Sunday, May 20, 2007

K-Swiss: More Downside in the Short-Term

K-Swiss is a shoe company which designs, develops, and markets sneakers for athletic and casual purposes. K-Swiss has been in business since 1966. They have two main product strategies, one is their “classic” line of sneakers, they are the sneakers which were the company’s first product. They have longer product cycles than normal sneakers and long product cycles reduce the markdowns on a sneaker. This makes it more attractive to retailers. K-Swiss keeps a large inventory of classics in their warehouse. Their other product strategy is based on current consumer fashion trends. They do not keep a large inventory for these. Their goal is to take advantage of current fashion trends in the marketplace while minimizing risk. K-Swiss’ primary goal is to become the “retailers’ most profitable vendor,” meaning that through longer product cycle, they can maximize the effect of market expenditures and minimize retailers’ markdowns.

Industry


They operate in the athletic footwear industry, which is very competitive. Their biggest competitors are Nike and adidas. Investment gurus who are bullish on Nike, and by extension the footwear industry, include Warren Buffett, Bill Miller, and Glenn Greenberg. There are some issues with the economics though, people are worried consumers will slow their spending, due do them being overextended in debt and gas prices that are rising. To some degree though, a recession cannot destroy the footwear industry because it meets one of the 3 basic needs of people, clothing.

Recent Developments

Their 1st quarter 2007 report was a mild disaster. Although they managed to beat Wall Street earnings estimates by one penny, they lowered full-year estimates due to significant obstacles in the domestic environment. They lowered their range from $1.20 to $1.50 a share for fiscal 2007 to $1.20 to $1.35 for fiscal 2007. Revenue guidance was also lowered slightly. Domestic revenues decreased 39.7% year over year. Future orders (backlogs) also decreased significantly year over year. International revenues increased 29.2%. On the bright side, they do not see Gross Margin shrinking, they expect it to be between 46% to 47%, consistent with their recent results. They stated in their conference call that they will not clear out their inventories at any price, this will keep margins up but pressure sales down. This also will not damage brand reputation.

Their domestic business has been in a decline for the past few years though, this is a concern because it accounts for the majority of their total revenues. Domestic revenue has fallen 20% over the past 2 years. Management said during the last conference call that inventories at domestic retailers have been going down and so retailers will have to order more K-Swiss footwear in the near future. On the bright side, foreign sales have been growing rapidly going from over $80 million in 2004 to almost $170 million in 2006.

They have recently put in significant resources into developing new products. Their target date for new products is the 1st quarter of 2008. K-Swiss is also currently working on opening retail locations. Their most recent openings have been in Asia. Their other big investments have been in Royal Elastics and Apparel which are planned to be key future growth drivers. Near-term trends do not seem to be positive with backlogs significantly down year over year.

Recently, Anna Kournikova has signed on to be the new spokesman of K-Swiss. The thinking behind hiring her as the new spokesman is because she is a tennis star and K-Swiss is a tennis shoe company. It makes sense, but she is more of a celebrity than a tennis star. It will definitely give K-Swiss more publicity, but will people looking for tennis sneakers more likely buy K-Swiss tennis footwear just because Kournikova is their spokesman? I highly doubt it.

Valuation

They are trading at a trailing price/earnings ratio of 14.74. Their Earnings Yield is 11%. They have $264 million of cash on their books. There is no debt. They are trading at a forward price/earnings ratio for Fiscal Year 2008 of 17.22. They are a great cash generator, cash flows from operations as a percentage of total revenue has been 14.4%, 18.5%, and 17.7% in the years 2006, 2005, and 2004 respectively. Their return on equity has been very strong, averaging over 25% over the past 5 years. They also pay a dividend of $.20 per year or a dividend yield of 0.7% per year.

Regarding their cash position, they are very conservative with the use of their cash. Acquisitions are not a priority for them, unless the acquisition is an attractive candidate. A deal to do a deal is not something that interests them. They plan on doing more future share repurchases. A good indicator of when to start buying K-Swiss stock will be when they start buying back their shares in bunches, during their 1st quarter 2007 conference call, CEO Steven Nichols said that once they have a clearer picture of what 2008 will look like, and if it will be positive, they will aggressively start repurchasing their shares.

Management

Management is fiscally conservative and seems to be on the right path of expanding the company with their new investments. They also have been using their cash wisely by buying back K-Swiss outstanding shares. Their management is very shareholder friendly. Their bonuses are based on Economic Value Added (EVA), which better aligns their interests better with shareholders instead of regular bonuses based on EPS. Their CEO, Steven Nichols, has been with the company since 1987. George Powlick, who is their CFO and COO, has been with the company since 1988. Steven Nichols basically controls where the company goes because he, through a Family Trust, controls 92.4% of the Class B shares. Each Class B share is worth 10 votes compared to each Class A share.

Technicals

KSWS has been in a trading range the past few years mostly between $26 and $36 a share. The medium-term trend is down and the short-term trend is neutral. RSI and MACD are both neutral. KSWS is currently above the 50DMA but below both the 20DMA and the 200DMA. On the bright side, the 20DMA just crossed over the 50DMA, which could be a signal of a change of the trend. Recent volume has been mixed.



Conclusion


K-Swiss was growing rapidly until they starting experiencing issues in the United States. That has thrown their growth curve way off and currently domestic sales are still trending down. There are definitely short-term issues with K-Swiss, but I think management has taken steps to correct this downtrend in domestic sales with new products in the pipeline. Also, the retail stores, the apparel rollout and the Royal Elastic subsidiary should provide growth. Buying right now would not be terrible, but since their outlook for the rest of 2007 is not bright, there should be more downside on the way in the near-term. Once their domestic sales start to stabilize, and management starts to repurchase shares in big quantities, that could be a good entry point knowing that 2008 is the year management is planning for the big turn around.

Disclosure: I don’t have a position in KSWS.

2 comments:

Anonymous said...

I've been reading a lot on K-Swiss lately. Looks like their leadership is starting to create a hip culture around the sneakers. They're working with amazing artists. Check out this video:
http://www.youtube.com/watch?v=nle5iVbk9FU

Alex Shadunsky said...

I agree, I like their management as well. Thanks for stopping by and good luck!