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Author: mrchw Big gold star, 5000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 1264  
Subject: Cache, Inc (CACH) Date: 7/22/2004 8:07 AM
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Cache (CACH, $15.33 as of 7/21/2004) is a small cap company with a market cap of $240M and an Enterprise value of $200M. They have demonstrated increasing profitability metrics, have a growth strategy underway, and insiders own 20+%.

History (Note: 1st 2 paragraphs modified from annual report)

Cache is a specialty retailer of social occasion sportswear and dresses targeting style-conscious women. They own and operate two separate store brands, Cache and Lillie Rubin. Cache targets women between the ages of 25 and 45 while Lillie Rubin stores offer a more sophisticated line of social occasion apparel targeting women between the ages of 35 and 55. Both stores sell their own name branded merchandise.

Both store concepts focus on social occasion dressing designed for contemporary women. The two lines extend from elegant eveningwear to distinctive day-into-evening sportswear, which encompasses a variety of tops, bottoms and dresses versatile enough to be worn during the day or evening. As of the end of the 2nd quarter, 2004, there were 240 Cache and 29 Lillie Rubin stores primarily situated in upscale malls throughout the United States.

The Board brought in a new CEO 2000 to turn around a business that was very stagnant, with net margins under 3%, RONA in the high single digit range, and ROE in the low double digit range. Brian Woolf, an industry veteran who previously worked as a vice president at the Limited, was appointed CEO and Chairman of the Board in October 2000. Mr. Woolf has brought 2 top executives over from the Limited since joining, Catherine McNeal (EVP, Merchandise Manager) and David Desjardins (EVP Stores and Operations). There are other top executives who have had previous positions at Armani, Nine & Co, and Ann Taylor.

New management implemented a strategy to improve profitability by closing struggling stores, decreasing the number of SKUs, remodeling stores into more of a boutique atmosphere, and shifting to more sportswear away from evening wear. So far they have been successful. All profitability metrics have been increasing the past two years (ROE and RONA were actually down slightly the most recent year due to increased Assets from a secondary offering, more on the offering later). They still have zero debt and now boast cash in excess of $40M.

Growth Plan

The basis for this report is the growth in store base as well as continued improvements in profitability. At the end of the 1st half 2004, there were 269 total stores. They have planned 350 Cache branded mall stores and 125 Lillie Rubin Stores, for 475 total stores, or almost double their current base. They are also testing out street locations for their Cache brand, recently opening one in Lake Tahoe, Nevada. Depending on the success of this concept, the total number of stores could increase. Here is their historical store count and my estimate of future stores, numbers given for 2004 and 2005 are guidance from management:

Cache LR Total % Increase
1998 184
1999 183 18 201 9.24%
2000 190 25 215 6.97%
2001 197 25 222 3.26%
2002 207 27 234 5.41%
2003 227 28 255 8.97%
2004 262 38 300 17.65%
2005 302 53 355 18.33%
2006 325 68 393 10.70%
2007 350 83 433 10.18%
2008 350 98 448 3.46%
2009 350 113 463 3.35%
2010 350 125 475 2.59%
2011 350 125 475 0.00%

The majority of the growth will come in the next 2 years, with the majority of the earnings growth coming in the next 3 years (management expects Same Store Sales (SSS) numbers to be in the double digits once the new locations start reporting in late 2005 through 2006). This growth is entirely funded from cash on hand and operating cash flow. They have recently done public offerings to increase their cash to fund the growth. They have a revolving line of credit that limits their capital spending through 2005. However, they currently have not drawn on this and their growth plans are within the allowed capital spending amounts.

Income

The income statement shows improving results:

1999 2000 2001 2002 2003
Gross Margin 34.84% 33.45% 35.16% 41.85% 44.17%
Operating Margin 3.76% 0.95% 1.85% 7.15% 8.28%
Net Margin 2.48% 0.63% 1.82% 4.46% 5.13%
Growth Revenue 9.90% 9.36% 2.43% 10.82% 7.96%
Growth Operating Inc -5.74% -72.45% 99.34% 329.18% 25.10%
Growth Net Income 1.85% -263.46% 66.56% 63.11% 19.37%
Growth COGS 10.38% 11.70% -0.21% -0.61% 3.64%
Growth Store Expense 10.90% 12.67% 8.25% 11.77% 10.86%
Growth SGA 12.95% 24.61% -10.12% 36.52% 15.46%
Growth EPS 2.33% -72.73% 200.00% 172.22% 19.39%
Growth Diluted EPS 0.00% -72.09% 200.00% 158.33% 21.51%
Tax Rate 36.96% 36.50% 36.49% 38.65% 39.00%

The Tax rate is expected to remain between 39% and 40%. They recently switched marketable securities from municipal bonds to US Treasuries which caused an elevated rate in the 2nd quarter 04, and this rate of about 39.25% is what they are planning for the rest of the year. There will be increased expenses for the next 4-5 quarters as they implement the growth plan. Increased volume should improve margins even further.


