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  • value_catalyst value_catalyst Jun 7, 2007 9:34 AM Flag

    SHOE thesis; for Koala et al

    Koala, my quick take (I bought at $2.40) -

    SHOE is an off-price shoe retailer in the west/southwest US (70%+ units in California). In the past couple of months, the stock has dropped from around $7 a share to the low $2 range on guidance, which I feel is severely overdone. P/TBV is 0.55x, which is dirt cheap. The company is trading at 11x a depressed 2006 EBIT. Given 37% of current units are less than three years old and new units are coming online, a conservative margin assumption implies EBIT (2009 � 2010) could easily be double or triple the current amount (possibly more) as units ramp up. The company plans to increase sqft by 320K -360K sqft (around 25%) to about 1.7m sqft 2007. Net sqft growth in 2006 was 490K sqft, from 860K to 1,350K sqft. This rapid growth phase will pressure margins in the interim (part of the reason the stock is down) as the larger format units (20K sqft from 10K sqft) ramp up (which usually takes three or more years). Average sales/sqft is $106, with new locations comping in the $80s. This implies plenty of upside as stores mature. But the catch - the question then becomes how bad will it be during the upcoming growth phase, given you have counter balancing effects(new vs mature units, new vs old formats, debt vs incremental returns, macro issues, etc.). I believe when the dust settles (although it may be bumpy in the interim), a more mature unit base (2009 - 2010) implies SHOE would be trading at 3x � 5x the forward EBIT, which is very cheap. Downside is limited given P/TBV of 0.55x, a great margin of safety (you may lose some BV in the interim, but I don't believe it will be that bad). Also, I think bankruptcy is a long shot, but let�s say it�s a coin flip scenario, Then you are getting a 2.5 to 1 payout for a 1 to 1 bet (but realistically much more favorable). So you are not going to bet the farm, but it is not a bad bet.

    Catalysts: normalization of sentiment (reduction of market hysteria) and operations, smart gsf/unit expansion, normalization of margins, strategic takeout. If SHOE would just open a unit in the northeast where all the finance types live, the stock would probably double (just kidding, but not really).

    Risks: operational missteps, mismanaged growth, negative comps, macro issues.

    Any strong bear case out there? Would love to be convinced.

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    • Thanks for the post value_catalyst. I appreciate you putting in the time for that post...

      Yikes, it looks like SHOE is above the low value I pegged it at ($3). Hope I didn't miss a great opportunity...

      I'm not really bearish on this stock (neutral right now) but if I may play Devil's Advocate...

      """Any strong bear case out there? Would love to be convinced."""

      I notice that Shoe Pavilion's operating margin is under 5%. Even from a historical point of view, it has been quite low throughout time. If they can't raise the margin then I don't see it becoming big (it can still do well from an investment point of view, but not sure about growth). Will it raise its operating margin (especially after the new stores are rolled out)?

      Its 'cash conversion cycle' and 'days inventory' are also very long compared to the big competitors (like Payless Shoesource, Brown Shoes, etc). Shoe Pavilion seems to keep its goods in inventory for a much longer period of time (around 2x longer than Payless Shoesource). Granted, it's hard to compare a large company with superior distribution and inventory management systems, but nevertheless, that's a bear argument.

      • 1 Reply to KoalaBear33
      • Yeah, I am surprised by the move and hope it's not a dead cat bounce. You're right about the cash conversion cycle. I wish the management would take a page out of the book from competitors. It would free up a lot of capital stuck in the business. However, I guess it's part of the trade off for an off-price business model.

        Also, I'm hoping they are managing growth and not biting off more than they can handle. They are adding quite a bit of sqft. I guess we'll get a better sense of how things are going to unfold from the performance of the 20K sqft locations. It's really a judgement call if you think a 20K sqft of shoes is supportable by the surrounding demographic area within the context of competition as well. 10K sqft has worked so I think 20K is reasonable. What's great about shoes are that they are "consumed" pretty regularly, like tires or socks. The market is determined by the rate of consumption (number of shoes bought per year) and the average price. So if they are capturing or creating more of that particular market (off-price) through a bigger selection, then we are in good shape. The sales per sqft of the new locations will give a sense of that.

    • Nice post. Thx.