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Subject: Christopher Banks CBK Date: 8/7/2004 5:24 PM
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Christopher & Banks Corporation is a Minneapolis-based retailer of women's specialty apparel. They operate 556 stores in 42 states including 426 Christopher & Banks stores and 130 C.J. Banks stores.  The company's Christopher & Banks stores sell exclusively designed, coordinated assortments of sportswear, sweaters and casual dresses in sizes four to 16. The company's C.J. Banks stores offer similar assortments of women's specialty apparel in sizes 14W and up. Christopher & Banks' target customer is a 40 to 60 year old working woman with an annual family income of $50,000 and above.  Management believes this target customer leads a busy life, shops in regional malls and purchases fashions which are suitable for both work and leisure activities. In 2004, lines of merchandise included three principal categories: sportswear, sweaters and dresses.  Plans are to reduce the amount of dresses sold in its stores in fiscal 2005.  Selling space previously allocated to dresses will be shifted to other merchandise categories. 

I have seen one of their mall locations. They attempt to attract mall traffic through appealing visual presentation.  Christopher & Banks carefully designs front-of-store displays to draw customers into its stores. The window showed a neatly dressed mannequin in a pastel coordinated sweater/pants outfit. A look through the window also showed rack upon rack of soft pastel yellows, pinks and greens. This was about 18 mos. ago, right before they started their decline. If you were not a fan of neat matronly pastel, you had no reason to go into the store. It was bland. The visual program emphasizes attractive window displays focusing attention on current merchandise styles and a brightly lit, open store entrance area.  To keep its fashions fresh, Christopher & Banks introduces six different color stories each year.  Merchandise from each color story is featured in the Company's stores for approximately 12 to 16 weeks.  Each color story has a two to four week build-up period in the back of the store.  The color story is then featured in the front of the store for approximately eight weeks.  Remaining merchandise from the color story is then moved to the back of the store for a two to four week liquidation phase. This is a strategy that is failing to work now. Same store sales have taken a plunge. Very different story from the breathtaking rapid rise that started in the mid 90's.

http://finance.yahoo.com/q/bc?s=CBK&t=my&l=on&z=m&q=l&c=

CBK directly imports approximately 96% of its total merchandise purchases. They anticipate that direct imports, as a percent of total purchases, will be approximately the same in fiscal 2005. Direct importing allows Christopher & Banks to obtain high quality merchandise at a lower cost and keeps them competitive with all the other retailers that get clothing from emerging nations. They have their own private label brands to help distinguish them from the rest of the pack. They anticipates private brand clothing will account for substantially all of sales again in fiscal 2005.



During the fiscal year ended February 28, 2004 CBK opened 68 Christopher & Banks stores and 29 C.J. Banks stores.  The Company closed one store during fiscal 2004.  They plan to open approximately 100 new stores in fiscal 2005 and 115 to 120 new stores in fiscal 2006.

Stores are located primarily in regional shopping malls in mid-sized cities and suburban areas, which offer high-traffic by potential walk-in customers.  Approximately 85% of the stores are located in enclosed regional malls that typically have numerous specialty stores and two or more general merchandise chains or department stores. The average store size is approximately 3,425 square feet--approximately 85% is selling space. All of the stores are leased. Lease terms typically include a rental period of ten years and may contain a renewal option.  Leases generally require payments of fixed minimum rent and contingent percentage rent, typically calculated at five percent of sales in excess of a specified level.


Some financial news

In July 2003, a 3-for-2 stock split took place. They split 3-for-2 on four more occasions: December 14, 1999, July 11, 2000, February 12, 2001 and December 12, 2001.  Share and per share data have been restated to reflect the effect of the stock splits.

In September 2003, the first cash dividend was declared.  They pay an on-going cash dividend of $0.04 per share paid quarterly, subject to Board approval.  Quarterly dividends were paid on October 6, 2003, January 6, 2004 and April 6, 2004 .

The Board of Directors authorized a stock repurchase program in February 2003, enabling the CBK to purchase up to $20 million of its common stock, subject to market conditions.  During February and March 2003, they purchased a total of 1,608,000 shares for a total cost of approximately $17.3 million.  This stock repurchase authorization expired in February 2004.

