Maidenform's Prospects Take Shape

With its solid sales outlook, the intimate apparel company gets a strong buy rating from S&P

Founded in 1922, Maidenform Brands (MFB; $20.09) is a global intimate apparel company that designs, sources, and markets intimate apparel products such as bras, panties, and "shapewear" under the Maidenform, Flexees, Lilyette, Sweet Nothings, Rendezvous, Subtract, Bodymates, and Self Expressions brand names. The company filed the patent for the modern seamed bra in 1926.

Maidenform declared bankruptcy in July, 1997, because of operating difficulties, after which it closed underperforming stores, distribution centers, and redundant offices and sold several manufacturing plants. In May, 2004, the company was bought by Ares Management and revamped. It went public through an initial public offering in 2005.

We at Standard & Poor's think that Maidenform competes in an attractive area with strong opportunities to improve earnings at a midteens rate over the next few years. We have S&P's highest investment recommendation of 5-STARS, or strong buy, on the stock.

Maidenform shares are up about 10% so far this year, about even with the S&P SmallCap 600's gain. Our 12-month target price for the stock is $27, up 35% from the current level. We reached it by applying a 17.5 forward price-earnings multiple to our 2008 earnings-per-share estimate of $1.55. The 17.5 p-e, which is at a slight premium to its peer average of 17.3, is appropriate given Maidenform's better revenue, operating margins, and EPS growth prospects.

Solid Sales Growth

We think demand for Maidenform's products is less fashion-dependent and more replenishment-driven than its apparel peers. We project that Maidenform can increase sales at a solid 6% in 2007 and 2008, ahead of S&P's forecast for apparel sales increasing at a low single-digit rate.

Last year's sales in the intimate apparel category, by our estimates, grew at about twice the low-single-digits rate of women's apparel, with the shapewear and full-figure categories among the fastest-growing areas. We think Maidenform, with its leading shapewear (Flexees) and full-figure (Lilyette) brands, in particular, is well positioned to extend its market share.

We also see the company continuing to expand in the faster-growing mass channel. Last year mass merchants such as Wal-Mart (WMT), Target (TGT), and Costco (COST) accounted for 25.5% of Maidenform's sales. We look for sales in this segment to grow at a double-digit rate as Maidenform increases its presence in more stores and in more product categories.

Brand Equity

In addition to sales growth, we project improved operating margins as a result of new products, a product mix shift to higher-margin, higher-growth items, economies of scale in purchasing and production, and cost reductions. Based on intimate apparel peer margins, we think a mid- to high teens operating margin is achievable over the longer term, up from last year's 13.3%.

Maidenform uses a multiple brand strategy that provides access to the faster-growing mass market channel without diluting the strong brand equity that its Maidenform, Flexees, and Lilyette lines enjoy in department stores and national chain retailers. We believe the shift from manufacturing to 100% global sourcing using lower-cost providers gives Maidenform the opportunity to maintain margins in a market that we project to be increasingly competitive with higher private-label penetration. Maidenform's competitive advantage, particularly in the growing mass channel, is its product innovation and merchandising functions.

Over the past few years, the retail landscape has been consolidating, with share accruing to mass merchants and specialty chains as traditional department stores lose ground. Department stores and national chains represented approximately 62% of Maidenform's annual sales volume in 2006, with mass merchants representing 25.5%.

We see Maidenform's sales growing in tandem with this trend as it expands its presence at mass merchants while still generating good growth at department stores through new style introductions and product line extensions. The international market, at 7% of sales in 2006, represents a large untapped opportunity, in our view.

The Wal-Mart Factor

We see sales supported by continued expansion into the mass channel and sizable exposure to the profitable shapewear category, which accounted for 22% of Maidenform's sales in 2006. Specifically, we forecast continued penetration into one mass customer (Wal-Mart Stores), with more than 4,000 stores domestically and close to 3,000 internationally. As of the end of the first quarter of 2007, Maidenform's Sweet Nothings brand had expanded domestically into approximately 2,000 stores in the full-figure category, 800 stores in shapewear, and 1,300 stores in panties at this customer. In addition, the company says that Sweet Nothings is the leader in strapless bras with a 2,800-store presence, and that it has a complete presence with average figure bras.

