What do Beyonce, Paris Hilton, and Eva Longoria have in common? They've all been photographed wearing True Religion (NYSE: TRLG) jeans. True Religion designs, manufactures, and sells one of the most popular, expensive, and luxurious brands of denim on the market today. At around $150-$300 a pair, the brand was popularized in recent years by wealthy west-coast trend setters and celebrities. Since its founding in 2002, True Religion has leveraged its star appeal and high-margin product into rapid financial growth.
The company sells its products through high-end department stores such as Bloomingdale's, Saks Fifth Avenue, and Nordstrom and through boutique stores across the country in addition to their own True Religion Brand Jean Stores. Jeans that are not sold are typically liquidated through off-channel stores (outlets), although management has indicated that they are going to be scaling down this sales stream in order to protect the brand and its prestige.
TRLG can be segmented in many different cross sections.
As one can see from the graph there are distinct trends that management has commented on with regards to how the business operates and why, especially if purposeful, these changes are occurring.
Consumer Direct: The consumer direct segment is the portion of business that is done through either e-commerce or their True Religion Brand Jeans stores. The most significant trend on this particular graph is the substantial increase in percentage of revenue derived from the consumer direct segment. This has been a definite tactic of management because they feel that there is a domestic movement away from department stores such as Neiman Marcus and Saks Fifth Avenue. Since 2008, the sales from this particular distribution channel has increased by a staggering 153%, from $75.3MM to $189.1MM. This is a higher margin business when compared to U.S. Wholesale, and the shift, is therefore beneficial. This difference in margins is likely caused by purchasing power the department stores have, which is something that is later discussed. 
U.S. Wholesale: The U.S. Wholesale segment represents True Religion Jeans that are sold through boutiques across the country or through department stores. This revenue source has been moving downwards since 2008. The main driver for decreased sales is actually because women have not been purchasing as many True Religion Jeans since 2008. This is partially attributable to the economic downturn, and many department stores have yet to make a full recovery. Although department store sales have been on a decline, sales to boutiques fashion stores have been increasing, according to management. They believe that a by-product off scaling down off-channel sales to preserve brand prestige will be increased sales to boutiques across the country. Management has decided to pursue a ratio of 3-1 for full-price stores to outlet stores; this will be discussed later in this entry. 
International Wholesale: International wholesale represents the portion of clothing that is sold abroad. Major increases in distribution channel investment in the EMEA region has been a major factor of the increasing revenues, which have seen an increase of 78.6% since 2008 and an increase of above 30% for Q1 2011. The graph for this particular segment is misleading, however, because the growth is dwarfed by the extreme changes in the U.S. Wholesale and Consumer Direct segments. The substantial changes in revenue sources force the percent change in international revenue to decrease, despite the actual increases in revenue. Since 2005, internationally sourced revenue has been up quite substantially. 
Licensing: This segment has only just recently become a discernible portion of their revenue stream. The management team recently also, again for brand protection, ceased their relations with the previous licensee to target higher price ranges. 
As can be clearly understood from the graph below, sales percentages for TRLG pertaining to gender have also seen changes since 2007. This is an important trend to notice for several reasons. First, it has been noted by several fashion magazines, such as GQ, that when successful young men feel accomplished, they typically experience an increased desire to own new and luxurious goods, such as True Religion Jeans. This claim is further supported by two things: the upward trending sales for men as a percent of revenue for TRLG.
The second reason is that although the average man has decreased spending since the downturn, TRLG has not yet experienced growth lower than 15%. This is likely because of their core clientele, which is the fashion conscious, affluent consumer. Another notable change easily observed with this graph is the clear decrease in the percent of women that have been spending money on TRLG products. According to management, this is partially because women have stopped spending so much money at department stores. The likely reason for this decrease is probably a reaction to the financial collapse. According to a recent article in The Economist, Risky Business, Women produce less testosterone than men do and this leads to a higher level of risk-aversion than men. Given that budgets were tighter after a collapse, women would be more likely to spend less in observance of less money.