 As of April 30, 2004, under a new authorization, CBK has purchased a total of 294,000 shares of its common stock for a total cost, including commissions, of approximately $4.9 million, leaving $20.1 million available under the current authorization.

Ratios for the income statement

2004 2003 2002 2001 2000

gross margins 42% 44% 44% 44% 39%
operating margins 16% 18% 19% 20% 13%
net margins 10% 11% 12% 12% 8%
growth revenue 15% 23% 32% 46% --
growth gross 11% 21% 32% 67% --
growth operating 2% 14% 31% 119% --
growth net 2% 17% 29% 122% --
growth COGS 19% 24% 32% 33% --
growth SGA 16% 25% 31% 41% --
growth EPS diluted 5% 15% 25% 103% --
growth EPS 5% 12% 22% 109% --
inventory/COGS 14% 13% 12% 14% 13%
growth depreciation 20% 32% 51% 38% --
tax rate 39% 38% 39% 39% 39%

*growth in revenue is slowing significantly. The only reason for any increase was new store openings.

* All margins are declining. Since cost of sales includes markdowns and because same store sales are declining, this may be affecting gross margins.

*Cost of sales include the cost of merchandise, markdowns, shrink, freight in to and out from the Company's distribution center, buyer and distribution center salaries, buyer travel, rent and other occupancy related costs, miscellaneous merchandise expenses

*Net sales for t 2004 were $390.7 million, an increase of $51.9 million or 15.3%, from net sales of $338.8 million for 2003.  The increase in net sales was attributable to an increase in the number of stores operated by the Company during the year, partially offset by a 2% decline in same-store sales.  The 2% decline in same-store sales was primarily due to a challenging retail environment, as well as weakness in the Company's sweater business, particularly in the fourth quarter. 

*For the year,stores opened in fiscal 2001, 2002 and 2003 generated flat same-store sales, while the Company's mature base of stores, opened in fiscal 2000 and earlier, recorded a 4% decline in same-store sales. Other retailers were not finding the environment as challenging(Chicos, the Gap) and that suggests CBKs inventory is not competitive.

* The decline in gross profit as a percent of net sales was mainly the result of approximately 170 basis points of negative leveraging of store rent expense.  The negative leveraging of store rent expense resulted from a 2% decline in same-store sales combined with operating more stores in fiscal 2004 which were still in the buildup phase of their sales curve.  In addition, improved pricing obtained from suppliers was substantially offset by increased markdowns expense resulting from the heavily promotional retail environment. The increased use of markdowns appears to be a factor in declining margins. Older stores were not extracting full value from square footage for the rent paid. Margins suffered.

*Even though the company is debt free, they pay interest expense on a credit facility. Loans under the Wells Fargo Revolver bear interest at Wells Fargo's base rate, 4.0% as of April 30, 2004, plus 0.25%.  Interest is payable monthly in arrears. The Wells Fargo Revolver carries a facility fee of 0.25% based on the unused portion as defined in the agreement.  Facility fees totaled $2,555 in fiscal 2004. 


Balance sheet ratios

2004 2003 2002 2001 2000
current ratio 6.2 5.3 4.8 3.1 2.4
quick ratio 4.37 3.5 2.9 1.8 1.4
AR growth 26% 69% -20% 67% --
DSO 3.1 2.9 2.1 3.4 3.0
inventory days 50.3 46.0 45.1 49. 47.3
growth in payables 45% 88% -46% 70% --
growth in inventory 30% 27% 20% 39% --
CCC 42.5 39.9 41.30 38.5 39.1
ROE 22% 27% 29% 37% 31%
ROA 19% 23% 26% 27% 20%
ROIC 22% 26% 29% 34% 27%
debt/equity 0.0% 0.0% 0.0% 7.6% 14.2%
debt/capital 0% 0% 0% 7% 12%
book value 4.7 4.2 3.2 1.9 1.1
cash/share $2.37 $1.91 $1.17 $0.97 $0.73
NC WC 17.2 14.6 14 4.8 -0.4
change in NC WC 2.6 0.6 9.2 5.2 -0.4
increase in LT debt 0 0 -5.2 0.1 5.1
increase/decrease total shares 4 -1.5 -1 4.7 31.3
payable days outstanding 10.9 8.9 5.9 14.4 11.2

*No debt
*Accounts receivables increasing--a very small account of $3 million
*DSO stable
*Inventory not turning as rapidly. The last two years, inventory is increasing at rates exceeding growth in revenue. Is it just not appealing to the consumer?
*Still have remarkable ROE,ROA and ROIC in spite of the slow down
*Shares increasing in spite of buybacks. Options are a little on the high side.
*$2 cash per share makes the $14 price per share not quite as painful. They warn the cash will be used up pre-Christmas and then accrue post Christmas.

