Insiders Like Two Retailers Cutting Across the Grain of Major Internet Trends

By Michael Brush
Exclusively for InvestorIdeas.com
October 19, 2006

At a time when many brick-and-mortar retailers are still looking for growth from stronger online sales, the teen clothing retailer dELiA*s (DLIA) is doing just the opposite.

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It already gets half of its revenue online. Just 30% of revenue comes from regular stores. The rest is from catalogue sales.

So the next logical step for growth is clear: Capitalize on a solid Web presence by expanding aggressively in malls and shopping centers across the country.

It’s not been an easy sell, however. Landlords initially resisted – maybe because they don’t spend a ton of time online. And maybe because they aren’t teenagers who are familiar with the dELiA*s, Alloy and Central California Skate brands managed by the company.

“Just because you build a store and some people might think it’s an attractive store, doesn't mean people will shop there,” chief executive Robert Bernard said in the company’s most recent conference call. “So I think a lot of landlords held back, waiting to talk to their friends to see if these new stores indeed worked, and were they a benefit to the malls they were in.”

Then dELiA*s struck a victory earlier this year when it opened its doors in an upscale Dallas mall called NorthPark Center, along with three other Dallas openings. “I think that sent a message to all the landlords that dELiA*s is a brand that they should want to have in their center,” said Bernard.

If he’s right, that’ll make dELiA*s aggressive brick-and-mortar growth plans over the next several years that much easier to achieve. It’s growth that shareholders will need to offset a hefty overhang of debt that will continue to convert into new shares in the company.

To be sure, dELiA*s isn’t turning its back on the Internet. It’s putting in new software that should convert more surfers to buyers and get them to spend more -- by suggesting related items they might like.

But the main push from here on is the bold brick-and-mortar expansion that should bring a 25% annual growth in the square footage over the next several years. By the end of the year, the company expects to have 75 stores compared to 57 the year before, for a 32% growth rate.

The dELiA*s insider buying

The company was spun out of Alloy (ALOY), a media and marketing company, at the end of last year. The spinout put lots of shares in the hands of MLF Investments, run by Matthew Feshbach, who is a director at dELiA*s. His purchases account for most of the impressive $5.3 million worth of insider buying between early June and early October. But chief executive Bernard bought $170,000 worth and two other directors have purchased about $114,000 worth of the stock. The insiders bought for prices between $7.80 and $9. The stock recently traded for about $.870.

Despite the bullish tone of this buying, there are a few red flags. Overall gross margins slipped slightly in the most recent quarter to 36% from 36.5% -- despite sales growth of 12.6% to $48.9 million. Internet and catalogue gross margins were flat at 43.8% even though sales increased 16% to $33.9 million.

Then there is that convertible debt overhang which clouds the picture. In corporate filings, a description of products and operations ominously veers off quickly into a complex account of the company’s recent financial activities. Basically it boils down to this. Debt instruments held by Alloy can be converted into over four million shares in the coming years and outstanding warrants could add dilution of another 600,000 plus shares. That’s a big overhang for a company with a share base of 26.5 million.

Cherokee (CHKE)

If dELiA*s is bucking trends by planning for most of its growth off line, Cherokee’s business model offers a smack in the face to another growing Internet trend: The blatant disregard for old-fashioned concepts like copyright protection and royalty payments for content producers.

Not only are “social networking” and video sharing sites dependent on the cribbed video and music content that users post to draw attention and traffic. Many sites, both offshore and at home, offer up free or discount downloads of digital content.

In short, at a time when cutting edge websites show little regard for brands, trademarks and royalties, Cherokee’s whole business model is based on the premise that these concepts still matter. It makes its money licensing popular brands -- like Mossimo, Sideout, Carole Little, Chorus Line, Saint Tropez West, and All That Jazz -- to retailers in exchange for royalties.

Cherokee’s main customers in the U.S. are Target (TGT) and TJX (TJX), which runs TJ Maxx and Marshall’s. Abroad, Cherokee’s main customer is Tesco, a UK retailer with ambitious growth plans at home and in Europe and Asia.

So as a brand licensor, Cherokee offers you exposure to retail growth without all the risk of excess inventory that can kill margins at stores. The upshot: Cherokee has high margins, strong cash flow and a solid dividend yield, points out Susquehanna International analyst Thomas Filandro. That could help explain why Cherokee insiders purchased about $424,000 worth of stock for about $34.30 in mid-September.

Brean Murray, Carret analyst Eric Beder has a price target of $39 on the stock. This may seem like a modest target since the shares recently traded for $37. But keep two things in mind. This is a fairly volatile stock -- so patient buyers should be able to get a decent price. And the company pays an annual dividend of $2.40 per share. So even if the stock goes nowhere in a year, you make 6.4%.

The bottom line: Retailers are notoriously risky – especially when you are dealing with fickle teen tastes, an ambitious store expansion plan that could stumble, or the vagaries of foreign currency which could hurt Cherokee since much of its growth is expected to come from the Tesco expansion, abroad. But insiders have purchased compelling chunks of stock, and both companies have plausible growth stories. So I’d look to buy both on weakness.

Disclaimer

At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.

For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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