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Just 1 day after we conducted our conference call on the reemergence of the bankruptcy cycle, Shoe Pavilion, a 115-store retailer of off-priced footwear, publicly filed for Chapter 11. Two of my key themes in this space – footwear supply chain squeeze and aggressive off-balance sheet activity – are teaming up to KO those with little reason to exist.

There are several major implications and themes here…
  • 1. This is not just a ‘weak consumer issue’ issue. Margins are under pressure due to the supply chain squeeze that I think is just starting, and the weak players are dropping off. There will be more.
  • 2. Investors need to look at retailers with different lenses (check out Exhibit 1). One of the key themes I highlighted on yesterday’s call is that you can’t just look at EBIT margins and debt levels in evaluating bankruptcy candidates. You’ve gotta look at REAL debt (incl off balance sheet liabilities) plus the duration and flexibility of a company’s lease portfolio. In the case of SHOE, accounting for operating leases doubles its implied debt. Also, minimum rent obligations are going up while competitors’ are coming down. In other words, SHOE was borrowing from the future to prop margins and keep its head above water. An aggressive strategy that just came home to roost.
  • 3. Big Box Footwear Retail simply does not work! Look at the facts over time; Just for Feet, Footstar, Foot Action, Stave and Barry’s, and now Shoe Pavilion – can’t this industry take a hint?!? Managing hundreds of brands, with each design in multiple colors across 28 different sizes simply does not leave enough margin to justify paying higher rent structures for bigger and better real estate.
  • 4. Note to DSW and Brown Shoe (Famous Footwear) – that’s exactly why I think your margin structures are headed towards zero.
  • 5. Impact on competitive landscape. 72% of SHOE’s 115 stores are in California and Texas. How I’m doing the math, this overlaps with about 24% of the store base for Payless. DSW could benefit as well as 21% of its stores are in those states – but are geographically not as aligned – and not enough jump ball business to offset DSW’s own flawed real estate strategy (DSW’s rent escalators look similar to SHOE’s). Also keep in mind that Dick’s sporting goods and Hibbett are both adding capacity in Texas (and DKS is stepping up in CA). That’s concerning.
  • 6. Creditors. The most notable point to me is that of the top 20 creditors, Nike is not one of them. Kind of interesting given that Nike has a 40% share of the Athletic Footwear business. This also is a good nugget as it relates to Nike’s US Footwear business (i.e. not jamming product into bad channels). Here’s a list of top creditors in the Athletic/Athleisure space. Solid representation from Adidas and Reebok. Not good.
    a. New Balance, $324,302;
    b. Asics America, $196,166
    c. Adidas, $128,514
    d. Reebok, $117,583
    e. Diesel USA, $111,212
    f. Keds Corp., $100,165;
    g. Naturalizer (Brown Shoe), $95,310
We can't simply look at reported debt levels. We need to add the value of operating lease obligations and then adjust by the flexibility of those obligations. This exposes big differences in risk management.