Ratios for the cash flow statement

2004 2003 2002 2001 2000

growth in operating cash flow 3% 48% 32% 41% --
operating cash/revenue 14% 16% 13% 13% 14%
operating cash/net income 140% 139% 110% 107% 169%
operating cash/debt+interest 27.6 6.7 0.07 0.04 0.03
capex/operating cash 40% 38% 85% 62% 54%
free cash flow 32.9 33.1 5.3 10.4 9
common shares 37.5 33.5 35 36 31.3
free cash flow/share $0.88 $0.99 $0.15 $0.29 $0.29

*Operating cash flow positive and increasing
*Capex easily covered by operating cash
*Operating cash not being consumed in proportion to revenue and net
*Free cash flow positive
*Shares increasing in spite of repurchases
*The company plans to spend approximately $25 to $27 million on capital expenditures in fiscal 2005 to open approximately 65 new Christopher & Banks stores and 35 new C.J. Banks stores, to complete approximately 20 store remodels and to make various capital improvements at its headquarters and distribution center facility. 


Options

Exercised 699,632
price $5.37
amount $3.8 million
outstanding 3.9 million
total dilution 10%
total amount @ $8.24 black-Scholes $32 million
price per share $0.85

Debt value of leases

Debt value of leases is $209 million due through 2013. These are off balance sheet obligations and even though the company has no debt, this expense must be considered as a form of debt.

Debt(lease)/Equity=1.15 is fairly high. With revenues declining and same store sales spiraling ever downward, this may become a problem. They discuss the negative impact of lease”leverage” versus declining sales and it's negative impact on margins. Unless the problem is fixed, the future looks uncertain for CBK and expansion may only start to hurt revenue rather than help modestly as it does now.

Valuation

Assumptions
Beta 1.5
Cost of equity 9.95
High growth 10%(from new store openings unless things change) for 5 years
Stable growth 3%
Capex, WC & depreciation grow at same rate as revenue
Depreciation exceeds capex by 100% in stable growth



Value $16.44
Value with options $15.59

CBK is a company I have longed to own for several years, but didn't like the price. At the time, they were growing at 16-17% and looked like there was no stopping them. Well, they hit the wall in the last year and a half:

Comps
2004 2003 2002 2001 2000
Same-store sales increase (decrease): (2 )% 1 % 6 % 18 % 17 %
Stores at end of period 534 438 351 273 223
Net sales per gross square foot $ 238 $ 253 $ 256 $ 247 $ 201

Starting in 2002 things look like they are beginning to slow down and by 2004, the trouble is obvious(at least to investors as comps and price decline). Management is in denial as far as I can tell although I haven't heard the most recent conference call. They cite a challenging retail environment and declining sweater sales. By the looks of the steep drop in comps, I would suggest the trouble goes a lot deeper. There are other retailers that have done well the last 2 1/2 years. Chico FAS has no trouble getting the consumer to shop for casual clothes. The Gap has made a decent come back. Where is CBK going wrong? In clothing retail, it has got to be the clothes, although slowing mall traffic may be partly to blame. They rely on drawing the mall shopper in and do no advertising. This strategy may be failing them.

At $15.59, I would want a discount of 20-30% to take a chance on a turn around and even then it would be nice to see some sign of changing strategy or customer interest before committing dollars. The last quarter(May) was down 5% compared to 2004 and that is not a good sign.

In retail, there seems to be a fair amount of previously strong companies going out of favor and later coming back. CBK is not in financial trouble and is still generating cash and has no balance sheet debt. If they start consuming operating cash or take on debt, it would be reason to decline investment. If they can weather the storm and stay afloat, they may hit the consumer mainstream again. They have done it before.
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