Designer Brands, Inc. (NYSE:DBI), formerly known as DSW. Inc. and unofficially “Designer Shoe Warehouse,” officially changed its name and stock ticker on April 2nd. The DSW store brand will continue as an operating segment of Designer Brands. The retailer operates nearly 1,000 stores across the U.S. and Canada between different concepts. The recent acquisition of apparel and shoe manufacturer Camuto Group represents a major strategy change for the company that will now incorporate its own brand merchandise in its store network. The stock has been under pressure since the Q4 earnings release in March with weaker-than-expected results. The market appears skeptical of the acquisition despite positive guidance from management. I think the current weakness in DBI is a buying opportunity. I’m bullish based on the strengths of the core business and growth potential from the new initiatives.

In a previous article, I described DBI (then DSW) as “The King of Discount Shoes,” a company that has proven to be resilient against the broader theme of declining brick-and-mortar retail over the past decade. DBI has thrived even as other major retailers are scaling back or shutting down outright. Indeed, recent news of competitor Payless Shoes liquidating 2,300 stores across North America is a positive for DBI as it continues to build market share. DBI simply has a retail concept that works with effective management and execution. It’s a great business to own in my opinion.

The following points highlight my bullish thesis covered in this article:

  • Growth momentum – 2019 revenue guidance of double-digit growth with positive comparable same-store sales.
  • Expanding margins – TTM gross margin at 29.7%, up 100bps from last year; upside going forward based on acquisition impact.
  • Industry leadership – “King of discount shoes”/nationwide store footprint/growing e-commerce segment/brand recognition.
  • Solid balance sheet – No net long-term debt.
  • Value in Camuto acquisition – Vertical transaction adds new revenue streams and a number of strategic synergies.

Q4 Earnings Recap

Q4 revenue of $843 million came in line with consensus for the quarter, while EPS missed with a reported loss of (-$0.07) per share against expectations of a profit of $0.05. The loss on the quarter was related to the recent acquisitions, and charges exiting a portion of its old Town Shoes business. Higher marketing expenses also weighed on margins. Management also released weaker-than-expected current-year EPS guidance between $1.80 and $1.90 compared to the then market consensus of closer to $2.00. Without sugarcoating it, DBI’s stock fell a massive 13% on March 19th following earnings report and the announced name change on the same day. The market appears to not yet be convinced of the changes that have been made.

The full-year 2018 results paint a healthier picture for the underlying business. Revenue climbed 13.3% to $3.2 billion, including $310.0 million from acquisitions. Comparable sales increased by 6.1% compared to last year’s 0.4% decrease.

Industry Leadership

DBI through its DSW stores is a leader in its segment, namely off-price/discount shoes, a niche that in some ways is less exposed to domination by online competition. The idea is that within the apparel industry, consumers typically need to or prefer to try on shoes for fit and comfort. For this reason, I believe there will always be a market for a big box shoe retailer with brick and mortar locations.

DSW, Inc. store front example. Source: Company website

The company’s e-commerce platform has become a growth driver helping to expand margins. DSW stores benefit from strong brand recognition and customer loyalty. If you search Google for keywords like “women’s shoes” or “shoe sales,” DSW consistently ranks among the top of organic results, highlighting the market position. Still, I believe the physical stores are the key strength and advantage to the business. Management has noted a dynamic, where in-store customers are often making future purchases online and vice versa. The option to make exchanges locally also supports store traffic. The company points to its recent loyalty program as driving brand engagement. The point here is that this is a healthy business; don’t look at the stock price performance and assume something is falling apart.

Loyalty Program Growth. Source: Investor Day Presentation

Growth Momentum

Guidance

Management is positive on its business position and growth potential. Guidance through fiscal 2021 released in a “3-Year Strategic Priorities and Financial Goals” looks for a number of growth initiatives. CEO Roger Rawlins made the following comments in the press release:

“Over the next three years and beyond, we will leverage our integrated enterprise to continue delivering differentiated products and experiences while significantly expanding our gross margin by bringing the production of our private brands in-house through our industry-leading Camuto Group and increasing the sales penetration of all of our produced brands across our retail channels…We look forward to continuing to drive innovation and increase market share by delivering positive comp sales while also growing complementary categories and markets.”

