Reitmans: Over 50% Upside On Plus-Sized Lingerie And Athleisure Wear

January 2, 2016 by admin
Filed under Latest Lingerie News

Summary

Reitmans is one of the cheapest retailers trading at 2x EBITDA, below TBV and 60% of its market capitalization in cash.

Strong following in plus size lingerie with the Ashley Graham collection. Additional upside from Hyba, Reitmans’s new athleisure wear brand.

Abandoned by Canadian investors due to a dividend cut and poor retail environment.

Author Update
Dec. 6, 2015, 12:25 AM

Reitmans reported its 3Q results last night. Key takeaways are as follows:

Sales were up 80 bps YoY which was very strong considering RET has closed over ~60 Smartset stores over the period.
Same store sales were better than expected, coming in at 7.6%, with a 4.8% increase in physical stores, the best comp in years. Furthermore we saw an acceleration in e-commerce sales. Both items correlate with physical traffic we witnessed as well as GT data.
The company released November SSS, which was a monster 9.1% driven by a 5.5% increase in stores, an acceleration from Q3.
Gross margins more or less came in where we expected them, at ~57.4%, however down significantly YoY. Roughly 60% of the decrease in gross margin were derived from FX. Moreover, we believe there is some margin drag from Smartset store closures as Management liquidates that concept. Assuming margins remain, we expect 1/31/16 full year EBITDA between $50MM to $55MM, implying a 2x EBITDA multiple.
Cash flow from ops was down YoY, however we expect some of this to reverse as Q4 is one of their highest cash balance quarters.
We continue to like the set-up as Reitmans is underfollowed and generally disliked. While retailing is a mediocre to crappy business, RET continues to have catalysts particularly for 4Q which includes upside from Hyba as well as roll-out of Ashley Graham lingerie and clothing in Lord Taylor USA/Nordstroms. Finally we are getting paid to wait with a ~5% dividend yield.

(Editors’ notes: Figures listed are in CAD unless otherwise mentioned).

Reitmans Canada, Inc. (OTCPK:RTMAF) (“Reitmans,” “RET” or the “Company”) is the largest Canadian women’s specialty retailer in Canada, operating 815 stores across 6 brand names. Reitmans represents an attractive long opportunity as the market is overlooking a cash generative business in midst of a turnaround.

Reitmans’s equity has fallen out of favor with Canadian institutional investors as demonstrated by its 50% year to date decline. Due to unfavorable FX movements between the CAD and the USD, Reitmans has felt significant impact to its margins yet these headwinds should subside over time due to better hedging practices, price adjustments and USD/CAD normalization.

Canadian institutional investors also are overly focused on the lack of top line growth and poor historic same store sales, overlooking two free call options: (1) the roll-out of its Hyba athletic wear brand in Canada and (2) continued success of Addition Elle lingerie (backed by plus sized model Ashley Graham) and roll-out of Addition Elle within Lord Taylor in the United States.

As Reitmans exits its turnaround with a smaller yet more efficient store fleet and assuming no further degradation of the business, RET offers an asymmetric return profile of 40% to 100% versus downside of ~20% at the current price.

A long position in Reitmans is merited by the following:

Attractive Valuation: Reitmans currently trades for 2.0x LTM EBITDA, at a 15% discount to tangible book value and at a ~24% LTM EV to FCF yield. This is an undemanding multiple for a business, which has generated positive free cash flow and EBITDA. This low multiple ascribes no value to Reitmans growing its Hyba brand, valuable plus sized lingerie business or partnership with Lord Taylor and other retailers.

Furthermore, recent transactions in the retailing space (particularly women’s fashion) have been consummated at multiples ranging from 7.0x to 9.0x EBITDA. To highlight on a recent example, ANN Inc. (NYSE:ANN) was recently purchased by Ascena Retail Group Inc. (NASDAQ:ASNA) for ~8.5x EBITDA while carrying a similar SSS profile. While in the current retail environment, particularly Canada, Reitmans won’t be bought out at 8x, we believe the founding family could easily take RET private at 4x to 4.5x EBITDA, simply by utilizing a turn of leverage and rolling over their equity stake or partner with Prem Watsa.

