Is Talbots a Good Buy?

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Return on my hard-earned money is the first thought that comes to my mind when I think about investing. I look for good returns from small investments. In an earlier article on Talbots (NYS: TLB) , I wrote about how the company continues to struggle. Let us now chew over its intrinsic value to see if it might be worth an investment.

Reasons to worry
The struggling retailer has been suffering from declining revenue and gross margins for quite some time. Sales tumbled 9.8% and operating margins were 16% lower than the year-ago quarter. The company tried aggressively to sell off its slow-moving spring and summer collection with promotions, but had difficulty resonating with customers. This is reflected in their disappointing 9.6% decrease in same-store sales from the same quarter last year. The promotional activities on these items also noticeably deteriorated their gross margin, hurting bottom-line performance.

These lower-than-expected sales resulted in higher inventory levels. What concerns me more is that its short-term debt shot up 124% from this quarter last year to $83.9 million. These liabilities are the result of Talbots tapping their revolving credit facility. The move will likely increase its interest obligation and put further pressure on its operational activities. Additionally, Talbots foresees continued promotional activity going forward, which will keep putting pressure on their gross margins.

Reasons to smile
Talbots is taking measures to weather the erratic economic environment and inflationary pressure. The company is working toward checking its costs, improving its operational efficiency and gradually bringing its working capital on track. It has entered into an agreement with Li & Fung, its strategic partner, to extend credit for merchandise purchases by 30 days. This should help relax Talbots' operational cash flow.

Talbots is improving on its apparel assortment by focusing on sweaters, pants, and sportswear. Its two new pant styles, "curvy" and "modern," are picking up in the market. They are also experimenting with prints, patterns, and fabrics based on customer feedback.

During the quarter the retailer opened seven upscale outlets and closed nine stores, and now has a total of 566 stores. Also, it plans to close down its not-so-productive 110 outlets by 2013. These stores contributed a $1.4 million operating loss in Q2 2011, so their presence won't be missed.

While these things do look good, is the stock looking cheap?

A comparative picture
Considering the fact that the company is losing money, conventional valuation based on returns would produce hard-to-compare ratios. Thus, I am taking a look at the following two metrics to see the position of the company when compared to its peers.

Company

Enterprise Value / EBITDA

Enterprise Value / Revenue

Talbots

5.6

0.2

New York & Company (NYS: NWY)

5.5

0.2

ANN (NYS: ANN)

5.0

0.5

Chico's FAS (NYS: CHS)

5.1

0.8

Coldwater Creek (NAS: CWTR)

N/A

0.1

Source: S&P Capital IQ. N/A = not applicable due to negative EBITDA.

Talbots' enterprise value/EBITDA multiple looks to be somewhat high for its industry, likely affected by depressed sales. Operational earnings, or EBITDA, are currently depressed, likely due to lower revenue from continued promotional activity. In addition, the enterprise value/revenue ratio seems quite cheap. Think about it this way: someone who's buying Talbot's stock today is paying just $0.23 for each dollar of sales.

Together, these two metrics show that the company is having decent sales as compared to the price of its stock, but continues to struggle with worse margins as promotional activity and markdowns persist. Management sees this trend continuing for at least the short term.

The Foolish bottom line
Investors will probably think twice before investing in this stock. However, I am curious. These are testing times for Talbots, but I have faith in the management. Already their September sales have largely improved over August. Many people might be bearish about this company's future, but I will bet my money on it and add it to my portfolio. What do you think?

At the time this article was published Fool contributor Navneet Bajaj does not own shares of any of the companies mentioned in this article.Motley Fool newsletter serviceshave recommended buying shares of New York & Company. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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