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Each season designers spend many hours creating new designs for the coming seasons. The designs are plopped through expected developing trends as well as new creative bends conjured up by designers In the hopes that consumers will take to the newly developed creations. This industry is also complex because there are several broad sub categories within apparel of which some cater exclusively to specific consumers while other categories might market to one type of consumer but the apparel might cross over to other consumers as well. The weather also strongly affects sales within the industry.
For example, the outdoor/welter sport apparel category has had a decrease of 2% In their sales year over year ($2. 91 M vs.. $2. 241 M for 2010) for the dismal snow season during November and December of 2011. Industry analysts “noted that snow coverage in the Lower 48 states was 23% this year compared to 48% last year as of Deck. 20. ” At the end of January, one month after the peak Christmas season, the retailers and industry are managing well due to an extremely heavy snowfall from last year which caused their inventories to be very low at the beginning of this season.
Generally, the industry has been growing organically and keeping pace with the slow US and world economic recovery. In addition there have been numerous consolidations making companies larger and increasing competition between companies. Apparel itself is undergoing a transition to more complex and technical clothing. Sports apparel is developing into specific and technical clothing with specialized materials to help athletes in their competitive activities.
Outdoor and action related clothing (extreme winter/water sports and outdoor related activities) has continued to increase their technical development by producing lighter, increased material strength, and increased flexibility and fit for strenuous activities. As the product development for apparel has turned to more complex signs with costly but more protective materials, consumers have been willing to pay the extra price for the fashion appeal and increased cost for technical apparel.
The apparel industry is made up of 127 companies and most are apparel companies. There are several companies within the industry list that seem odd fits for apparel, or seem misplaced. For example, Atlas South Sea Pearl Limited is a pearl manufacturing and retail company, BSM Management is a large modeling agency diversifying into the energy business, Brownies Marine Group is a specialized manufacturer of diving ear, and there is also a diamond trader, French and Canadian property management companies, and one company that is in Chapter 11 restructuring.
The main categories are manufacturing (several Indian and Chinese manufacturers), high end business and leisure apparel companies (Barberry, Benton, Perry Ellis, Oxford, Hugo Boss, Ralph Lauren, Pierre Cardiac, Seville Row, Van Houses), Technical sports (Nikkei, Luncheon, Under Armor, Quicksilver, Blabbing, Kappa, Sickout Sport), Women’s apparel (Liz Collarbone, Maidenhood), Children’s apparel (SSH Gosh), and Technical Outdoor (The North Face, Columbia). Current position in the industry Columbia competes with many different companies in the apparel industry.
They name a broad range of different companies manufacturing a very large number of products, but their main competitor is IF Corporation, the holding company for brand names The North Face@ and Timberland@ footwear. IF Corporation is significantly larger than Columbia due to the additional brand names they carry in the apparel sector but that do not directly compete with Columbia such as Lee Jeans. Columbia competes on a day to day basis with The North Face on product quality, innovation, and fashion levels. Columbia has proven to be more innovative yet their balance sheet shows a company with a more conservative approach to growth.
IF Corporation has been growing through aggressively purchasing or merging with other companies (Timberland was their latest in July of 2011). Columbia is not anathema to this strategy but they are slower and more deliberate in the process. A indicates selected ratios of various competitors. I Columbia Sportswear Company I COOL Rank I Textile – Apparel Clothing I Luncheon Athletic Inc. I Quicksilver Inc. I Under Armor, Inc. I V. F. Corp. I Nikkei Inc. I Market Cap I 1. BIB | 32/119 | 1001. B 1 9. BIB 1 713. MOM 13. BIB 1 14. BIB 1 50. BIB I PIE I 17. 14 126/119 125. 6 156. 593 1 AN 145. 95 121. 1151 23. 111 | ROE% I 8. 968 | 62/119 | 11. 7 | 38. 806 | -2. 877 | 16. 577 | 16. 377 | 22. 592 | Dive. Yield % 11. 8 1 5/119 11. 125 NINA NINA NINA 12. 2 1 1. 3 | Debility’s I 28. 66 | 95/119 148. 943 1 AN | 120. 087 | 18. 497 | 66. 839 | 3. 626 | Veneto Book 11. 535 139/119 17. 35 117. 5331 1. 169 16. 702 13. 229 14. 989 1 Net Margin | 11. 916 | 23/119 | 5. 3 | 16. 851 | 12. 454 | 9. 878 | 10. 934 | 9. 579 | Conclusions Columbia has survived a severe economic recession and come out the other end much stronger.
