PSS: Timing is Everything

I’ve been concerned that margin expectations are too high headed in to the upcoming quarter for PSS, which is the ONLY factor that has prevented me from getting loud on an otherwise high-conviction long-term name. Combine that with a big debt burden, such risk has driven this name down to 3.3x EBITDA (the new trough multiple level for retailers – so far – in this cycle). It’s also driven up short interest to 30% of the float. I think we’re going to need more than a big miss to send this lower. We’ll also need a commensurate guide down, and I don’t think we see it.

Why do I like PSS? I hate to regurgitate a term that the company coined – because I am anything but a mouthpiece for anybody. But the fact is that there remains a massive ‘white space’ in footwear between $13 and $20. The basic private label brands are under $13, and any ‘brand’ that the consumer has actually heard of is usually over $20.

Make no mistake, if it were easy to gain share in this white space, someone would have done it already. What I think was brilliant at PSS is they took what was arguably the Radio Shack of footwear retail (lots of tired stores in decent locations), refurbished them, and most importantly bought (and at the time overpaid for) Stride Rite (which included Saucony, Sperry, Keds, etc…). What does that mean? That PSS owns content AND distribution. In a space with increasing cost pressures as capacity closes in Asia and props up price, it’s the companies that own the consumer relationship (ie content and distribution) that will win. Will PSS sell Sperry in Payless stores? Saucony? No way. But an exceptional brand manager can tier these brands and subsegment them in a way to touch numerous consumers in different channels. Note Ralph Lauren with $500 denim in its stores, and $75 denim Kohl’s. Nike with $325 Jordan’s in its own stores, and $35 walking shoes in JC Penney. It can, in fact, be done. I very rarely tout a CEO, but I’m extremely confident that Matt Rubell at PSS is the man for the task.

This is one of those names where the upside outweighs the downside but at least 3 to 1.

Note: Here’s a couple of tools you’ll see from me more and more often in advance of key earnings events for companies that I think are particularly important to watch.

The first exhibit below is a P&L margin walk. The second is our SIGMA analysis. It’s a bit intimidating visually but tells me everything I need to know on a retrospective basis about how sales triangulate with inventories, margins, and capital spending. How to read it…

1) Vertical axis is the spread between sales growth and inventory growth. The higher up, the better.
2) Horizontal axis is yy chg in EBIT margin.
3) The yellow line synchs points 1 and 2, and shows you the path over the past 1.5-2 yrs.
4) Columns are change in GM% and SG&A%
5) Grey line is capex as a percent of sales.

Putting it all together, PSS, is about to lap a qtr last year where they had high GM, but inventory was building rel to sales. Starting in 4Q, GM compares get very easy, and the company goes up against very favorable inventory and capex compares. If it is off on the quarter bc of a miss, it will be a layup from a timing perspective heading into 4Q.

(Click on picture to view full screen image)