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August 15, 2008

Normalcy Accompanies Growth and American Apparel Bounces Back

One of Northlake's biggest portfolio headaches is a lot better today. Pain relief came in the form of very solid quarter from American Apparel (APP). 2Q results were inline to a bit better than the few analyst estimates. Revenues of $133 million exceeded the estimate of $126 million. EPS of 10 cents matched estimates despite much higher expenses to beef up corporate support and dramatically increase manufacturing personnel in support of rapid overall and same store sales growth. Guidance was confidently affirmed. Given the history of controversy surrounding the CEO and accounting and reporting issues, the 2Q results should come as a great relief to investors and leave shorts scrambling.

Leaving aside the controversies, APP is executing quite well in its growth initiatives. Revenues rose 39% with retail only sales up 51%. Gross margins expanded by 300 basis points. Operating income grew 29% despite the aforementioned expense ramp. Net income rose 42% thanks to lower interest rates and some debt reduction. Same stores sales for 2Q were up 23% and are on track to exceed full year guidance of 15% even with a 40% comp coming up in 4Q.

Given this growth profile the shares are cheap at less than 20 times 2008 estimates and just 12 times 2009 estimates. Growth in 2009 will be driven by aggressive new store growth, high single digit to low double digit comps and leverage of operating expenses that are finally reaching the point at which a public company should operate. On the call, management indicated that over the next few years operating margins could expand by 600-800 basis points.

Were it not for the controversy surrounding CEO Dov Charney....

....APP would be the hot teen retailing stock of the moment. It is understandable why many investors will never invest with Charney. However, I challenge anyone interested in growth retailing to listen to the Q&A on the conference call and come away without thinking that Charney is a thoughtful, creative, and decisive retailer. He may be an asshole to some folks but the guy can do retail.

If 2H08 results support current 2009 estimates, a permanent CFO is hired, and Sarbox compliance is achieved, APP shares are headed to at least $10, possibly the teens. I think those things will happen and the upside is worth the risk of dealing with Charney's chaotic and controversial personality and management style. This quarter was going to be the one that made me either throw in the towel and take the losses or build confidence and convince me to hold on. I am not sure yet if I will average down but I am definitely planning holding onto client positions.

Posted by Steve Birenberg at August 15, 2008 03:00 PM in eda