For the current 2019 fiscal year, DBI expects to achieve double-digit revenue growth as compared to fiscal 2018 and a single-digit increase in comparable store sales. Fiscal 2019 adjusted earnings per share are expected to range between $1.80 and $1.90, representing a year-over-year earnings growth of 5% to 11% excluding fiscal 2018. Published consensus earnings in the YCharts database are currently in line with management’s outlook for the current fiscal year, but slightly lower longer term, looking for $2.50 in FY2021 compared to management’s range of $2.65 to $2.75.

ChartData by YCharts

Expanding Margins

Despite a softer Q4, gross margin at 29.7% for the trailing twelve months has been on a trend higher over the past couple of years. Management highlights the addition of accessories and new shoe categories like boots and children is helping to boost operational figures including a higher average sales ticket. The acquisition of Camuto Group will be a large part of the margin story going forward as DBI already sells those products, but are now a “house brand” going forward. Management is guiding for a 240bp improvement in gross margin by 2021 from the 2018 level.

ChartData by YCharts

Solid Balance Sheet

DBI ended the fiscal year with cash and investments of $169 million compared to long-term debt of $160 million. Liquidity and solvency ratios represent a strength even after the capital intensive Camuto acquisition. The current ratio stands at 2.1x. The company remains free cash flow positive and is targeting $800 million in cumulative cash flows over the next three years according to guidance.

ChartData by YCharts

The quarterly dividend of $0.25 per share is annualized to an approximate payout of $81 million per year or a 55% payout in 2019 consensus earnings, decreasing to about 35% by 2021. DBI is authorized to repurchase $477 million in shares under an existing share repurchasing program, although it did not materially conduct transactions over the past year.

DBI Consolidated Balance Sheet. Source: SEC filing 10-K

Value in Camuto Acquisition

It’s understandable that investors didn’t really get excited about Camuto Group. The first question may have been: Camuto who? The group produces a number of different labels that are currently sold in stores worldwide disclosing approximately 20 million pairs of shoes produced last year, a number it expects to increase to 32 million by 2021.

Camuto Group Brands. Source: Investor Day Presentation

Separately Camuto bills itself as a leader in private brands with agreements from major retailers like Saks Fifth Avenue (OTCPK:OTCPK:HBAYF), Nordstrom, Inc. (NYSE:JWN), and even Amazon, Inc. (AMZN). Even if U.S. consumers aren’t buying shoes at a DSW store, DBI likely now has a slice of it. DBI points to three key points of how Camuto Group will help drive margin growth:

  • Reduced costs and margin capture (lower COGS)
  • Increased penetration of produced brands
  • “Holistic focus on brand vision” (improved marketing with a unified message)

Camuto Retail Partners. Source: Investor Day Presentation

DBI highlights the acquisition of a global infrastructure across 13 countries in all continents that will drive the next phase of the company’s expansion. DBI currently has a small international direct retail footprint outside the U.S. and Canada, but has opened two DSW store locations in the Middle East. I’d expect future stores in the European and Asian market as a new market.

Camuto Global Infrastructure. Source: Investor Day Presentation

One source of uncertainty in the Camuto relationship is the potential for cannibalization and conflict of interests between DSW stores and other Camuto retail partners. There’s a thought that DSW stores will focus too much on its “house” brands, taking shelf space away from other consumer options. There’s also a risk that competitor retailers may balk at renewing Camuto Agreements. I view these concerns as sensationalized, taking the leap of faith that DSW management will set the correct store product mix based on extensive consumer data while the Camuto Group brands can grow independently of DSW. The corporate name change to DBI provides a good structure separation.

Analysis and Conclusion

ChartData by YCharts

Considering a current forward PE of 11.75x, the stock looks cheap here. DBI could trade at a more normalized 15x, implying a share price of $27.50 or 33% upside. The bullish case with strong operational performance at the store level should send the stock higher. I have a higher price target of $34 per share, representing 18x 2019 full-year management guidance. The stock already traded at that price level as recently as last October and I believe can bounce back as the market begins to appreciate the quality of earnings and growth opportunity.

ChartData by YCharts

The current dividend yield of 4.6% looks attractive while the growth story plays out. Investors should focus on the evolution of quarterly margins and look for positive same-store sales as a sign of effective execution by management. Risks to be aware of include an under-performance of targets and the potential negative impact of a possible cyclical slowdown.

Disclosure: I am/we are long DBI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-04-27