Competitive Positioning: Reitmans is the largest women’s specialty retailer across Canada with multiple store formats, 75 plus years of history, particularly in women’s value fashion and plus-sizes. The plus-sized and maternity categories are particularly attractive as they face limited pure-play competition and wider inventory selection versus department stores. RET’s brands are private label which allows for RET to maintain competitive prices while having higher quality items than Wal-Mart (NYSE:WMT), Hudson’s Bay (OTC:HBAYF) or other department store peers.

Note certain bears believe entry by U.S. brands and new plus sized entrants such as Torrid will provide a considerable headwind to Reitmans’s plus sized brands. Our channel checks and Canadian mall sleuthing revealed an entirely different target customer and product as Torrid is akin to a Rue21/HM, versus Addition Elle which tends to be higher quality and at a higher price point. The low-end on the plus size category is also competitive as Torrid will face competition from HM and Forever 21.

Improving Top line Momentum: After five years of consecutive SSS declines, SSS turned positive in FY15 as the Company benefited from a repositioning of its e-commerce division and greater productivity from its smaller store base. Further improvement should translate into improved EBITDA margins, which currently are at an all-time trough of ~7% versus the previous peak of ~17%. Going forward ~8% to 10% EBITDA margins appear to be attainable although not modeled in our base case. Margin expansion will likely come from top line stabilization or growth, FX pressures to decrease, further cost cuts and upside from Addition Elle or Hyba. However, even with flat margins and flat sales, Reitmans’s equity is highly attractive.

Moreover, we expect SSS to continue to uptick driven by the weak Canadian. While a weak CAD impacts margins, it boosts Canadian SSS as Canadian consumers are inclined to spend in Canada versus crossing the border to purchase items.

Reitmans’s e-commerce platform has been a success to date, with revenue growth accelerating throughout the year from ~40% to over 90%, which correlates with positive Google Trends traffic. Note e-commerce carries higher margins due to lower rent expense and labor.

Insider Ownership: The Reitman founding family continues to own an ~18% stake in the Company, as well as hold majority voting control. The family has been fairly conservative stewards of the business maintaining a strong, overcapitalized balance sheet and cutting costs from their bloated cost structure after facing significant top line pressures. Fairfax Financial also owns a ~13% stake and in the past have supported take-private of family owned entities.

Strong Balance Sheet: Reitmans boasts a strong balance sheet with $169MM of net cash or ~60% of its market capitalization. RET’s financial position has allowed the Company to weather heightened competition over the past four years as well as provide flexibility to execute on its turnaround plans.

Free Cash Generation: More telling, over the past four years Reitmans has generated $300MM of cash flow from operations, which has been either re-invested in the business or distributed as dividends. As same store sales comps and EBITDA margins improve, free cash flow generation will undoubtedly grow.

Furthermore, the Company closed ~34 Smart Set stores thus far at the beginning of Q3. Assuming average inventory per store of $0.8MM to $1.0MM, this could lead to an incremental ~$30MM of cash unlocked in 3Q before wind-down expenses for the concept. Reitmans will look to close its remaining 34 Smart Set stores by year-end.

Competition Exiting: Reitmans is a prime beneficiary by Target Canada’s exit (NYSE:TGT), Gap’s (NYSE:GPS) store closures as well as Sears Canada’s (SRSS) continued decline. Core brands from abroad such as Jones New York has faced significant pressure and Mexx have also left Canada, which is perceived as a fickle market. Smaller niche competitors also are floundering, with women’s retailer (also participating in plus size), Laura’s Shoppes and Melanie recently filing for bankruptcy. While the competitive landscape continues to be brutal for Reitmans over the past five years, it is poised to improve as companies such as Reitmans benefits as being one of the “homegrown” survivors.

