- This post examines the past catalysts that have brought American Apparel down on its knees and it explores what’s in store for 2014.
- It is also a follow-up post to American Apparel: This Wart Looks So Perfect, in which we justify our bullish position.
- Here we explain why we decided to participate this week in the latest round of equity funding, bringing our total long position to 3.17mm shares.
Throughout its brief history, American Apparel ($APP) has been spewing negative catalysts. First, it started with the hiring of thousands of illegal immigrants which had to be fired after the company got caught by the INS. The company paid a dear price for this value destroying action.
The company’s balance sheet got decimated has it tried to recover from this situation by firing thousands of employees and having to interview 12,000 candidates to replenish the lost stock. In addition, the financial crisis created a great recession for retailers and APP sales collapsed in the process.
All of this brought the company down the precipice. The stock traded down from $17 in 2008 to $.55 in 2011.
Despite getting rescue financing in 2011 (We wrote about it here) and getting back on track in 2012 and early 2013, the company faltered again in late 2013 because of execution issues at its newly minted Distribution Center (DC) located in LaMirada, management’s diverted attention away from merchandising to fixing the issues at the DC, a less vigorous youth market, and bad weather in the American Northeast. The company is now facing catastrophe once again.
So for most of its public life, American Apparel stock has been driven down by the following negative catalysts:
- Immigration issues.
- Bizarre behavior from the CEO of the company (Source: Media).
- A very ugly Balance Sheet.
- Strong dilution favoring management, and in particular the CEO.
- Distribution Center (DC) Issues.
- Management focus diverted to fixing DC issues instead of running the business.
At this juncture the company is facing delisting, it has raised money to pay an April debt payment, and the company is late filing its 2013 10-K. APP is as ugly as you can get.
But despite all these issues, we decided to participate in the last round of funding lead by Roth Capital. We think the worst is over for the company as we explain in this post titled American Apparel: This Wart Looks So Perfect.
The funding should allow the company to end 2014 with close to $50 million of cash on its balance sheet (B/S). This is how we derive this amount (caveat: We don’t have the 2014 1st quarter numbers yet).
Assuming $0 of cash on the (B/S) as of 3/26/2014
Equity Raise assuming over allotment options is exercised= +$32 million (about)
2014 EBITDA guidance = +$45 million
2 times cash interest payments of $13.7 million (Source Here) = -$27.4 million
Capital Expenditures (Source: Preliminary 2013 annual results) = -$12 million
Decrease in Inventory (Source: Management) = +$12 million
Total Cash as of 12/31/2014 = +$50 million (Very rough estimate)
As investors gain confidence these numbers will be met, we believe the news flow is about to turn from negative to positive and the following catalysts are about to drive the stock much higher and investors will pay attention:
- Distribution Center Issue resolved (Source: Management).
- Cleaner Balance Sheet.
- Partial debt repayment starting in late 2015.
- Aggressive inventory reduction by 14% (Source: Management).
- Deal dilution will somewhat weaken Dov’s control over the company and insure a more balanced approach. Investors will appreciate that.
- Deal dilution will be counterbalanced by Charney’s performance package not meeting key milestones.
- A more subdued Charney with a better narrative for the company. A narrative focused on what this company is doing right instead of discussing sexual harassment issues which has been baked a thousand times over.
- The beauty of the American Apparel brand is about to become more obvious to many investors. No wonder Goldman, an APP bond holder, is playing to keep (Source Here).
A better environment will allow Charney to implement his vision. He said:
Our 247 stores could be 20% more productive with the right tweaks, the online business could double, wholesale could grow by 20% to 30%. We could even develop a $100 million third-party retail business, selling items like American Apparel nail polish at drugstores or having hooded sweatshirt blowout sales at Costco.
Using this delta over the 2012 sales baseline, American Apparel could generate between $800 million to $900 million in sales in 2017.
There seems to be quite a bit of confidence from some senior executives at American Apparel, that annual sales could reach $1 billion within 4 years (Milestone could be reached in 2018). That is about $350 million of incremental revenues over 2013 sales. That is a big number and given the recent management execution issues, one should be very skeptical about the ability of management to deliver on this.
Nonetheless, it is a good exercise to figure out how the company intends to get there. Using the information released by the company over the past year, let's see if the numbers jibes with this expectation.
Baseline Anuual Sales (2012)
Total Sales 2012 $617mm
Management indicated in early 2013 that they could open 65 new stores over the next 3 to 5 yrs. The store base is expeted to grow 26.31%. In addition, management has said current stores could improve productivity by 25%.
So in total, retail sales could increase by 58% by the end of 2018. We are assuming no comp sales growth to counterbalance the fact that new stores are not fully productive right from the get-go.
2018 Retail Sales = $588mm
Growing wholesale sales by 25% over that period.
2018 Wholesale Sales = $207mm
Internet to double.
2018 Internet Sales = $110mm
To build a $100mm third party business (Example: Selling hoodies at Costco)
2018 Sales = $100mm
Total 2018 Sales = $1005mm
The company's goal is to increase EBITDA margin to 15% over that period. Using a 200 million shares count, the company could generate $.75 per share in 2018. Using a 10% EBITDA margin, the company could generate $.50 of EBITDA per share in 2018. Even if we assume that the company generates $800 million of revenues in 2018 at a 10% EBITDA margin ($.4 of EBITDA per share).
On the debt side, currently APP has approximately $200mm in debt outstanding at 15% interest (We are excluding ABL), total annual interest payments of about $30mm. If they reach their goal of $1Bn Revenues in 2018 and 15% EBITDA margin, that means $120 in pre-tax earnings ($0.60 / share). Even at $800mm Revenues and 10% margin, there is still $50mm in pre-tax earnings or $0.25 / share. That is without repaying a dime of debt. We think it is likely they will start to pay down debt gradually beginning as early as 2015 and refinance as early as 2017. (Rough Calculation)
Since the company raised the necessary amount under the shelf according to our thesis, we believe the fog will lift rapidly and investors will start focusing on the bright future ahead.
Written by Michael Bigger
Disclaimer: Bigger Capital, LLC, Bigger Capital Fund, LP, Bachelier, LLC and the Bigger family own more than 3.17 million shares of American Apparel. American Apparel is a highly distressed situation and it is not suitable for the majority of investors. The likely outcome of an investment is a loss of principal. In other words, the probability of losing all your investment in this situation is very high. We have been purchasing American Apparel since May of 2011 and we have nothing to show for it. Take our opinions with a grain of salt and do your homework.