TRLG, according to the graph below, has clearly declined the average price per denim pair for the two largest sales segments (men and women). Although more data was not available regarding this transition, and the average price per pair of jeans is still considered expensive, this decline may either mean a transition for the brand, or simple shift in consumer preference.
It is difficult to extrapolate exactly what this means for the brand. Since 2006, the percentage of denim jeans has dropped from 90% to 72%. The decreased percent of total sales from True Religion jeans is the likely reason, however, that the average price per sales has decreased. This is because shirt and other non-jean products have increased in total sales and those items are typically less expensive than the average denim prices. So, while this graph may look although it indicates a loss of market traction, it actually indicates quite the opposite with increases in other clothing type sales.
Note: TRLG did not release data from 2006 or earlier regarding the average price per pair per gender or net sales per gender.
True Religion Brand Jeans sells a multitude of products, although their net sales are still highly dominated by their denim bottoms (jeans) sales which constitute a staggering 72% of total units sold.
However, despite popular belief, TRLG markets and sells products including cologne, shoes, non-denim pants, skirts, shirts (multiple kinds), outerwear, dresses, and swimwear. Further, materials that constitute the products sold by TRLG are categorized as denim, knit and non-denim and can be further classified into tops and bottoms.
True Religion contracts out the manufacturing of their apparel to local contract manufacturers. 80% of sportswear apparel is made in the United States (obviously indicating that the remaining 20% is made by foreign contract manufacturers) This is beneficial for several reasons. One such benefit is that they can brand their products as 'Made in the U.S.A.'. Further, this helps control the costs because suppliers have a lack of pricing power and distribution costs are kept at a minimum due to the strategic positioning of the contract manufacturers by management's choice. Major consolidation within the EMEA region is also evidence of management's apparent focus on maintaining margins and efficiency. These sort of practices signal strong future earnings potential. 
Understanding a business and fundamentally decomposing it for understanding is essential in investing. It is in this section that the financial, human capital, marketing and supply chain aspects of the business.
The below table lays out some growth and valuation metrics for True Religion. According to these metrics, TRLG is an attractive company to invest in. According to all metrics, they are undervalued relative to their peers, except for the Price to Sales ratio, of which a major competitor, Buckle, is more highly valued. Further, TRLG has experienced exceptional revenue growth for their competitors. This earnings growth has significantly helped their business, and indicates the continued strength in their brand. One particular draw back from the industry landscape is that many of their competitors are privately held labels, such as Adriano Goldschmied, Citizens of Humanity and Rock and Republic. Some of these other designers are held by extremely large conglomerates who dwarf True Religion's size, effectively making comparison very difficult for any analyst because of the significant difference in available resources. However, although this stands as a hurdle for True Religion, it is not an insurmountable one.     
The difference in size can be clearly seen through the market cap differences in the various peers. The range for market cap is from only $63MM (Joe's Jeans) to $12 and $13 billion (Gap and Ralph Lauren). Further, Because these firms are conglomerates, extrapolating information of the individual brands based on valuation and growth metrics of the conglomerates is extremely difficult and distorts an analysts ability to adequately compare a company. For example, Ralph Lauren retails items through many different labels such as Purple Label and Polo Ralph Lauren. Both of which, are vastly different labels and attract vastly different target audiences, neither of which is the same as the target audience for True Religion (other labels of Ralph Lauren are comparable, such as Black Label and Polo Denim).
True Religion, according to Bloomberg LP, has a weighted average cost of capital of approximately 13%. However, this metric is misleading for several reasons. First, TRLG holds no long term debt, and this position is further enhanced due to all leases for their branded retail stores being classified as operating leases.      
