In looking at the upcoming quarter for PSS, we like what we see. The bottom-line is that we believe earnings are more likely to start with a ‘6’ than a ‘5’ as suggested by consensus expectations of $0.51 when the company reports next week. That said, there’s a reason why the stock is just now back to its pre analyst day price on October 20th while peers have surged 20% higher on average over the same period. In short, a disappointing long-term outlook for Payless domestic coupled with the reality that management is more actively vetting acquisition candidates spooked investors – as we hit on in detail in our “PSS: Ready, Shoot, Aim” post on 10/26. After walking away last month thinking the story was intact with room for upside compared to management’s outlook, we’re even more confident this is indeed the case due to both underlying industry strength confirmed in peer results and strong mid-quarter trend data.
Here’s a detailed look at how we're getting to $0.60 in EPS this quarter:
Top-line:
- In taking a look at our monthly NPD POS footwear data, we can get a sense of what brands are doing from a directional standpoint. While in no way does the data capture all U.S sales of the Performance Lifestyle Group’s big brands, it has still proven to track closely with reported trends. Since Q2, three of PLG group’s four brands have accelerated sequentially. In addition, with Q3 backlog up +70% compared to +50% in Q1, we expect revs up +21.5% on the heels of +20.3% growth last quarter.
- In the domestic business, the river cards have all have all been revealed in the form of peer results and the results are exceptional. However, since Q4 last year – this has mattered little with PSS decoupling from its peers and significantly underperforming on comp. The primary reason - the company missed the the boat on BOTH the boot and toning trends last year, which for a few quarters each contributed +4%-5% to peer comps alone. With boots accounting for roughly 20% of the fall assortment well above the single digit presence it’s had in the recent past and toning now contributing as well accounting for a +2.5% boost in Q2, we expect the comp performance gap to start narrowing this quarter.
- We expect a comps to come in down -6% driven by more positive traffic seen across the channel as well as mix, which is likely to drive ticket up LSD. Simplistically, if we take 5% of the portfolio with an average ASP of $18 and shift it to boots/toning with an ASP of $30, this would increase the average ticket by +3%-4% alone.
Gross Margins:
- Headwinds in the quarter consist primarily of product costs and channel mix. With product costs expected up LSD in the quarter we estimate an -80bps impact in addition to another -50-60bps headwind from mix (greater PLG sales) assuming ~$45mm in incremental PLG sales at say an average margin below 30%.
- More than offsetting these factors will be several tailwinds in the form of lower promotional activity (Oprah alone impacted GMs by roughly -200bps in Q3 last year), rent/occupancy with mid-to-high-teen reductions on 20% of the portfolio renegotiated annually equating to +30-40bps, and product mix by category with addition of toning and boots.
SG&A:
- With another ~$10mm of expense related to building out both PLG wholesale and international similar to what we saw in Q2, marketing spend up slightly to support new lines/product, and Payless domestic and PLG retail to be kept relatively flat, we expect SG&A to be up a modest +3% in the quarter.
Given the company’s recent performance, it’s going to take more than a quarter to convince investors that this story is on track. However, we expect to see clear signs of progress when the company reports next week. With shares barely responding to strong peer results again yesterday, PSS is clearly in “show me” mode. As such, shares are likely to move higher on any results that come in less bad presenting investors with one last play on footwear before year end.
Casey Flavin
Director
