this reason I have international sales increasing marginally as a
percentage of revenue into 2017 where the segment stops growing at 22% of revenue. Aggressive moves by the
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company to build international sales could result in higher numbers as a percentage of revenue. At this juncture, I
don‟t see a strong immediate change to the international segment as a percent of revenue because entering new
markets is comparable to repeatedly “re-launching the brand”. It requires substantial investment in a time of
uncertainty.
Consumer Direct
The consumer direct segment will continue to see substantial growth as a percentage of revenue. True Religion‟s
branded retail stores are able to offer the company‟s full product line, including licensed products, as well as generate
higher margins than U.S. wholesale. Management believes in the brand and will continue financing new stores until
the market is fully saturated. This included the build out of 28 new consumer direct stores in 2009, with another 30 to
come in 2010.
Other
In order to project licensing revenue as the company grows and develops, I again looked to some of its comparables
for help. Coach Inc generates 1%-2% of its revenue from its licensed products. I felt this was reasonable for True
Religion going forward, and in line with company levels in the most recent fiscal year.
Cost of Sales
True Religion‟s cost of sales is projected to decrease moderately as a percentage of revenue as the company transitions
from sales generated by U.S. and international wholesale, to selling more through the consumer direct channel. The
most eventful development in cost of sales came out of the international segment, where the addition of factory outlet
stores in European and Asian markets contributed to much better gross margins for international sales. The gross
margin is projected to widen over time, again due to increased sales through full-price branded retail stores in the
consumer direct segment.
Selling, General and Administrative Expense
SG&A expense is projected to increase moderately in 2010 and subsequently level off. The initial jump is due to
some one-time expenses for a new Chief Operating Officer, an international sales team, and a U.S. wholesale sales
team. As a percentage of segment revenue, U.S. wholesale expense should fall as the company shifts its focus to the
consumer direct segment. SG&A is projected to increase moderately for the international segment, as international
expansion will be accompanied by more employees and high incremental advertising costs. Consumer direct SG&A is
projected to remain relatively steady as the pattern over the last four years suggests.
Depreciation and Amortization
Depreciation and Amortization is expected to increase as a percentage of revenue due to capital expenditures from
build outs and leases of 70 retail locations hitting the books. Past growth in capital expenditures, in combination with
sustained future levels of capital expenditure should contribute to higher overall depreciation and amortization of
certain assets. The trick here was trying to find the appropriate lag between the property, plant and equipment
investment and levels of depreciation. For this reason, higher levels of depreciation lag behind the higher capital
expenditure growth.
Tax Rate
The tax rate in 2010 is projected at 37.5% because of guidance issued by the company in the Q4 earnings call. The
longer run tax rate, projected at 37% is lower than historical norms for True Religion, but reflects its expansion into
international markets.
Current Assets and Current Liabilities
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True Religion‟s current assets were adjusted because much of the cash position sits idly on the balance sheet and is
not used to fund operations. I projected a slight increase in current assets as a percentage of revenue, reflecting the
likelihood of True Religion holding more inventory as global economic conditions improve and as they expand their
brand internationally. Current Liabilities stay relatively constant over the period, as does the current ratio at just under
four.
Capital Expenditures
Capital expenditures will likely remain high over the next few years, as True Religion invests in information
technology and more consumer direct branded retail stores. But at some point it will fully saturate the market, and
capital expenditure as a percentage of revenue should decline. On my DCF, this transition begins in 2012 and ends
with capital expenditure declining to 4% of revenue.
Beta
To calculate beta, I ran a simple regression of True Religion‟s 5 year monthly returns against the returns of the S&P
500. I arrived at a beta of 1.51 which I believe to be realistic for two reasons. (1) True Religion is a growth company
and should thus perform better to the upside than to the downside and (2) because many of True Religion‟s
competitors, with similar capital structure, enjoy similar betas across the board.
RECOMMENDATION
True Religion‟s position within the high end retail market is unique. They‟ve been expanding rapidly with zero debt,
despite some of the worst economic conditions imaginable for a premium retailer. In the near term, the
macroeconomic fundamentals behind this stock and its sector are not particularly good. However, based on my
comparables analysis and DCF valuation, I believe True Religion will outperform other apparel and footwear retailers.
My comparables and DCF yielded implied prices of $30.47 and $30.92 respectively. Weighted equally at 50% I arrived
at an implied price for True Religion of $30.69, an undervaluation of 19.76%. Thus, I am rating True Religion
Apparel, Inc. (TRLG) a BUY for both the Tall Firs and Svigals portfolios. We are currently underweight consumer
goods in both portfolios. As for DADCO, True Religion‟s beta of 1.51 could help bring us closer to our benchmark,
but the transaction costs associated with a buy would limit some of the upside. Because of the transaction costs, I am
recommending a BUY/HOLD for the DADCO portfolio.
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True Religion Apparel Inc.
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http://uoig.uoregon.edu
APPENDIX 1 – COMPARABLES ANALYSIS
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APPENDIX 2 – DISCOUNTED CASH FLOWS ANALYSIS
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APPENDIX 3 – DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS
APPENDIX 4 – BETA SENSITIVITY ANALYSIS
APPENDIX 5 - REVENUE MODEL – FORECASTS OF VARIABLES
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university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 6 – SOURCES
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Standard & Poor‟s NetAdvantage
Finviz.com
Yahoo finance
Google finance
TrueReligionBrandJeans.com
St. Louis Federal Reserve Data (FRED)
True Religion SEC Filings (10-K, 10-Q, 8-K)
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