Legendary investor Warren Buffett has always believed in buying a simple business that is easy to understand. Iconix Brand Group (ICON) is as simple a business that you could ever find. The company possesses a stable of leading brands that they license to manufacturers and major retailers throughout the world. Consequently, not only is their business very simple, but it’s also one of the lowest capital-intensive business models I’ve ever seen. Iconix owns the brands and leaves all the heavy lifting such as design, manufacturing, distribution, warehousing and finally retailing to its licensees. However, the company does support its licensees with advertising and product development.
The following F.A.S.T. Graphs™ plots the earnings and price relationship on Iconix Brands since the beginning of 2006. As we can see, earnings (the orange line) have grown at a significantly above-average rate of 18.8 percent per annum. Earnings have grown from $.85 per share in 2006 to $1.56 a share in 2011, and are estimated to add another 15 percent growth to $1.80 per share in 2012. However and perhaps most importantly, the reader should note that stock price is currently at one of its lowest valuations in the company’s history with a PE ratio of only 9.1 times earnings.
(Follow this link to a free, live, and fully functioning F.A.S.T. Graphs™ on Iconix Brand Group. Run this “tool to think with” through its paces. Draw graphs displaying 2 to 20 years of history. Discover how this tool dynamically re-evaluates valuation based on the company’s earnings and price relationship.)
As the above F.A.S.T. Graphs™ illustrates, Iconix Brand’s shares are historically undervalued. However, thanks to such consistent and powerful earnings growth, shareholders have dramatically outperformed the averages as measured by the S&P 500 to the tune of 6.2 percent per annum versus 1.8 percent per annum for the S&P 500.
But even better than earnings growth, is the fact that Iconix Brand Group is a prodigious generator of free cash flow due to its asset light business model. The following graphic illustrates free cash flow growth (the orange shaded area) since 2006. In addition to the obvious benefits of strong cash flow growth, this low capital-intensive, high cash flow generating machine has a history of growing by acquisitions. Therefore, its strong balance sheet, with only 19 percent debt, and strong cash flow provide the flexibility of not only continuing to make strategic acquisitions, but also to follow-up on its recently approved stock repurchase agreement.
A Profitable and Growing Stable of Recognized Brands
The following slide taken directly from their investor presentation summarizes Iconix Brand’s strong portfolio of internationally recognized brands. The Peanuts Brand was added in 2010, as was the Madonna Material Girl line. This year, the Sharper Image brand was acquired which gives them their first entrée into electronics. I believe these powerful brand franchises position the company to effectively compete with their major competitors, Gap Inc. (GPS), Cherokee Inc. (CHKE), and the Jones Group (JNY).
The consensus of leading analysts reporting to Standard & Poor’s Capital IQ expect Iconix Brand Group to grow earnings over the next five years at approximately 9.2 percent per annum, which is only half their historical rate. However, as I’ve already indicated, a great deal of their growth has historically come from strategic brand acquisitions. Consequently, since future acquisitions are unknown, I believe they are not included in these estimates. Therefore, I believe there’s a good chance that future earnings growth could exceed current expectations. Additionally, there is some negativity surrounding the company’s recent earnings growth shortfalls, which are mainly related to their transitioning of their Royal Velvet brand to JC Penney from another retailer. The costs associated with this transition have had a temporarily negative effect on their profitability.
Summary and Conclusions
Iconix Brand Group licenses their strong stable of brands to leading retailers worldwide. They include the following retailers as depicted by their investor presentation slide below:
What attracts me most about this company is its asset light business model, high and stable cash flow generation and long-term opportunity to continue growing their high margin business. I believe the current PE ratio of 9.1 represents compelling value. Therefore, I believe that investors seeking above-average capital appreciation at a below-average level of risk might want to look further into this quality licensee of consumer brands. As always, we suggest you conduct your own thorough due diligence.
Disclosure: No positions at the time of writing. Read disclaimer here.