However, the lack of long-term debt may not be a hindrance for TRLG, limiting growth as it does for some. As the need for Capital Expenditures is likely not very high because they lease all of their branded retail stores. Additionally, TRLG has a very high cash position at approximately 50% of their net assets. This means that liquidity is a very unlikely problem that management would experience, and that they should not experience any problems with payment capabilities with accounts payable in the near future. This claim is supported because TRLG has a current and quick ratio of 10.3 and 7.7, respectively. This is compared to a a sector average current ratio of 3.3 and quick ratio of 2.0. The only downside to holding such a large cash position is that the company has an opportunity cost of either earning a return through investing in either itself or the markets. Lastly, such a large cash position indicates that the management may be thinking about making an acquisition in the near future. Such a large cash position also provides them with the opportunity to organically fund growth without having the burden of interest payments, as their competitors may.
However, the above table also exposes some of TRLG's weaknesses as well: inventory turnover and the days spent in inventory. While these two metrics are clearly highly linked, they both indicate that TRLG is turning over inventory at a slower rate than their competitors. While this may be alarming, it is not completely surprising. TRLG markets and typically sells it's products to affluent customers. This demographic represents a smaller portion of the population when compared to stores such as Abercrombie & Fitch or Buckle, and so there is a smaller target market for TRLG. This indicates that inventory turnover may be inherently lower simply due to the difference in target markets.
TRLG is performing well when compared to its peer group. Again, although it is difficult to extrapolate how the entire industry may be doing because so many premium denim labels are privately made, it is clear that True Religion's strong ROA, and gross, profit, and operating margins make the company very desirable for investors to own.     
As can be seen in the above table, TRLG is not only effectively using capital and creating value (the ROE and ROA are both above the WACC), but they are also very competitive in their market. To key on the most important aspects of True Religion when compared to their peers would be to point out the margins of the company. It is very clear that independently contracting manufacturers across the world is very helpful for TRLG to keep their COGS low for the amount of sales generated. Further, through observing both the profit and operating margins, which are 9.6% and 15.8%, respectively, as compared to a sector average of 6.1% and 11.9% indicates that the company is operating very efficiently. However, it is worth noting that extreme growth may cause these margins to deteriorate.
Leadership is key in evaluating the success potential of a company. Management decisions will ultimately make a company efficient or sloppy, or even lead to to maintaining or losing competitive advantages. Below are some key additions to management and some of their plans for the firm, as well as other key management
Jeffrey Lubell - Chief Executive Officer, Chief Merchant and Head of Design Mr. Lubell founded the first in 2002 and is responsible for several entire aspects of the firm. He is the head of design for the brand, directing 29 other design-focused individuals, and with that, is in charge of every aspect of the marketing, including the creative aspect. The loss of Mr. Lubell could adversely financially affect the firm. 
Pete Collins - Chief Financial Officer Pete is the CFO of True Religion and joined True Religion in March of 2007. Mr. Collins served as divisional vice president, corporate controller and principal accounting officer for Nordstrom, Inc. from 2004 to March 2007. From 2002 to 2004, Mr. Collins served in various financial roles with Albertson's, Inc., most recently as group vice president and controller. Prior to that, from 1998 until 2002, Mr. Collins was a partner with Arthur Andersen, serving clients in the healthcare, retail, distribution and manufacturing industries. 
Mike Egeck - President (New Addition) Mike is leading the international sales for the firm. Management expects that under his leadership, substantial year over year growth will be experienced. It is under his leadership that significant international investment was made to expand the brand recognition and sales. Wholesale operations have begun in Korea, Hong Kong, and Germany, as well as opening stores in Tokyo, London, and Cologne. Here is a list of all of the True Religion Brand Jeans Stores - the international stores can be found at the bottom of the page. Mike feels that the single largest opportunity for the firm is international expansion, which heads his growth initiatives. He also plans on expanding sales in U.S. Consumer Direct, as it is the highest margin business. Next, he would like to expand the U.S. Wholesale business and repair lost sales in that segment, followed by continuing to strengthen the online sales segment. Lastly, he believes that maintaining and growing brand awareness and affinity are key. Mike plans on quite seriously increasing marketing expenditures over the next several quarters. 
