Barron’s might be right on this stock – but for all the wrong reasons. If you want to play a short squeeze on this company coming anywhere near expectations on a lousy quarter, then be my guest. But for those of you that are actually thinking of investing in this company due to a rebound in the business – be aware that there is no reason why this company cannot go bankrupt. Seriously. Consider the following…
- 1) 70% of sales come from Famous Footwear – a moderate footwear chain with about 1,100 stores throughout the US. There’s nothing wrong with these stores, but I’m concerned that BWS has been underinvesting in store-level capex, and is now incrementally channeling its capital towards accelerated store openings. These stores are in more expensive locations with higher rent hurdles.
- 2) Competitive risk: there is an 87% store overlap between Payless Stores and Famous Footwear. At the same time where BWS arguably underinvested in its stores, Payless did the opposite. This puts Famous in a tough position regardless of the operating environment throughout ‘09.
- 3) The industry risk here is tremendous. BWS is at the apex of the massive margin squeeze I expect to see beginning in 1Q09. With 97% of its product made in China (both direct and indirect), and with brand exposure that is squarely ‘caught in the middle’, this company will be a price taker.
- 4) The wholesale portfolio accounts for about 40% of cash flow. Yes, there are some good brands like Via Spiga, and maybe even Naturalizer. But I’d argue that half of the portfolio does not even need to exist. (brands include Franco Sarto, Via Spiga, Etienne Aigner, Nickels, Private Label, Carlos, Naturalizer, Life Stride, Dr. Scholl's, plus Children's portfolio).
- 5) BWS looks relatively healthy from a balance sheet perspective with a 21% debt to total capital ratio. But including the impact of operating leases, it is about 61% based on my math. In addition, as I outlined in our bankruptcy call last week, we also need to look at the flexibility of the operating leases – which is often the key factor in retail bankruptcies. BWS’s trend is not good. The flexibility ratio has been declining, and particularly took a leg down last year as BWS reaccelerated its growth strategy. Translation = it is getting into more expensive properties with higher lease minimums just as the industry is heading into a major margin crimp.
- With EBIT margins at about 4%, this name might seem down and out, but the reality is that it has margins that in the same ballpark as others in the industry, and it has a materially weaker portfolio. I could make a case where margins head to zero – or worse.
- The bottom line -- Barron’s might have this ‘Trade’ right into 2H08, but if that materializes, then this could be one heck of a short for 2009.
BWS is signing leases with more aggressive terms. This is something to watch...
