The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (TheStreet) -- For those who have ever wandered into a Target (TGT) to buy new clothes or shoes, encountering the Cherokee (CHKE) brand is inevitable. What you may not know is that this remarkable little company has only a handful of full-time employees, has less property than many small families and yet collected over $30 million in revenue last year and turned 40% of those revenues into free cash for its stockholders. Clearly, this is one remarkable business -- and according to the Magic Formula, its stock is also on sale. Let's take a look at this intriguing little ($160 million) company.
First, the business. Cherokee is strictly a brand licensor. It owns the Cherokee, Sideout and Carole Little brands (among others), which it licenses to selected retailers. The company does no product design, no production sourcing and little marketing -- this is left to the licensees. Cherokee provides and fosters well-known brands that allow customers to charge more for what is, in effect, store-brand merchandise. This is what's known as a "light" business model, requiring next to no capital investment and few expenses save for paying the handful of employees and maintaining the brand trademarks in various countries. As a result, Cherokee is a phenomenally efficient business, with post-tax returns on capital routinely climbing above 150%.
Cherokee gets paid a percentage of the net sales of licensed products, and most of their deals also have a minimum annual payment clause. The largest deal, by far, is one with Target to sell Cherokee-branded apparel, which has accounted for about 42% of revenue for the last several years. This deal runs through January of 2013. The other large contract is with U.K.-based Tesco, the third-largest global retailer. In fiscal 2011 (roughly calendar 2010), Tesco contributed 27% of sales. The remaining 30% or so are spread through multiple agreements with retailers both big and small, domestic and international. Examples include a licensing deal for the Carol Little brand to TJX Cos. (TJX) and Sideout to volleyball equipment maker Mikasa Sports.This is a company in a bit of a transition. Cherokee has stagnated badly over the past five years, with revenue declining 29% and operating profits down 25% since 2006. In that same period, the dividend has been cut from $3 a share in 2007 down to $0.80 today (a still respectable 4.4% yield). Tesco, in particular, has not been a very good partner, with royalties down almost by half from just three years ago, and failing to expand Cherokee's brands into Asia. Predictably, the stock price has followed suit, down to the high teens today from about $45 five years ago. The wheels started turning last August, when long-time CEO Robert Margolis handed the reins over to licensing veteran Henry Stupp. In January, Margolis also gave up his chairmanship, effectively leaving the company (though he does still have a 7% ownership stake). There was turnover at CFO as well. This should help Cherokee in several ways. For one, the company is in need of some fresh energy to ignite growth. Second, Margolis was handsomely paid. His salary was $800,000, and Cherokee will end up spending nearly $13 million in severance (through bonuses, severance and buying back some of his stock) -- $10 million of which it had to secure debt for. Stupp's compensation, at $375,000, is more reasonable, and the difference is material to such a small business. Cherokee's dividend has been its biggest attraction for many years. It once paid out a 8%-10% yield, but was never sustainable. The current dividend should be. It represents just 50% of last year's free cash flow, and provides the firm additional cash to pay down the newly minted debt, and also to pursue growth avenues, such as acquiring new brands. Modeling low single-digit growth going forward, the stock looks to be worth about $22 a share. That is 25% upside from current prices (including the dividend). That makes Cherokee a solid Magic Formula pick. Given the management turnover, downward trend, and revenue concentration between two customers, I'd like to see the stock get a bit cheaper before considering it for a "top buy" recommendation, however. The writer owns no positions in any stocks discussed in this article.
Select the service that is right for you!COMPARE ALL SERVICES
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV