14 November 2005

Timberland Has the Pig on the Fence

Blog Hog John Coumarianos e-mailed that he was looking into Timberland (TBL), the maker of those ubiquitous tan workboots, as well as the black boots now advertised on NYC subways, as well as pictured to the left. The positives for TBL: "monster ROIC and very little debt." The negatives: declining sales and free cash flow, as well as the recent acquisition of SmartWool.

John's dilemma is clear. The Pig is here to the rescue, or more probable, to muddy the waters.

I tried to work out a DFCF model, but my numbers grossly overvalued TBL. Please notice that I've kept my gaudy numbers and the boring calculations to myself. Let's just say I didn't trust the 5-year FCF growth average of 19.4% to continue, even though that's how the numbers worked out.

Charlotte's Web will come through for the Pig. The Motley Fool delivered several articles of note. Here's the first and most recent in its entirety:

Timberland's Stuck in the Mud

By Nathan Parmelee (TMF Doraemon)
October 27, 2005

Let's jump right into the mess today. Timberland (NYSE: TBL) had a
mediocre third quarter, and its guidance was even less inspiring. So
far today, the shares are down by more than 11%. Therefore, the
question is whether we've now hit the level where there is some value.
Given that the company's P/E ratio is now around 12, I think we're
close but not quite there.

Sales for the quarter came in 2.4% higher than last year; the growth
was driven entirely by international sales gains of 14.1%.
Unfortunately, sales in the U.S. portion of the business, which is
approximately the same size, came in 6.1% lower than last year. On the
earnings front, the company posted $1.02 per diluted share versus last
year's $0.96, a 6% improvement. The $1.02 figure includes a
restructuring charge, which should be one-time in nature. If you back
the restructuring charge out, earnings were up 9% to $1.05.

The performance for the quarter was fair, but the company's flat
guidance for the fourth quarter, as well as its statement that it
faces "challenges" to growth in revenues and earnings in the first
half of 2006, is what really appears to have investors worried. While
I share that sentiment a bit, this is a company with a balance sheet
free of long-term debt and a history of repurchasing shares during
tough times. Indeed, earnings growth was stronger than sales growth
this quarter primarily because the company's share buybacks have
decreased its diluted share count by 5.2% in the past year.

For many retailers, the fourth quarter makes or breaks the year for
free cash flow, and Timberland is no exception. Through the first nine
months of this year, free cash flow was a bit softer than last year,
mostly because the company is recognizing the transfer of title on
inventory shipments earlier. (Higher inventory translates into lower
cash flow.) Assuming things balance out, and the fourth quarter is
flat with last year, free cash flow should come in at roughly the same
$154 million (excluding tax benefits from options) the company has
averaged over the past two years. Given that scenario, the shares
trade at a price-to-free cash flow multiple of 12. This is pretty
cheap, but it's important to remember that the fourth-quarter numbers
aren't yet certain.

Furthermore, 12 times cash flow is not dirt cheap, given the growth
"challenges" that management forecasts in the first half of 2006, and
given the tough competition from Wolverine Worldwide (NYSE: WWW) and
others in the shoe industry. For a company facing a low- to no-growth
situation, I'd like to see that cash flow multiple in the single
digits. Bottom line: Investors are probably wise to wait for a better
price. For those who really want to jump into retail and take
advantage of the recent stock market swoon, companies like Home Depot
(NYSE: HD), Wal-Mart (NYSE: WMT), and Costco (Nasdaq: COST) are safer

Parmalee has changed his tune, and is much more negative on TBL. Two consecutive crap quarters, plus pessimistic guidance has taken its toll on the author. Back on July 26, 2005, Parmalee thought shares looked cheap, but he now thinks that investors should wait for TBL to get cheaper. Let's look at some excerpts when he was more optimistic:

Timberland Chopped Down

By Nathan Parmelee (TMF Doraemon)
July 26, 2005

It's tough to look at what Timberland (NYSE: TBL) had to say about its
second quarter and feel positive about the results. But investors'
shock and disappointment about the quarter is a bit surprising,
because the company had mentioned that the results would be flat.
While some pundits may point to the poor quarter and recommend staying
away from the shares, I'm not in that camp. I get curious when I see a
12% haircut at a company that generates a mountain of free cash flow
on an annual basis. Based on the free cash flow and potential for
growth, the shares look cheap to me. You can say much the same for
competitor Wolverine Worldwide (NYSE: WWW). The primary difference is
that Wolverine rewards its shareholders with cash dividends and share
repurchases; Timberland only goes with the latter.