Low Expectations Create a Favorable Setup: Reitmans’s equity is universally disliked amongst the Canadian institutional community as seen by sell-side reports (covered only by CIBC/BMO both rated “market perform”) as well as discussions with Canadian institutions. Many were previously burned by the dividend cut a few years back and lack of top line growth. Any sign of life and Reitmans equity will likely re-rate.

Why Does this Opportunity Exist?

A long opportunity in Reitmans’s common equity is available due to the following:

Dividend Reduction: In FY13, RET cut its dividend from $52MM to its current run rate of $13MM per annum. This led to a key Canadian index deletion and negative sentiment in Canada for which the institutional community places strong emphasis on dividends. While it is unlikely for RET’s dividend to be increased to $50MM in the near term, as financial performance improves, RET will likely increase its dividend in tandem.

Declining SSS: Same store sales have been meager, declining three years sequentially. In FY15 and 1Q16, same store sales have remained positive as Reitmans right sizes their store base.

FX Headwinds Margin Pressure: RET purchases its inventory from Asia in US dollars and then sells its inventory denominated in Canadian dollars (i.e. COGS in USD and sales in CAD). The decline of the Canadian dollar versus the US dollar has had a negative impact on gross margins, which have declined from ~65% in FY09 to a staggering 55% for the last quarter. Management currently hedges 60% of its FX exposure yet a 1% move in the Canadian dollar is expected to have a $0.5MM impact on operating income.

Moreover, their hedging program was incomplete during 2Q15 for which gross margins declined to 55% from 59.5% the prior, with ~60% of the impact derived from FX movement. Excluding FX, gross margins would have been ~58.3%. While due to the lack of disclosure, we have little ability to forecast gross margins for the next two quarters, we believe over the next two years they should normalize.

Low Float Out of Favor: Reitmans is a Canadian small cap retailer, with low float due to high insider ownership and Fairfax’s stake. Moreover, it has been orphaned by Canadian institutional investors due to the lack of top line growth, a similar phenomenon seen with Imvescor.

Additionally, it was rumored Reitmans was looking at potential alternatives such as a sale a couple of years ago. While obviously that process failed, we’d argue that it was much harder to sell the business at ~8x EBITDA yet at 2x EBITDA it’s materially easier to make a case that it sells for 3x or 4x EBITDA.

Poor Canadian Consumer Outlook: The outlook for the Canadian consumer is bleak, as consumer debt levels are at an all-time high and Western Canada ex. British Columbia is definitely in a recession. This potential risk could be partially hedged out through a short position in a Canadian retailer such as Sears Canada or a handful of Canadian retailers and mall REITs. Moreover, with this overhang and given it’s a retail stock, position sizing plays a big role (i.e. never size retailers large).

No Formal Investor Relations: While it is easy to access Jeremy Reitman, the Company doesn’t participate in conferences, holds no quarterly calls and has no formal presentation, etc. If the Company provides better granularity, has an actual IR outreach or investor day, institutional investors will likely come back to the story.

Business Overview

Founded in 1926 by the Reitman family, Reitmans is Canada’s largest retailer of women’s apparel and accessories with 815 stores across six banners. The largest is Reitmans, which sells to a broad demographic. The Company also has a strong market position in the plus-size and maternity segments. RET has roughly a 4% market share of Canada’s $27 billion apparel market

Store Banners

Reitman: The Reitman’s brand operates 333 stores averaging about 4,600 square feet and is Canada’s largest women’s apparel specialty chain and leading fashion brand. The brand can be seen as a comparable to Express or the Limited, while also catering to the plus sized category (to a certain extent). Note Reitmans recently signed Megan Markle as one of their spokespeople.

Per the below Google Trends data, traffic for Reitmans continues to increase, coinciding with the SSS increases. Notably, we also view similar trends with a consistent increase in Facebook “likes” and Twitter followers over the past three months. For example, Facebook followers have increased by ~4% per month.