Not Sold on Kenneth Cole

In this week's small-cap spotlight, Frank Curzio and Larsen Kusick take a close look at Kenneth Cole Productions(KCP Quote). Shares were recently trading at $18.68, just above the 52-week low, but is this diversified retailer looking at more losses or has it finally bottomed?

Curzio: Few Reasons to Buy This Stock

In mid-2004, Kenneth Cole implemented a three-year strategy that included raising prices on its New York label and repositioning products into high-end retail outlets such as Saks(SKS Quote), Bloomingdale's and Nordstrom(JWN Quote). Also, the plan was to make Reaction into a lifestyle brand.

But after three years and counting, it seems the company is still struggling to implement its business model and, with the current climate for retailers becoming dire, it's hard to find a short-term catalyst that would move shares higher.

Kenneth Cole: Fashion Do or Don't?

Looking at the company's latest conference call, management tried to explain the evolution of its brand strategy. First, the Kenneth Cole brand becomes dominant with the sub-brands underneath, and stores over time become just Kenneth Cole and New York goes away.

Then management went on to say that it launched apparel at Kenneth Cole but women's apparel stays in Reaction for the time being and will probably go to Kenneth Cole, but it hasn't yet. Marketing and merchandising resources are being used to re-energize growth at Kenneth Cole, but this has come at the expense of footwear. But management believes that it can get Reaction back on track.

In other words, after three years of investors being patient, there is still confusion on what management's business strategy is and the timing could not be worse as consumer spending is slowing and we may be on the brink of a recession, which is not a good scenario for retailers in general.

Management also noted in the call that international sales were strong. Sales were up 50% from the comparable period, but taking a closer look, they account for only 3.5% of total sales. This is a bright spot for the company, but not a short-term catalyst, unless the company is able to integrate the Le Tigre brand that it purchased last quarter sooner rather than later. Financially, Kenneth Cole has a very strong balance sheet, with about $4.80 a share in cash and no long-term debt. But its wholesale segment, which accounted for roughly 60% of revenue last quarter, declined 13.9% from last year. This is significant, and management said that it expects continued softness in this segment going forward.

On a positive note, the stock trades at less than one times sales and pays a 4% dividend, much higher than the industry average. This may attract income investors but they may be better off investing in Con Ed(ED Quote) than a retailer that pays a high dividend but lacks a comprehensible business strategy.

Finally, after buying back 282,300 shares last quarter, the company has 1.4 million left under its repurchasing plan. These positives reduce downside risk, but I don't see any short-term catalysts to make me want to purchase the stock here.

Kusick: Few Reasons to Buy This Sector

I think Frank is being a little too tough on Kenneth Cole. Yes, it's true that management seems to change its mind an awful lot when it comes to the intricacies of branding, and while I don't profess to be an expert on marketing, I can't imagine the company's recent strategy decisions being put in any textbook for MBAs anytime soon.

However, when it comes to retail/fashion, the buying public remains the ultimate judge of a company's brand, regardless of the intricacies of management's strategy. In this respect, Kenneth Cole remains on solid ground. The company's third-quarter results, reported a little over a month ago, showed a continuing uptrend in same-store-sales, with the strength of the Kenneth Cole brand evidenced by the 7.5% growth in licensing revenue.

Retail Pullback 2007 is shaping up to be a tough year for earnings in the retail space
		Earnings per Share			Expected Annual Growth
Company	Ticker	2006	2007E	2008E	2007	2008
Kenneth Cole	KCP	$1.28	$0.64	$0.81	-50%	27%
Jones NY	JNY	$2.28	$1.26	$1.62	-45%	29%
Liz Clairborne	LIZ	$2.99	$1.75	$2.15	-41%	23%
Ralph Lauren*	RL	$3.73	$3.55	$4.55	-5%	28%
Source: Thompson First Call 2007 & 2008 numbers represent consensus estimates from Thompson First Call * Ralph Lauren's most recent fiscal year ended March 2007, but is labeled 2006 for comparitive purposes