NEW YORK — Citigroup is feeling good about Liz Claiborne Inc. and its new chief executive officer, William L. McComb, going into the vendor's long-awaited July 11 strategic meeting.
After meeting with McComb, president Trudy Sullivan and chief operating officer Mike Scarpa on May 30, Citigroup released a report of its findings, which included Claiborne's focus on growing its "power brands" and retail division, while divesting smaller and lackluster brands, in addition to general cost-cutting.
Citigroup maintains its "hold" rating on Claiborne stock, calling the company high risk. Its target $42 stock price compares with Wednesday's closing price of $35.98.
Citigroup's meeting with McComb — its first since the former Johnson & Johnson group president took the position in November — was scheduled before the company's first-quarter earnings dropped more than 60 percent. "There was very little they were able to say, but the lunch ended up being a really good conversation," said Citigroup analyst Kate McShane.
The report put faith in McComb, whom it dubbed "McCEO" and labeled "a dynamic speaker and extremely sharp."
"We think he has a very strong command of the apparel industry and Liz's business despite not having an apparel background and given that he has been in the role only seven months," according to the report.
McComb declined comment Wednesday on the report.
But the report was not without serious concerns for the July 11 meeting, in which McComb will unveil his manifesto. McShane's biggest concern over the next year is Claiborne's relationship with Macy's Inc. Although she believes the two companies will ultimately resolve their differences, she thinks it will take years, not months. She referred to past troubled relationships in the industry, such as that between Foot Locker and Nike, as an example of how long such reconciliations can take.
Citigroup expects Claiborne to continue its investment in its five "power brands" — Lucky Brand Jeans, Juicy Couture, Mexx, Liz Claiborne and Kate Spade — and their accompanying retail stores.
"Lucky Brand is just reaching the scale necessary to better leverage overhead costs, and Juicy is soon to follow as it approaches a base of 40 to 50 stores," according to the report. "With operating margins well below the corporate level (5.1 percent in fiscal 2006 versus 10.5 percent overall), we think there could also be more opportunity for margin improvement over both the short and long term."Brad Stephens, an analyst for Morgan Keegan & Co. Inc., however, is not optimistic retail will work, pointing to year-to-year declines in operating margins since 2003: 5.1 percent in 2006, 5.6 percent in 2005, 6.9 percent in 2004, 8.5 percent in 2003 — all down from 12 percent in 2000.
Margaret Mager, retail analyst and managing director for Goldman Sachs & Co., is waiting to hear how much retail investment — particularly in Kate Spade — will cost, and if the margins are high enough to fund itself.
"If it's a tale of low-growth legacy businesses versus high-growth newer businesses, I want to know if the higher growth stuff will be self-funding, or does it need resources from the legacy business to expand?" Mager asked.
And while the focus on the power brands grows, Citigroup expects Claiborne will announce that others in its 40-plus brand portfolio may be sloughed off through divestiture. The report "noted a willingness to exit the distribution channels that are waning. Management stated that it does not want to manage a brand just to 'tick a box' in a certain price point."
"I don't see them cutting the portfolio in half, but I think they may sell brands with good brand equity that don't meet their qualifications, and some of the moderate brands they may just close," said McShane.
She identified C&C California as "a tiny brand but one that does pretty well and has a loyal customer following — though at the end of the day is mostly a T-shirt company." She added that recent management changes, including taking Liz Munoz off C&C to focus full-time on Lucky, made her think it might be a sell-off target that could be an attractive buy for a department store that could use it for private label. Enyce struck her as another potential divestiture.
Some industry sources are speculating Claiborne may sell off its approximately $250 million fragrance arm, which McShane said "would make sense, if they would license it and make higher margins licensing it out."
But divestitures are not the only thing McShane expects to see. The analyst predicts a reduction in workforce, particularly through eliminating duplication from acquisitions. Other analysts echo the concern over cost-cutting plans."On conference call one, they increased expenses, and on conference call two, they cut revenue," Mager said. "That's not a good formula. I think the market would like to see something on expenses that at least gives some cushion against further erosion of wholesale revenue."
Cost-cutting is more important to Mager than divestitures, most of which she predicts will be relatively small. "Divestitures shouldn't be a distraction from what they should be doing," she said. "The real needle movers are cost-cutting, streamlining and reorganization, plus funding and growth of new businesses."
Stephens said Claiborne would have to announce on July 11 thorough cost-cutting plans, including possible layoffs totalling 10 percent of the workforce, and closing of brands, the latter of which he thinks is more likely than selling troubled brands because "you can't sell something that has no value to someone else."
While analysts think they know what to expect in terms of content — power brands and retail will get more funds, some brands will be divested, costs will be cut — the biggest variable analysts are waiting on is timing.
"What I would really like to hear is 2007 is the reset year," McShane said. "I would like Bill to say, 'I set the bar low in 2007, but 2008 can be a much better year for us.' What I don't want to hear is that we have to wait until 2009."
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