Balance Sheet Review The first step in analyzing COLA’S financial statements is a review of its balance sheet and its related footnote disclosures. COOL has minimal off balance sheet liabilities as indicated in the table below. Off Balance Sheet Liabilities I ($ thousands) 1. Inventory purchase commitments | 353,883 | 2. Capitalized Lease (liability) | 26,537 | The table above indicates that there is approximately $381 million in liabilities that have not been included in the company’s reported figures. COLA’S 2011 balance sheet has been adjusted for these liabilities and the firm’s value has been evaluated eased on the restated balance sheet.
COLA’S PAYOFF pro formal balance sheet is provided in Exhibit 1. Adjustment 1 – Inventory Purchase Commitment Inventory purchase commitments are required to ensure delivery of promised goods to retailers. Production requires prepayments to subcontractors for the purchase raw materials as well as labor costs for production. COOL issues Purchase Commitments to subcontractors which are used as collateral for lines of credit during the production process. COOL guarantees these commitments to make sure the manufacturing entities have the funding necessary to produce the orders.
A debit to Inventory and a credit to current liabilities is made to adjust for this liability. Adjustment 2 – Capitalization of operating leases COOL leases retail space, office space, warehouse facilities, storage space, vehicles and equipment. The company is obligated under these lease commitments but they are not reflected on the Balance Sheet. This adjustment has been made to reflect the true value of the company. The amortization table and adjustment entries for operating leases payments are provided in Exhibit 2. Balance Sheet Trend analysis and possible financial issues
COLA’S 7-year Balance Sheet and balance sheet trend analysis is provided in Exhibit 3. Cash: COOL has held an average of approve. 17% of its assets in cash. This significant fluctuations based on different company strategic initiatives, such as paying down debt, increasing or decreasing inventory levels or increasing or decreasing investment in securities. Short-term investments has decreased to 0. 2% of assets as management has preferred to invest extra cash into the company rather than outside investments – Accounts Receivables (AIR): A/R has been showing an increasing trend from 2009-2011.
AR has grown higher than revenue growth in this period (55% vs. 36%). AR that grows more quickly than revenue can suggest a company that is trying to boost sales by giving generous payment terms or loaded sales at the end of the period. Strong early sales into the channel due to high forecasted sales and ending weak sales was likely a cause of the freeloading of inventory. Retailers’ weak results due to the warmer weather were likely the cause of the higher levels of AR. – Inventory: Inventory has been increasing steadily since 2009, amounting too 64%.
It was at a historical high of 26. 4% of total assets at he end of 2011. Cost of inventories is determined using the first-in, first-out method which raises the value versus last-in, first-out valuation. However, the primary driver of this increase is due to the seasonality of the product. The company is affected by seasonal trends typical in the outdoor apparel industry, and has historically resulted in higher sales and profits in the third and fourth calendar quarters. As a result sales are strongly correlated with weather and consumer discretionary spending activity.
The 2010-2011 winter season was particularly long and store inventories were cleared out. The industry expected a similar season due to the “La Nina” weather pattern. Pre-season sales were very strong and inventories were built up but the weather pattern did not occur as expected causing sales to weaken significantly once inventories were built up. Intangibles and Goodwill: The company amortized a large portion of intangible assets as well as a larger than usual charge for impairment of goodwill in 2008.
It can be surmised that the company might have taken the opportunity to charge off large portions of these assets during a particularly bad economic period and when analyst’s expectations for all companies were low. This larger than usual charge understated income in 2008 and has potentially caused the subsequent years net income to be overstated. Land/Property, and equipment: Columbia has opened several company owned stores in the past several years causing this line to increase by a modest 6. 5% over three years, with construction in progress growing the most at 272% in the 2010 to 2011 opened.
Current Liabilities: Accounts payable has maintained an approximate 10% of current liabilities for the prior five years. Three year trend has been 45% due to the growth cycle of the apparel industry in anticipation of large growth. Overall current liabilities have grown at the same approximate pace as accounts payable. – Working Capital: Working capital was $782 million as of December 31, 2011, compared to $739 million as of December 31, 2010. COLA’S current ratio has held steady at 3. 93 for the past two years.
Columbians debt ratios are significantly better than the industry standard. Stockholder’s Equity: COOL has a share repurchase plan which started in 2004 which is currently at a total amount of $441 million (9,588,798 shares) as of December 31, 2011. Despite (8% over the prior three years). This has been due too healthy growth rate of net income. Conclusion Columbia is in outstanding financial health. The balance sheet is debt-free and there is more than $1 billion in cash, short-term investments and other current assets, which are more than three times total liabilities.
