Tuesday, August 28, 2007

Is Niche apparel a Niche stock ?

Clothing is a very ugly industry despite its glitz and glamour. For small businesses to survive and thrive – they need to create products that are emotionalized, authentic and, above all, differentiated. These businesses must be able to distinguish themselves from their direct competitors, establish themselves in consumers’ minds and therefore create a niche. Over the past few years we have seen an explosion of new brands in the niche apparel market. I’m going to examine two companies going in two very different directions in this hyper fickle realm of retail. Both companies have products that qualify as niche markets. HEELYS specializes in wheeled footwear that is currently all the rage among children, tweens and even teenagers. Under Armour has specialty sportswear that is engineered to keep athletes cooler during physical activity. These companies represent niche apparel as well as niche stocks. Stocks that are considered to have a short life once the fad (demand for the underlying product or service) begins to decline are known as niche stocks. Niche stocks have been making waves in the stock market for some time but it is difficult to determine which companies will qualify for more permanent status on the market and in your portfolio.

Heelys, Inc. (HLYS) is a designer, marketer and distributor of action sports-inspired products targeted to the youth market. The Company’s primary product, HEELYS-wheeled footwear, is a line of dual-purpose sneakers that incorporate a removable wheel in the heel. HEELYS-wheeled footwear allows the user to seamlessly transition from walking or running to skating by shifting weight to the heel of the sneaker. During the year ended December 31, 2006, approximately 98% of HEELYS’ net sales were derived from the sale of its HEELYS-wheeled footwear. The Company, however, also offers a selection of HEELYS branded accessories, including protective gear such as helmets and wrist, elbow and knee guards, heel plugs, wheel bags and replacement wheels, and a limited variety of apparel items.

HEELYS current share price of $9.25 is in stark contrast to its public debut late last year when its shares received an enthusiastic welcome at $21. Heelys Inc.'s shares dropped to a then all-time low of $11.84 on August 8th, 2007 as a reduction in orders cast a cloud over sales for the remainder of the 2007 fiscal year. The shoe-maker forecast a dismal second half of the year due to over-inventoried U.S. accounts. It cited aggressive expectations and retail softness in footwear and apparel as explanation for the downward trend. The company's shares were trading down about 57.72 percent at $9.25 in morning trade on the NASDAQ, August 28, 2007. Robert W. Baird analyst, Mitch Kummetz, downgraded the stock to "neutral" from "outperform," adding that even if the company's sell-throughs were to improve before orders for spring 2008 came in, revenues for the first half of 2008 will likely be hurt due to cautious ordering. Bear Stearns analyst, Jennifer Childe, reports that retailers are hesitant to place additional orders in the face of already bloated inventories. Childe lowered her rating on the stock to "peer perform" from "outperform," but said management's guidance appears to reflect a "worse case scenario," with room for potential gains if back-to-school sales momentum continued. Bear Stearns was one of the underwriters for the company's initial public offering. At least three other brokers also downgraded their ratings.

Under Armour (UA), founded in 1996 by former University of Maryland football player Kevin Plank, is the originator of performance apparel - gear engineered to keep athletes cool, dry and light throughout the course of a game, practice or workout. The technology behind Under Armour's diverse product assortment for men, women and youth is complex, but the benefits are simple: for optimal performance wear HeatGear® when it's hot, ColdGear® when it's cold, and AllSeasonGear® between the extremes. Under Armour's mission is to "provide the world with technically advanced products engineered with their [our] superior fabric construction, exclusive moisture management, and proven innovation. Every Under Armour product is doing something for you; it's making you better...”

The sports apparel company is popular among more than just gym rats and teenage athletes. Short sellers, who try to make money by betting that the price of a company stock will fall, have made Under Armour one of the hottest stocks for short sales on Wall Street in recent months. In a Bloomberg News July 2007 ranking of companies with more than 10 percent of shares available for short trading, Under Armour ranked 25th among companies with the largest amount of short sales on the New York Stock Exchange. According to several analysts, it is not surprising that Under Armour’s stock is hot among short sellers. Since the company became publicly traded in November 2005, its stock price has prompted frequent Wall Street criticism. The company’s price to earnings ratio – the common Wall Street gauge in determining how expensive a stock is relative to its market value and earnings during the past year – is 78.16, according to Bloomberg statistics. In comparison, Nike, which dwarfs Under Armour, has a P/E ratio of 19.57. Under Armour has revenue of $467.32 million, while Nike $16.3 billion.

Many analysts have also wondered if the company can maintain a large enough growth in sales to justify its stock price. So far, the gamble that short sellers are taking has been stonewalled - by a large block of institutional investors who believe Under Armour stock will move even higher. Rather than falling, Under Armour stock has increased approximately 24.78 percent in 2007, and has achieved record highs during the past several months as investors push up demand for shares. Institutional investors, who are satisfied with the business fundamentals of the company are aware of its popularity among athletes and non-athletes alike, have been buying the stock and pushing up its price. The stock reached a record high of $67.10 after the company released second-quarter earnings July 31, 2007, and raised its financial outlook for the year. These diverging views have created a Wall Street money battle on which direction the stock will turn. Under Armour continues to receive praise and criticism as its stock price has fluctuated wildly during its two-years being publicly traded.

It is not surprising that these companies are being scrutinized. With the fall season almost upon them, sales from these two niche apparel makers will help determine who will survive to become a household staple and a stock market portfolio stalwart. Based on the analysis from Haye Capital Group, it is believed that unless HEELYS starts to diversify its product offerings they will go out of style like the zipper and metal studded leather jackets of the mid eighties. Under Armour has a more utilitarian purpose so for the time being it is the clear choice for both a lasting brand and stock portfolio pick. With its current product lines having a longer and better product life that is not just trendy but practical as well, Under Armour has a clear advantage. The key for both of these companies is to get the “niche” out of the perception of both their apparel and their stock if they are to be truly mainstream and lasting brands.