Lynne Koplin - Chief Operating Officer (New Addition) Lynne is the new key in managing the day-to-day operations of the firm, which includes aspects such as inventory. Under Lynne are several initiatives to improve the day to day operations and efficiency of the firm. Planned for 2011 are the openings of 15 U.S. Stores with wall to wall operations. These stores will continue to build the U.S. Consumer Direct segment which will in turn add to the bottom line and profitability of the firm. Lynne also plans on pursuing an initiative to maintain the ratio of 3-1 for full-price stores to outlet stores, as she believes it properly positions the brand. 
Other Important Additions:
David Chiovetti - Senior Vice President, North American Retail 
Jamie King, Vice President of U.S. Wholesales 
True Religion appeals to the fashion-conscious, affluent consumer. This person is interested in not only being seen in premium label apparel, but also being seen as a good-looking, well-dressed person. As can be seen in the graph here, which is also displayed below, advertising expense for the brand has been rising since 2007. This is important because expenses such as R&D, advertising, and capital expenditures are fundamental in adding value. However, TRLG, because of the nature of their leases and manufacturing practices (out sourcing), R&D and CapX aren't necessarily feasible expenses for True Religion, and so, advertising expense is what the brand must rely on in order to maintain brand visibility. 
The above link is also documentation on the True Religion Brand Jeans website of free celebrity endorsements as well as clothing features in various magazines such as GQ, Marie Claire, and Cosmopolitan. This is an important method of advertising for this brand because it communicates three main messages to consumers: if you wear these jeans you will look like a celebrity, you will be fashionable, and that rich people buy these clothes, so you should too. Upward sales trends are a clear indication of strong marketing and brand buy-in, so clearly, with revenue growth amounting to 20%, True Religion management is doing a good job at reaching their target market. 
The supply chain is a particular focus for expansion, as consolidation is a key initiative for management so as to maintain costs. While the True Religion distribution strategies in the United States may not be mature yet, they are developing. However, the internationally based sales and distribution is where major changes are likely to occur over the following quarters.
United States Manufacturing is completely outsourced in the United States. 80% of products for True Religion are made the U.S.A., which allows them to tag their products as 'Made in the U.S.A.'. The core segment is the division of the company that provides distribution services to the firm, as well as product design and marketing. While the company's distribution operations are through the corporate headquarters, they also contract distributions to third parties so that they may optimize the efficiency of their supply chain. 
International The company has focused plans on growing its international segment, and so, for this reason, it maintains showrooms and administrative offices in Japan, South Korea, Hong Kong, Germany and Italy. However, per Mike Egeck's plans, TRLG has consolidated their international process centers to just three sites: Hong-Kong servicing the Asia-Pacific Region; Switzerland, servicing the EMEA Region; and Vernon, CA, servicing the Americas. Furthermore, each process center now has a senior management team in place so that they can optimize the effectiveness of each center through providing it with strong leadership. Six new retail locations are going to be opened by TRLG in the EMEA in 2011 so as to better capture that market. Lastly, two additional retail stores and a new distribution center in Mexico will be opened in 2011. 
Quality Control Quality control is a major concern for True Religion, as a compromised product would seriously erode sales and brand image. Therefore, they have set up a system, throughout their supply chain, to maintain the quality of their products and to ensure they are retailing high-end merchandise. Although final product inspection occurs at the distribution centers. However, management also maintains a policy of inspecting products for quality at the contract manufacturers' facilities. Management believes that this process is key in maintaining the brand for customers. 
With regards to competitive advantages, there are effectively three potential incumbent competitive advantages that, if managed correctly, will create barriers to entry. With regards to TRLG, there are several aspects of the competitive landscape that need to be addressed. Strategy, with regards to this entry, means strictly externally based decisions that will force competitors to act in a certain manner. Further, everything is based upon local concepts: either product space or geographic space. TRLG's strategy is to maintain its brand image within its product space, which is arguably the most recognizable high-fashion brand image, which will present it with an incumbent advantage based on consumer habit. Management has also placed importance on consolidation and efficiency. This however, is not an incumbent advantage because it is possible that every other competitor, if they deemed necessary, could replicate these practices. 
