Danier Leather (12.33 last)

Danier Leather is a vertically integrated retailer that designs, manufactures and retails leather and suede products. Danier's coats, jackets, handbags, gloves, belts, and multitude of other products are available at their that 91 shopping mall, street front and "power center" locations across Canada. Danier currently has a pristine balance sheet with $43mm working capital with virtually no debt, a tangible book value of $61mm, and a market cap of $58mm. The company is well in the black, trading at only 8x trailing PE. Its these discount valuation metrics and Danier's competitive position that makes the stock attractive

Initially founded in 1972 as a manufacturer for direct sale to Canadian department stores, the company opened its first retail "Danier" location in Toronto in 1981. The strategy has been to primarily target the 35 to 55 year old middle to upper middle income female customers who seek quality garments and accessories at reasonable prices. The company has good relations with suppliers, sourcing animal "skins" from Europe and Asia at economical prices given the high volume of purchases. 92% of Danier's manufacturing is performed in Asia under supervision of Danier personnel, with the balance in Canada. This mitigates the strength of the Canadian dollar on COGS as these purchases are denominated in USD. Design, distribution and some manufacturing is done at a fully owned 130,000 square foot facility in Toronto. Danier's other distribution facility and retail locations are under lease.

During the economic crisis the shares hit panic stricken levels at 2.20/share. This was 0.2x book value! the shares have been a five and a half bagger since then, but even now the shares barely reflect the replacement cost of assets, let alone Danier's franchise value as the most recognized leather product company in Canada. Sales metrics are volatile, in 2010 same store sales were up 4%, although in the first two quarters of F2011 same store sales decreased 6%. Part of this stems from CEO Jeffrey Wortman's focus on higher margins instead of volume. Gross margins hit a record 58% in the most recent quarter. Overall floor space has shrunk as the company focuses more on mall locations versus outlets. Less seasonal and economically sensitive accessories sales have jumped to 25% or sales from 4% in 1998, and were up 11% for the 27 week period ended Jan 1 2011. The company is also starting to target 20 to 35 year old customers with more fashion forward designs at popular price points. Sales per square foot has increased every year since 2006.

The Wortman family owns all 1.22mm multiple voting shares and Danier has been aggressively buying back stock. In a dutch auction in March/April of 2010 the company bought back 1.12mm shares @ $6.25. Of the 4.7mm shares, 1.22mm are multiple voting held by the Wortman family, leaving 3.48mm subordinate voting shares outstanding. According to Bloomberg 6 institutions (mostly value funds) hold 2.86mm shares. This means 620k shares are in retail and other accounts, which partially explains why the stock's ADV is 8,800 shares. There are very few holders to convince in a buyout, and leverage could certainly be used given the businesses strong cash flow and clean balance sheet.


Risks to Danier's investment thesis include the cost of leather, which has competitive usage in shoes, furniture, car upholstery, as well as the cost of chemicals used in tanning. Emerging economies with higher incomes now compete for raw material. Also, China could reduce or eliminate its value added tax (VAT) export refund and could have an adverse effect of costs for Danier. Consumer debt levels in Canada are shockingly high and discretionary income is taking a hit from high commodity prices and still elevated unemployment levels. A slew of US retailers including Target, J Crew, Kohl's and several others are rumoured to be entering the Canadian retail space due to higher sales per square foot and lower retail square footage per capita vis a vis the US.

The first two concerns about cost are faced by virtually every retailer and are definitely something to be cognizant of. I admit that I do not have strong views on the leather market, although the strong CAD has mitigated USD based costs. Debt levels in Canada are high, but a stroll around the mall suggests that consumers are not hurting. Danier in particular has a steady flow of customers in a number of locations I visited, and family members love the accessories and jackets. The last point, that high sales per square foot is attracting competition is concerning, but Danier already has a foothold and if the company can improve operationally, as they have been over the last few quarters, then they have a compelling franchise value.

From a valuation perspective I do not see a massive ramp in same store sales or outlet expansion. Management's philosophy is to focus on profitability. Many Canadian retailers have realized greater than 10% operating margins versus Danier in the 5-6% range. With no significant Capex outlay in excess of depreciation and minimal need for increased working capital, Danier has huge free cash flow leverage to modest margin improvement. While the shares are unlikely to deliver another 5 bagger anytime soon, managements newfound commitment to profitability and clean balance sheet makes the shares look compelling at prevailing levels.