Even after making the pro-formal adjustments to the balance sheet, Columbia still maintains its higher-than-2:1 current ratio. As mentioned above, a potential financial issue is the AIR growth, which is significantly higher than revenue growth. If this continues, it could potentially lead to cash flow problems for the company, negatively impacting its value. Income Statement Review A 5-year income statement trend and common analysis for Columbia is shown in Exhibit 4.
Margins have been generally 200 to 300 basis points lower in the post financial crisis period compared to the 4 years prior to the crisis. Margins are expected to slowly rise due to higher levels of inventory, continuing increases in consumer discretionary income from a slowly improving economy, continued improvement in manufacturing efficiency and engagement of cost-cutting and the statement items and pro-formal adjustments Adjustments have been made to Columbians income statements in order to better assess the company’s value. The resulting pro-formal income statement is shown in Exhibit 1.
Conclusions Columbia grew significantly in the post economic crisis of 2008. The results, as can be seen on the ratio comparison exhibit 12, have been reasonable but not stellar. Cash-flow statement review A cash flow summary schedule for is included in Exhibit 6. Comments Outlays for investing were $136,881 million and investing $151,136 million. Despite fairly high outlays Columbia still experienced a slight increase of cash of $10,417 million. Operating cash flows for the period are sufficient to fund all of Columbians investing and financing needs and still leave excess cash.
Significant decreases in AR ND inventories coupled with larger than usual increase in AP in 2009 caused a significant increase in Operating cash flow, offsetting a particularly low cash flow from Operating in 2010, and higher than usual investing and financing activities which were increased to spur growth after the downturn period. The figure below depicts the trend of the operating cash flow. Cash Flow Ratio Analysis The calculations for the ratios are shown in Exhibit 6. Cash-flow Adequacy Ratio.
Cash flow adequacy: short term period adequacy ratio of . 73 implying funds generated from ops are insufficient to cover these items and so external financing is squired Looking at the 7 year period the ratio is 1. 07. The reason for the lower number in the shorter period is the inordinate amount of cash that was required during the recession to continue growing the top line. Cash Flow Reinvestment Ratio The cash reinvestment ratio is useful for determining the amount of cash flow that a company is routinely plowing back into the business.
The cash reinvestment ratio for Columbia is 33% for 2011. This is somewhat high compared to S&P 500 but is within the boundaries of the apparel industry where higher levels of investment are necessary for manufacturing processes. Conclusion Columbia cash levels from operating activity are very healthy. In 2010 the company spent a large portion of cash on dividends and ($75 million) and share repurchase ($20 million) while at the same time the downturn caused a significantly lower amount of operating cash flow generated.
These higher than average dividend and share repurchase charges were likely transacted due to the high level of excess cash that existed at the end of 2009. Decisive management action in 2009, after the economic crisis, helped to significantly lower AR and inventories, decreasing risk while also increasing cash flow from operating activities. Overall cash is in very good shape and this is an important barometer for valuation of the company. Return on Investment (ROI) Analysis Return on Assets This is the area that is most disappointing concerning Columbians financial and valuation.
Columbia is a solid company with good products and a good reputation but as can be seen in the ratio comparison (Exhibit 12) Columbia generally lags behind in most areas compared to their competitors. Given the low debt levels of the company initial estimations would be expected to indicate that investment returns would prove to be better than the competition. But they are not. Columbia earned an ROAR of 7. 7% in 2011, a healthy increase from 6. 1% in 2010. But this pales in comparison to competitors ranging from a low of 11 too high of 30%.
Columbia does beat the industry which is at 7. 59%. In the same exhibit there is a presentation of Columbians ROAR components, profit margin and asset turnover shown through a DuPont Analysis. This analysis shows that Columbians increase in ROAR is due to an increase in the company’s profit margin and a slight increase in the amount of leverage. Columbians ROAR is improving along with its asset turnover. Their use of average is still behind the competitors’ rates but they are not behind the industry rates. Return on Equity (ROE) The ROE analysis is shown in the same exhibit 8.
ROE results are similar to ROAR, there is a healthy growth from 2010 to 2011 but Columbia lags significantly behind their competitors and the industry as a whole as well. Conclusion Columbia is improving after the economic downturn of 2008. However, their improvement is lagging behind industry as well as their competitors. Columbia has lower net profit margins, and lower gross margins than the industry and their competitors. The large number of new entrants may be requiring them to lower prices to maintain market contributing to their lower profit margin.
