Most people are probably familiar with the late Johnnie Cochran's quote from the OJ Simpson murder trial, in which he states, "If [the glove] doesn't fit, you must acquit." Cochran used a little theatrics to question the logic of the prosecution's case - and it worked. Logic is the linchpin that holds together all good arguments. In an argument of a different kind, I'll compare apparel firms Liz Claiborne (NYSE:LIZ) and Quiksilver (NYSE:ZQK), making the argument that if Liz is worth $7.50 a share - KeyBanc 12-month price target set in February - logic dictates that Quiksilver, currently trading at $3, is also worth $7.50 a share. If so, the maker of Quiksilver, Roxy and DC brands is in for some serious appreciation.
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Similar Business Models
While the two companies' core customers are completely different, their business models are almost identical. Quiksilver distributes its three primary brands wholesale to customers, like Zumiez (Nasdaq:ZUMZ) and Dick's Sporting Goods (NYSE:DKS), while also operating 518 company-owned retail locations and licensing another 213. Liz Claiborne has five key brands (Juicy Couture, Lucky Brand Jeans, Kate Spade, Mexx and Liz Claiborne) also distributed through a wholesale network that includes exclusive licensing deals with J.C. Penney (NYSE:JCP) and QVC, and through a large complement of company locations. In terms of revenues, Liz is bigger, but not by a huge amount. In 2009, Liz did $3 billion to Quiksilver's $2 billion.
Similar Problems
Both companies have gone through growing pains in the past five years, resulting in impairment charges, tax losses as well as actual losses from continuing operations. Business has been a struggle for both of them. Quiksilver's problems stem from one fateful acquisition in 2005, when it bought Rossignol, a leading ski brand. Nothing good came of its foray into hard goods, and in November, 2008, it sold the company for a pre-tax loss of $212.3 million. Liz Claiborne's problems are a combination of the iconic legacy brand losing its core customer, and undertaking far too many acquisitions, making the company bigger but doing little to project a business with purpose. CEO Bill McComb was brought in to make radical changes, including selling or shuttering brands. Clearly, a lot of work is left to be done and investors are lining up to place their bets.
Valuation Logic
The purpose of this article isn't to debate the true value of Liz Claiborne stock, but rather to make the case that Quiksilver is worthy of a similar valuation. Here's why. As of March 5, 2010, Quiksilver's market cap was $378 million, $300 million less than Liz Claiborne. Yet Quiksilver's operating profit in 2009 was $68.6 million compared to an operating loss of $334.6 million for Liz Claiborne. In terms of net losses, Quiksilver's was lower by $100 million. Impressively, Liz's full-year cash flow was the same, at $207 million. So, what exactly is holding back a similar valuation for Quiksilver? In one word: debt. Quiksilver has $1 billion of the stuff, much of it acquired in the Rossignol disaster, compared to $516 million for Liz. That said, most analysts would admit that Quiksilver's earnings in the last five years on a relative basis have been better. If this is true, logic suggests Quiksilver should trade at price-to-book and price-to-cash flow valuations equal to Liz. That's currently not the case.
The Bottom Line
Liz Claiborne currently trades at 3.2-times book value, and 3.3-times cash flow. Quiksilver, on the other hand, trades at 0.8-times book value and 1.8-times cash flow. Assuming the quality of Quiksilver's future earnings is similar to Liz Claiborne, an argument can be made that Quiksilver should trade somewhere between $5.41 (assuming the same P/CF and P/B as Liz Claiborne) and $11.84 a share. Logically speaking, that is. (To learn more, see Free Cash Flow: Free, But Not Always Easy.)
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