To briefly explain, incumbent advantages with regards to supply occur when a firm can supply its customers in a cheaper manner than its competitors are able to. This is typically achieved through advanced technology or a greater access to inputs. However, because TRLG does not manufacture the denim in-house, the notion of a competitive advantage or barrier to entry based on supply can be dismissed. Outsourcing the actual production to third parties, focusing their business model on what they do best (marketing their superior designs) clearly makes TRLG efficient. However, this method is something that can be replicated, and so it therefore is not considered an incumbent advantage because new entrants would be able to enjoy this strategy as well. Therefore, TRLG enjoys no supply-based barriers to entry.
Typically, brand differentiation is not considered a competitive advantage. This is because brand, especially associated with status is not usually a sustainable support for earnings because typically, brands, looks, and features can be easily replicated. However, it is within the sincere belief of this analyst that TRLG does occupy a brand-based competitive advantage, which is further explained below, under Brand Image and Status.
Economies of Scale
Economies of scale is a phenomenon that is experienced by companies that are so much larger than their competitors that they can spread fixed costs over an outstandingly large output, effectively decreasing the total cost per unit. There are many other players within the apparel and more specifically, denim industry. Several of these players are much larger than True Religion and are owned by conglomerates such as Gap, Inc. In order to experience an advantage under economies of scale, True Religion would have to dwarf their competition so that they could outperform them on a total cost per unit basis.
Brand Image and Status
While many people do not consider brand image as a competitive advantage, it is within the sincere opinion of this analyst that True Religion has an incumbent competitive advantage due to the high level of recognition that TRLG receives for its brand as compared to its competitors. Most brands of denim receive free celebrity endorsements because celebrities are photographs wearing various brands of jeans. However, few brands are nearly as recognizable as True Religion Brand Jeans to the extent that if a celebrity if photographed wearing them, magazine readers will recognize the brand of denim.
This high level of recognition is due to the embroidery on the back pocket of the jeans as well as the high level of contrast stitching used. Further, other denim designers have attempted to replicate this particular strength of True Religion (such as Miss Me Jeans, Rock and Republic Jeans, and 7 For All Mankind), however they have not had the same level of success with brand recognition.
While efficiency is a dominant tactic in markets with commodity based goods, it still plays a major role in propelling a company to success, and True Religion management makes a distinct effort in minimizing costs so that their shareholders reap the maximum benefit.
Manufacturing is done through contract manufacturers that are strategically placed throughout the country and world so that distribution costs are minimized. This provides TRLG with an advantage over some, but not all of its competitors because of lower distribution costs. Further this allocates the pricing power across many suppliers so that no single supplier has an incredible amount of pricing power. The combination of low pricing power and low distribution costs empower True Religion Jeans to become a financial leader in its sector.
True Relgion Brand Jeans are lessening their dependency on department stores such as Nordstrom, Bloomingdale's, and Neiman Marcus. This transition has its benefits and drawbacks, and those changes are what power the key drivers for 2011.True Relgion has historically had a strong dependence on department stores to move their products since the company was founded. However, The percent of net sales attributable to department stores had 57% to 29%. Should this transition continue, it will mean two things for the brand. First, the U.S. Consumer Direct segment, according to management is a higher margin business than the U.S. Wholesale segments, and so it is clearly determinable that the change should lead to a higher margin financial performance. The drawback, however, is that the detachment from department stores may lead to a decrease in brand visibility. This is because department stores are attractive to consumers because they house many different brands, effectively making them a one-stop-shop for the average consumer. In order to combat this, management will have to continue to increase advertising expenses so as to maintain celebrity endorsements and high visibility with the affluent customer base they currently have.   
Clearly, as seen in the above graph, since 2007, management has significantly increased the advertising expense year over year. This trend, according to McKinsey Valuation, is a definitive method of increasing market share, visibility, and ultimately, return on invested capital. Further, TRLG's marketing expense has been trending upwards at a rate higher than both Buckle and Abercrombie and Fitch. Despite the size of TRLG relative to their referenced competitors here, they are approaching the same level of marketing expense, which is not only impressive, but leads one to think that TRLG will experience significant growth in earnings in the future.