VALUATION Prospective Analysis Assumptions Calculations for prospective analysis are presented in Exhibit 1. Assumption 1 – Sales growth: Bounce back from crisis years continues but tapers back due to sluggish growth in the economy, higher commodity prices, and increased competition for diminishing consumer disposable incomes. This sector is a luxury item sector whose demand is driven by consumer’s propensity and ability to consume discretionary items. High employment and slow economic growth diminishes discretionary income thereby diminishing consumption.
Economic growth is forecasted to grow at a slower pace of 2 – 3% for the next several years on average causing growth in consumption to remain below average compared to previous post recessionary periods. In addition, due to high margins, this sector will continue to be highly competitive dominated by a combination of company mergers to consolidate market share and innovative startups developing new products which diversifies and diminishes the pool of discretionary income.
Finally, commodity prices, especially cotton and petroleum, intention to put pressure on manufacturers forcing prices to rise. Overall assessment for sales forecast is downward pressure. Average 7 year historical growth pattern equals 6. 8%. Very bad crisis years drag the average down but are currently heavily weighted towards the winter season and therefore the warmer weather trends will cause some decrease in sales. Strong efforts to diversify to summer products will offset this lowering winter sales trend in the medium to long term nullifying the negative effect.
Assumption 2 – Cost of Goods The company has been very consistent with cost of goods percentage over its history, whether in a good or bad economic cycle. Expectations of a slight decrease in cost of goods in the short term as inventories increase slightly due to over bookings by retailers and slow down of sales from unusually warm weather. Conservative management practices and newly integrated Just in time inventory processes will help to sight improve COGS over the long term.
Assumption 3 – SO;A expenses COOL has consistently grown G;A expenses by approximately 11% per year. Expenses over the prior 6 year period grew by 82% versus 35% sales growth. Management has indicated the intention of decreasing the work force for the first mime in a decade, an indication of their commitment to cut costs. The company has been successful controlling COGS but not G;A. Generous employee benefits, a significant cost factor, are deeply embedded in the culture of the company after many years of providing them.
In addition, competitors maintain similar levels of benefits requiring the company to provide those benefits to retain skilled workers. Estimates are that the company will be successful in slightly decreasing as a percentage of sales but this is an area of growing concern for longevity and valuation. Assumption 4 – Depreciation and Amortization Capital expenditures have decreased in the prior three year period, from 3. 9% to 1. 9% of sales while depreciation has maintained an average 2. 6% and 2. 3% expenditure in the prior 3 and the prior 6 years, respectively.
The assessment indicates this trend will continue with a slight peptic in the early period for slightly higher capital equipment purchases for the Just in time inventory modernization effort but then will settle back to the average in the later years. Initial depreciation amount is increased due to converting operating leases into capital leases and adding these to the total depreciation. Assumption 5 – Interest expense The company has maintained low levels of debt since its inception. However, there will be a slight peptic in interest costs as interest rates will likely rise as the covet attempts to fight expected higher levels of inflation.
It is not expected that this will cause a significant change in the rate of interest expenditure. Interest expense is quite low and therefore net interest expense has historically been a net increase rather than decrease. This trend will continue as the company will continue a low debt to equity management practice. After making adjustments to the income tenement and converting to a pro formal statement, however, total interest expense increases substantially as operating lease debt is significant. Assumption 6 – Tax Rate Income tax has averaged 28% over historical period.
Government threats to lower taxes are unclear though the political winds are certainly blowing in that direction therefore it is safe to presume no matter who is elected rates will likely come down. This is offset, however, by increasing state and local costs which will cause those The Weighted Average Cost of Capital calculations can be found in Exhibit 5. COLUMBIA valuation A Discounted Cash Flow Valuation model was used to calculate Columbians valuation fugue which is demonstrated in Exhibit 10. An intrinsic value of $54. 66 is obtained for Columbia. This is very close to the current consensus valuation of $48. 2. Columbia recently released their 2011 financial and they announced record sales for 2011 and at the same time presented a report indicating their concern about the upcoming year. Weaker sales are expected, Columbians CEO announced, due to warmer weather. There also have been weak performances from some of Columbians most important retailers, including Kohl’s and Dick’s Sporting Goods, who are keeping inventories lean. The consensus from analysts maintains that Columbians valuation is solid and the current temporary sales weakness is not viewed as a structural weakness to Columbians long-term business.