Balance

1999 2000 2001 2002 2003
Current Ratio 1.63 1.78 2.03 2.07 2.41
Quick Ratio 0.59 0.61 0.92 1.18 1.49
AR Growth 79.74% 18.86% 32.54% -38.00% 72.36%
Days Sales Outstanding 6.20 6.74 8.72 4.88 7.79
Days Inventory 55.19 49.89 43.94 40.21 45.11
Days Payable 38.34 25.72 22.81 23.52 26.43
CCC 23.05 30.92 29.85 21.56 26.46
Growth in Payables 23.77% -24.49% -9.96% 8.11% 19.80%
Growth in Inventory 29.02% -1.13% -9.79% 1.40% 21.11%
ROE 12.57% 3.34% 9.08% 19.74% 17.02%
ROA 7.04% 2.00% 5.77% 12.54% 11.55%
ROIC 20.40% 5.61% 16.78% 45.39% 38.96%
Debt/Equity 0 0 0 0 0
Debt/Capital 0 0 0 0 0
Book Value / Share $2.29 $2.39 $2.62 $3.13 $4.43
Cash / Share $0.71 $0.49 $0.87 $1.71 $2.49
Net Change WC (000) ($497) $1,288 $4,032 $6,457 $14,380
% Change in WC -3.23% 8.66% 24.94% 31.97% 53.95%

Cache has a strong balance sheet. They have plenty of cash and no debt. Accounts receivable did grow in 2003, however they were down substantially in 2002. The 03 number is only 6.9% higher than 01. At the end of the 1st half of 04, A/R were 5.8% higher than the end of 03. Inventory will grow in line with new store openings. Working Capital has increased due to a secondary offering and increased store count.

Competition

Cache's competes with the other woman's fashion retailers. These include Chico's, Abercrombie, the Gap, Ann Taylor, the Limited, and even Urban Outfitters. Here is a comparison of some metrics:

CACH CHS ANF GPS ANN LTD URBN
CCC 28.7 28.7 60.9 35.5 72.1 37.4 39
ROE 20.19% 32.60% 25.27% 25.69% 14.41% 14.16% 18.80%
ROA 13.30% 25.95% 18.70% 11.63% 10.28% 9.48% 15.17%
D/E 0 0 0 0.51 0.14 0.12 0
Current Ratio 2.41 2.76 2.69 3 2.04 3.18 3.04
Quick Ratio 1.42 1.77 1.89 1.45 1.17 2.33 1.63
Gross Margin 44.17% 61.30% 42% 38.80% 55.70% 36.40% 38.90%
Net Margin 5.13% 13.04% 12.01% 7.05% 6.88% 8.03% 8.82%
P/S 0.98 5.05 2.03 1.29 1.15 1.26 4.22
Sales / SF $450 $924 $345 $415 $434 $342 n/a

Note: Data from Morningstar.com as of 7/13/04, with the exception of
Cache's gross margin, which incorrectly includes Store Operating
Expenses as part of COGS on M*.com
Sales per square foot from most recent annual reports. LTD number is
only apparel brands

Cache fits right in the middle of most of these metrics. The CCC equal's Chico's and is the best of the group. Margins are currently near the low end of the group, however they are expected to improve. Gross Margins are already running at 47% and the net margin for the 1st half of 04 was 6.4% compared to 5.0% in 2003.

Risks

The fashion industry always faces fashion risk. If Cache fails to recognize future fashion trends, results could suffer. Also, the American Consumer has been very strong throughout the economic downturn, and recent economic results have shown that this has begun to decrease.

Intangibles

Management seems to be quite straightforward. While I have not received a response to my question about total estimated store count and target net margin, they answer questions candidly on the conference calls. The most recent conference call had questions from at least 5 different analysts, previous calls have features perhaps 3 on average. The street seems to be beginning to notice Cache.

Option grants have not been excessive, with total shares increasing 10% over the past 5 years (about 2% per year). Insiders have recently sold a large stake (approximately 15% of the company, the majority in a private placement at approximately the same price the stock is today), however the stock price has risen from 2.50 to as high as 20 over the past few years, so this is understandable. They still own 22% of the company.

Valuation

I ran multiple discounted cash flow valuations. The assumptions across all my models are:

New Store Net Dep
Year Growth Margin Growth Capex
2004 10% 5.80% 8% $15,000,000
2005 17.65% 6.00% 8% $20,000,000
2006 18.33% 6.20% 8% $20,000,000
2007 10.70% 6.50% 8% $20,000,000
2008 10.18% 6.50% 8% $15,000,000
2009 3.46% 6.50% 8% $15,000,000
2010 3.35% 6.50% 8% $15,000,000
2011 2.59% 6.50% 8% $15,000,000
Terminal 0.00% 6.50% 5% $15,000,000

I ran the model with two additional variables that I changed. The first was Same Store Sales. I either included a 3% annual increase in SSS or no increase. I also ran the DCF model with two assumptions for capital expenditures and working capital. In the more conservative case, I deducted all CAPEX and the increase in working capital (WC was calculated as 8% of sales). In the less conservative case, I only deducted CAPEX equal to depreciation as some say capital spending related to growth is really cash flow for the owners. I assumed 2% dilution each year, but did not deduct this expense from net income. To my calculated DCF value, I added the $40M of cash and marketable securities, and came up with the following per share vales:

SSS Growth Discount Rate
Growth Capex 7.50% 10.00% 12.50% 15.00%
y n $45.09 $38.59 $33.25 $28.85
n n $39.19 $33.63 $29.07 $25.30
y y $34.45 $29.26 $25.00 $21.51
n y $28.98 $24.69 $21.17 $18.27

I typically look for a 50% margin of safety. I believe that at the current price of $15.33, CACH reflects this. I feel that my growth estimates are extremely conservative and therefore have a margin of safety built into them. I believe that it is possible for Cache to open even more stores in the future than they have current plans for. I also believe that they will be able to increase net margins at a quicker pace than I predict, and to an even higher value than my maximum estimate of 6.5%. This is still below the net margin of all of the competitors that I reviewed. However, ignoring these prospects, I put the fair value for CACH between $25 and $35, and expect that strong earnings growth, improved profitability, and increased street recognition will be the catalysts to get to this price. If everything goes flawlessly, I believe the share price could reach $45 per share in the next 3-5 years.
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