As can be clearly seen in the above graph, TRLG has been significantly increasing their number of branded retail stores since 2006. The expected additions to this number for 2011 is 15, for an expected total for 2011 of 109 stores. However, it would not be unlike management to increase the number of True Religion Branded Jean stores to increase to a total above 109. For example, they expected to at 20 stores to the group in 2008 and the actual increase was 27.
Further, on a call with Investor Relations with Anne Rakunas, several further distinctions between Consumer Direct and U.S. Wholesale were that while the cost of goods sold should be the same for both segments, yet management retains a higher level of control over the sales price for jeans in the retail branded stores. This can be visually observed in the graph below that details the margins for the two segments.
This graph clearly details how much pricing power management has when they are dealing with the retail branded sites. Consumer Direct gross margin (blue square line), since 2006, is consistently higher than the U.S. Wholesale gross margin (green square line). This again indicates the pricing power that customer groups including large, organized groups of consumers (department stores) have over individuals who make purchases through the branded retail stores. This pricing power is further highlighted when comparing the operating margins for both the Wholesale segment and the Consumer Direct segment. The operating margin for Consumer Direct has been higher than the U.S. Wholesale operating margin for all years graphed except for 2006 and 2010. In 2010, net sales for the U.S. Wholesale segment decreased from $123MM (2009 to $104MM (2010). However, despite this decrease, the SG&A costs for 2010 increased from $5.8MM to $7.0MM. This increase in SG&A was due to the transition in the first half of 2010 from a sales agent to an in-house sales team for the U.S. Wholesale segment. The probable increase in operating margin for the U.S. Wholesale segment was most likely due to a shift from selling more heavily to boutiques rather than department stores, which, according to management, has a higher operating margin than do the sales attributable to the department stores.
Trends in the fashion world tend to change very quickly. Consumer tastes can vary widely from one season to the next, leading to large swings in a company's profits. But as jeans, perhaps the most basic of all wardrobe staples, account for the overwhelming majority of True Religion's revenue, the company seems less susceptible to such swings when compared to logo-covered handbags and extravagant designer apparel.
But in spite of this different approach, True Religion must still contend with the risks inherent to the high-end denim industry. One risk that is inherently looming, is the subtle fashionable consumer preference trending towards khaki pants. Further, the brand is susceptible to a decrease in brand prestige, status, or visibility. However this is hedged by management by decreasing sales to off-channel stores (outlets) and increasing the number of retail branded stores. In addition, True Religion has been very dependent on the visibility celebrities have brought to the company's denim. Known for their fickleness when it comes to branded apparel, there is a strong possibility that True Religion could fall out of celebrity favor, which would serve as a significant blow to the brand's power.
True Religion's bottom line is strongly dependent on its U.S. sales, and is therefore susceptible to shifts in the region's economy. As rocky economic forecasts tend to damper consumer spending, the company's recent rapid growth could decline.
In the company's early years, wealthy individuals formed the original core of True Religion's clientele. In an economic downturn, their spending should remain relatively stable. However, as the brand gained national exposure, trendy middle-class teens became a greater source of the company's revenue. But while the expansion of its customer base may be necessary for future growth, the cost of True Religion jeans may prove too high for younger clients with less disposable income. Accordingly, these consumers may decide to pass on True Religion products and purchase less-expensive trendy labels.
The above image graphs the percent change in GDP for the United States on a quarterly basis. For the last seven quarters, the U.S. GDP has posted growth, and for the last six quarters, that growth has been above 1%. This bodes well for the brand as it indicates that as the economy continues to trend upwards, more people are going to be willing to spend more money. Further supporting this claim, is the graph below.
The above graph outlines the unemployment claims within the United States over the past 17 quarters, from Q1 2007 until Q1 2011. As is clearly visible, this line trended upwards for quite a few quarters until its first decline in the first quarter of 2010. The latest trend has continued through the latest quarter , indicating that spending on discretionary items, such as $170 - $300 pairs of jeans is going to rise.