Here's some more from fool.com, back in October 2004.

Taking Timberland for a Walk

By Lawrence Meyers
October 15, 2004

A Hidden Gem?
Fortunately, it turns out that Timberland is a solid company. It just
isn't the hidden gem I thought I'd uncovered. At a market cap of $2
billion, it is larger than I'd prefer. Its EV/FCF/G ratio is 1.15 and
its PEG is 1.24, which suggests it is mildly overpriced. I can't
honestly say that its product has a sustainable competitive advantage.
Boots are boots, after all. Wolverine World Wide (NYSE: WWW), Nike
(NYSE: NKE), and a host of other private companies like The North Face
produce excellent footwear as well. Nor is Timberland out of favor and
thus undervalued.

A silver lining in ROE
There is, however, plenty of good news. A company can't generate a 31%
ROE without there being a few other things that shine through. It's
generating some healthy cash flow, has coin in the bank and zero debt,
and a strong net profit margin.
As fellow Fool David Meier has pointed out, it's taking over 100 days to
convert resources into usable cash flow for the company. Also,
Timberland is a retail business. Now, boots may not be as subject to
teen fashion fickleness as are products of Abercrombie & Fitch (NYSE:
ANF), Pacific Sunwear (Nasdaq: PSUN), or Hot Topic (Nasdaq: HOTT).
Still, boots are boots, boots are retail, and retail has that random
"fashion factor" that makes for dicey investments.

Meyers bought TBL based on its alluring ROE and ROA metrics. He subsequently sold it for a small loss after figuring out that TBL had no economic moat as it profits from fungible fashionable goods with healthy competition.

Continuing my adventures on the internet, I searched on Google News for "timberland boots". Out of the first ten hits, two articles concerned the SmartWool purchase, but two mentioned Timberland boots negatively with the new NBA dress code rules. One mentioned a Pennsylvania rape suspect last seen wearing tan Timberland boots, and another a Massachusetts man who had his Timberland boots stolen by a gang of youths. Yes, this was an unscientific snapshot, but one that made me think: Is Timberland a good and reputable brand? Or are these varied negative associations indicative of trouble?

Or am I getting too old? Perhaps the Timberland brand and its boots gets some street cred if hep cat NBA commish Daniel Stern is banning them, and gangs of youths are stealing them.

Before I make my pronouncement on Timberland, let's look at its pretty numbers, care of SmartMoney.com. A PEG of 1.00, oooh, a ROE and ROIC of 31.52%, ahhh. Wolverine World Wide (WWW), a competitor, has a PEG of 1.19, a ROE of 16.19% and a ROIC of 15.10%.

TBL is a case where I think the negatives still outweigh the positives in the near-term. The consecutive disappointing quarters, the SmartWool acquisition that sent the stock plummeting, and the declining sales are weighing on investors, in spite of the high quality metrics (FCF, ROIC, PEG) that would otherwise entice me to this seemingly undervalued stock.

The high quality metrics were of similar quality a year ago, and an investment in TBL then would have netted a small negative return over the the course of the year.

Investing in TBL is betting that Daniel Stern will loosen the Iverson Rule to allow NBA players to don the black boots. We're wagering that the sales numbers will rebound. But TBL is no lavish Michael Jordan-betting-at-golf situation. (I make no apologies for the basketball puns and references.)

Perhaps this stock is near its (parquet) floor. (Okay, now I'm sorry.) My gut feeling is this stock could go lower before it goes higher, but the downside is small. I'm concerned that the stock could go stagnant. TBL's relatively large market cap and lack of sales growth, according to the company, Parmalee, and Blog Hog John C., are factors that could limit returns.

I don't think there is a hurry to get into TBL. If you have patience on initiating a position in TBL and a willingness to hold the stock for some time, it could pay off. But if sales and FCF fail to improve, I would be ready to cut my losses.

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