Although sales to the department store/national chain channel were down in the first quarter of 2007, we see top-line growth rebounding on new product introductions, such as the Smooth Bra collection with patent pending technology and a shapewear brand called Control It. We estimate healthy sales gains over the next two years in mass channels at a rate above 10%, with a good but comparatively lower rate of growth at department stores and national chains, resulting in total revenue rising approximately 6%.

We project a slight offset to the strong revenue growth at mass merchants from gross margins. But we see benefits from economies of scale in purchasing and freight along with an increasing overall mix toward higher-margin shapewear and full-figure products. Since the mass channel requires less merchandising, selling, and administrative costs than the department stores, margin pressure should be lessened, in our opinion. Together with these factors, we believe management's focus on cost control and efficiency will result in operating profit margins expanding from 13.3% in 2006 to about 15% in 2008. Maidenform already has reduced some recurring benefit expense by moving from a traditional pension plan to a 401(k) in the first quarter, and we look for some occupancy expense savings from a headquarters relocation this summer.

Changes at Rivals

In addition, we think the company has benefited and will continue to benefit from various issues and changes at some of its competitors. The intimates division of VF Corp. (VFC; $91; S&P opinion, hold) was sold to Berkshire Hathaway's (BRKA; $110,300; hold) Fruit of the Loom division in early 2007, and Hanesbrands (HBI; $26; not covered) was spun off from Sara Lee (SLE; $17; sell) in September, 2006. We believe Maidenform has been able to make some good hires and look for this to have more of an impact in the future.

We project EPS of $1.34 in 2007 and $1.55 in 2008 on operating margin expansion from 14.3% to 14.9%.

Beyond 2008, we believe an upper teens operating margin is achievable based on Maidenform's mix of business and the metrics of some of its competitors. The Limited's (LTD; $27; hold) Victoria Secret division posted an operating margin of just under 20% for full-year 2006, and Warnaco's (WRNC; $40; buy) Calvin Klein brand exceeded 20% in this year's first quarter. Maidenform's ability to exceed 20% is limited by the company's lack of a prestige brand, a weakness that we believe management is trying to address through acquisitions, although licensing is more likely given the enthusiasm surrounding luxury goods in the investment community.

In general, we view Maidenform's corporate governance favorably: The majority of the board is controlled by independent outsiders, the full board is elected annually, there are no related-party transactions involving any officers or directors, and the company does not have a poison pill in place. But, although the chairman and CEO roles are separated, an affiliated outsider is chairman, shareholders do not have cumulative voting rights in director elections, and the board is authorized to increase or decrease its size without shareholder approval.

Roster of Risks

Risks to our recommendation and target price include the possible sale of some or all of the 3.7 million Maidenform shares held by Ares Capital (16% of float); the company's dependence on large customers where private labels are an increasingly important merchandising strategy, which could limit its opportunities; a severe slowdown in consumer spending; and Maidenform's failure to successfully introduce new products.

We see favorable growth prospects for Maidenform and believe the shares are undervalued, trading at 15 times our 2007 EPS estimate, a discount to the market and lower-growth peers. In recent years, we believe that a bevy of new entrants have emerged in the intimate apparel space, including Chico FAS's (CHS; $21; hold) Soma, J.C. Penney's (JCP; $76; hold) private label Ambrielle, and American Eagle Outfitter's (AEO; $27; strong buy) aerie.

But we still regard barriers to entry as high, given the characteristics of the intimate apparel business, which requires innovation in design, materials, and construction as well as experienced management of many SKUs. We believe Maidenform's stable of strong brand names and 85 years of design experience will continue to set the company apart, and we think Maidenform has only started to leverage its brand in the international arena.

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