Phillips Van Heusen on the move

Today we took an initial position in PVH at $39.30 with the aim of investing more should the stock lower in the near term. The company owns Calvin Klein, IZOD, Arrow Van Heusen and Bass and licensed in 18 other brands including Timberland, Kenneth Cole.

I had been interested in investing in Ralph Lauren for sometime because I considered them to be the best overall clothing brand worldwide and the stock valuation had been regressing. An investor/friend I respect suggested that if I liked Ralph Lauren then I should take a look at Phillips Van Heusen as it had similar business fundamentals and was available for much cheaper.

Turns out PVH is similar to Ralph Lauren in that the company makes money through licensing its globally well-known brand. The Calvin Klein brand is number 2 in the US behind Polo and is the number 1 in China. Keeping the brand legitimate, Creative Director Francisco Costa has earned respect among the world’s high-fashion circles after taking over directly from Mr. Klein in 2003 (prior to CK Costa worked at Gucci and Tom Ford).

The Calvin Klein brand is also well-positioned among the price-point spectrum: they have a high-end luxury segment (which loses money, but keeps prestige); a mid-tier segment that markets to younger hipper crowd (this drives the business Asia and Europe) ; and the last tier is the CK ‘white’ label that specializes in t-shirts, underwear, socks, etc. (the basics).

PVH’s licensing model currently accounts for a small portion of sales (12%), but a large portion of operating profit (52%). PVH receives a royalty of ~10% on net sales from licensees while controlling the creative on design and advertising. Management’s aim is to grow the licensing business by 9%/year. PVH is also the biggest private label player in US department stores for both dress shirts and neck-ties.

Today, CEO Emanuel Chirico claimed the Calvin Klein unit of apparel manufacturer Phillips-Van Heusen Corp could grow to $7 billion in global retail sales by 2010. In 2007, PVH posted total revenue of $2.43 billion.

Valuation

I calculate margin of safety to be around 35%. The company is now trading at 12x trailing earnings compared to 18X for the industry and its own long-term average of 19x. Management believes it will achieve 9% organic growth. I think the recent stock price drop was due to the market underestimating the expected international CK trends. PVH is trading at good value (not as cheap as it was two weeks ago) and offers exposure to China/India consumer growth.

BCE M&A Arbitrage

We added to this position today. We think the biggest risk to the deal remains that the U.S. and European banks involved will try to pull out the financing as they have done in the Clear Channel deal. However none of the banks involved have hinted at backing out and OTTP and TD Bank have been consistent in their claims that they believe the deal will go through. We think that American M&A arbitrageurs are the ones keeping the spread wide as American investors were the most spooked by the recent credit crunch. Since the crunch began last summer there has been a tendency to lump all leverage-affected deals together. Remember, BCE is a much different company than Clear Channel in regards to cash flow generation and capex requirements. We view BCE’s balance sheet as strong, with more than C$2 billion in debt reduction and minimal funding requirements. Even with a spike in capital spending at Bell Canada operations to support wireless and wireline broadband access, BCE has had sufficient cash to support its dividend. Pre-takeover, BCE planned to pay out 70% to 75% of its earnings in the form of dividends, including spending on building out its broadband network. This strong financial position, along with private equity’s proposed productivity improvements, should provide enough support for the financing close.

Risks:
1) Approval by the CRTC is dependent on greater Canadian content on the BCE board post-LBO, although Industry Minister Jim Prentice has already given conditional approval to the deal. We don’t think this is significant enough to sink the deal.

2) The bondholders’ appeal starts today in the Appeals Court. Again, the Quebec Superior Court already threw out the bondholders’ case against the deal in March and most people believe Appeals will do the same. There is still a chance they can take there case to the Supreme Court if they lose.

RETURN POTENTIAL: 13.2% over two months, 78% annualized
HEDGE: Long the equity, long Bell 7.65% Dec. 2031

Related Reading:

network.nationalpost.com/np/blogs/tradingdesk/archive/2008/04/24/long-equity-and-long-credit-trade-recommended-for-bce.aspx