Fruit of the Loom Ltd. fared poorly from 1997 to 1999. Between April 1997 and October 1999, its stock price dropped from $38 to $3, a 92 percent loss in market value.

Fruit of the Loom manufactures men’s and boys’ underwear. It had an estimated 32 percent share of the U.S. market in 1999, second only to the Sara Lee Corporation’s Hanes brand, which holds a 37 percent share. The firm has had a checkered history. It was controlled by a financier, William Farley, who took the firm through a leveraged transaction in the mid-1980s and began considerable cost cutting. It was one of those “small-town America” companies where conflicts between management and labor arose with the cost cutting associated with leveraging and reorganization and with the shipping of production overseas to countries with cheaper labor. Remember the movie Other People’s Money?

With the cost cutting and dispersion of production came quality control problems and difficulty managing inventories. Financial difficulties in other apparel holdings forced Farley to reduce his stake in fruit of the Loom and, analysts claimed, distracted him from the business. In late summer 1999, Farley gave up control to Dennis Bookshester, an outside director and a veteran of the retail trade, who found the firm’s computer and control systems were in a mess. Some numbers on the firm are shown in Table 19.2.

The problems, most analysts claimed, were fixable. Product market share had declined slightly but was still at a respectable 32 percent. The market was pricing these sales at a low multiple of 0.11. The infrastructure from the cost-cutting program was still in place. Many systems, and computer consultants were working to do so.

In the fall of 1999, some analysts were forecasting that the firm would break even for the rest of 1999 and were forecasting an EPS of $0.79 for the year ending December 31, 2000. Subject to qualifications about the firm’s ability to get its systems under control, these analysts were also forecasting continuing profitability in the years after 2000. But other analysts warned that the firm might be heading for bankruptcy.

For the nine months ending October 2, 1999, the firm reported a loss of $253.2 million against a profit of $146.9 million for the same period of the previous year. Exhibit 19.2 presents the firm’s financial statements covering the first nine months of 1999.

A. Stock screeners would say that this stock has all the features of a buy: low P/E low P/B, and low price-to-sales ratio. How comfortable would you be with issuing a buy recommendation in this stock at a price of $3 per share? What other information would you like to see to make you more secure in your recommendation?

B. Carry out an analysis of financial statement ratios that indicate the likelihood of bankruptcy in October 1999.

C. Calculate a Z-score using the Z-score model in this chapter. Annualize ratios based on nine months for the calculation. How did the firm’s Z-score change between January and October 1999?