Talbots Overvalued as It Falls on Strong Quarter

Women’s apparel retailer Talbots, Inc. (TLB) has fallen nearly 8% in early trading after reporting a better than expected quarter.  Not only did Talbots top analyst’s expectations on earnings per share but they also raised guidance for the full year.  In the quarter, Talbots’ net loss was $4.4 million or 8 cents per share but adjusted for one-time items and restructuring costs the company earned 38 cents per share.  This result was better than estimates of $.16 cents per share and easily bested the quarter a year ago where they lost 44 cents per share.  The improved performance was thanks in large part to sales rising 21% in full-price items and also an 18% reduction in inventories.  Both of these occurrences served to improve gross margins.  For the full year, the company is anticipating 75 cents to 83 cents a share thanks to the healthier margins, and analysts had forecast 73 cents.

Perhaps most importantly, during the quarter Talbots was able to cut ties with Aeon Inc, Japan’s second largest retailer.  Aeon had amassed a 54% equity stake in the company and was also a large creditor, but in one fell swoop—through a complex transaction involving a merger with BPW Acquisitions—Talbots repurchased the nearly 30 million shares held by Aeon and repaid all outstanding debt to them approximately $488.5 million plus interest and costs.  At the same time, Talbots secured a new senior secured revolving credit facility through GE Capital Markets worth up to $200 million.  This served to greatly reduce the company’s debt load, one of our major concerns, as well as providing the company the liquidity to refresh many of its stores.  Overall, debt outstanding was reduced to a much more manageable level of $94.1 million as of the end of the quarter.

If there was one knock on the quarter it would be that sales did not rise as much as hoped.  Analysts were counting on 5.5% growth to $323.1 million, but actual results showed gains of 4.7% to $320.7 million.  Also full year sales guidance of 3%-5% growth was more conservative than Wall Street.  Same-store sales were up 2.4% aided by the improved sales of full-price merchandise.

At Ockham, we had placed our Overvalued rating on TLB as of Monday.  According to our methodology, the stock had appreciated far too much than had been justified by the fundamentals.  We believe that our assessment has been echoed by the market’s reaction today to what seemed to us a much stronger than expected report.  While our reservations regarding Talbot’s excessive leverage have been alleviated, we are still concerned that sales will not soon return to the much stronger levels of just 2-3 years ago.  It is clear that we are witnessing a turnaround at Talbots, and this stronger report may warrant an upgrade to Fairly Valued in the coming weeks.  However, at this time, we believe there are still many more attractive stocks for value investors.

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