J.Jill (NYSE:JILL) posted 2Q24 results last week, with the stock cratering almost 40% after the company reduced guidance. The quarterly sales were good on a comparable basis (growing in a challenging context), but the company was wary about traffic trends in July and August.
Since I wrote my first Hold article on Jill, the stock is basically flat after going from $24 to $40 and back down. The company’s business has not changed dramatically, besides management’s comments about traffic decreasing. However, the company’s capital structure is now less leveraged, thanks to the issuing of 1 million shares at $31 back in June.
Jill is a leveraged retailer that is guiding for decreased revenues in the next semester. We have no way of predicting future revenues, but we should not model an improvement in order to be conservative. The company has reduced its financial risk but still has leverage at high rates. In addition, I do not like the company’s capital allocation or management compensation policies. Therefore, I believe a current yield of between 12% and 14% (based on forecasts made in the valuation section) is fair for the stock. I do not consider the stock overvalued anymore, but neither an opportunity. For that reason, I maintain my Hold rating.
2Q24 Results and Guidance
Top-line growth: Jill’s revenues were down 0.9% YoY, but mostly coming from a calendar shift compared to last year. On a comparable basis, the company actually grew 1.7%. Not many apparel companies are growing in the current context, and therefore, Jill’s situation is positive.
Deceleration: If we look at Q1, the company was growing at 3% comparable, so the 1.7% print is a small deceleration. In addition, the company warned of worsening trends in July (part of Q2) and August (part of Q3). For this reason, the company guided for Q3 comparables down 1/2%. The company commented that July trends were bad in terms of traffic and customer reaction to more promotional activity. The trend was widespread across regions and is also evident in the digital realm (traffic via Semrush and search via Google Trends).
Reduced guidance: Based on the July-August trend and projecting into the year, Jill’s management reduced the top-line guidance from up 1/3% to flat to up 1%. This latter number still reflects comparables up 2/3%. Because of calendar shifts, the company was expecting to see adjusted EBITDA down 1/3% but now expects the figure to be down between 3/9%.
The wide range of EBITDA figures comes from three scenarios: improvement in the traffic trend, no improvement in traffic but reaction to promotional activity, no improvement in traffic and no reaction to promotional activity.
Gross margins to be hit: Gross margins and profits are expected to be challenged in 2H24. To begin with, with sales down on absolute and comparable figures, the margins will delever. In addition, the company bought inventory earlier to protect from Red Sea related freight delays, but looking at the trends before July. This led to Jill’s inventory going up 15% YoY, with the implication of potential promotions to control inventory during the fall and holidays.
SG&A up on inflation: Wage inflation continues to make a dent in almost all of the retailers. SG&A for 2Q24 was up $2 million despite lower sales, because of wages, bonuses (I have been critical of the company’s compensation structure), and a $500 thousand investment in an order management system (as reported on the 10-Q for the quarter). For the year, the impact of wages is already $3.4 million. The company is considering reducing performance marketing expenses to balance SG&A, but this figure will also delever YoY.
Questionable capital allocation decisions: Last quarter, the company sold 1 million shares at $31 each ($29.5 million received net) that it used to repay debts. The company’s net debt stood at $44.5 million, compared to $94 million one year ago. I believe this was a healthy decision, considering that retailers should not have financial leverage and that I thought the stock was overvalued at $31. However, I was surprised to see the company implement a $0.07 quarterly dividend this quarter. I don’t see the logic of issuing shares, diluting shareholders, and using part of those funds to pay a dividend while still holding debt. I would have preferred faster debt payments. At 15 million shares diluted, a $0.07 quarterly dividend implies a cash outflow of $1 million, not small. With the term loan yielding 13% (SOFR + 8%), each $1 million of excess repayment saves $130 thousand a year.
Warrants exercised: Since my first article, I had warned about the 3 million non-cash exercise warrants that Jill maintained. These warrants were exercised during August on a cashless basis (as reported in the 2Q24 release). Therefore, the company’s share count is now at the level I considered for my previous valuations, about 15 million shares.
Valuation Revisited
A lot has happened since my first article on J.Jill in March 2024. The stock went from $24 to $40 and then returned to $24. In addition, the company issued 1 million shares and used those proceeds to pay debt. It also issued 3 million shares in exchange for warrants (an event subsequent to the 2Q24 report). That means today, the company’s market cap is about $365 million, and its EV is closer to $410 million. The market cap figure is the same as in my March article because I had already considered the warrants as issued shares back then. The EV is now lower because the company repaid debts.
Using the company’s guidance as a base, we can expect adjusted EBITDA to finish the year between 3% and 9% below FY23 figures ($112 million). That would mean between $108 and $101 million. From these figures, we also have to remove $5 million in yearly SBC compensation and $23 million in D&A (matched approximately by $22 million in CAPEX expected for the year). This leads to an operating income range between $73 and $80 million. Applying a tax rate of 25% leads to NOPAT of between $55 and $60 million. This figure does not include the $9 million in debt repayment costs recognized this year from the early debt repayment.
If we move down the income statement, we have to remove interest going forward. With a debt of $75 million on a term loan, paying the crazy high SOFR + 8% (13% effective today), we can expect $10 million in interest expenses going forward (barring new repayments). Further, applying a 25% tax rate leads to net income between $47 and $52 million.
The above leads to an EV/NOPAT of about 7.2x and a P/E of about 7.3x. This is markedly different from the 10x multiples Jill offered in March at the same stock price. The difference comes from applying a lower tax rate (30% back then), and from the debt repayments (leading to a lower EV and a higher E).
Is 7x an attractive multiple? It implies a current earnings yield of 14%, not bad. However, the company’s margins are levered on revenues growing, a trend that might change in the future. Back in, I had calculated that with gross margins at 67.5% (compared to the current 70.5%), the company’s operating income would be $65 million (from the above $75 million in the midpoint). This would lead to NOPAT of $49 million (EV/NOPAT of 8.4x) and net income of $42 million (P/E of 8.7x), based on today’s figures. The yield does not change much, even assuming a decrease in gross margins.
Jill is a leveraged retailer that is guiding for decreased revenues in the next semester. We have no way of predicting future revenues, but we should not model an improvement in order to be conservative. The company has reduced its financial risk but still has leverage at high rates. In addition, I do not like the company’s capital allocation or management compensation policies. Therefore, I consider that a current yield of between 12% and 14% is fair for the stock. I do not consider the stock overvalued anymore, but I also don’t consider it an opportunity yet.
For that reason, I maintain my Hold rating on the stock.
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