Site News - A Call For New Editors

We apologize for the lack of new posts over the past few weeks, but we wanted to let readers know that we recently accepted a position as an equity analyst covering consumer-related stocks for Morningstar. As part of our employment agreement, we will no longer be able to provide content for this site, but we hope you will continue to read our notes in the future. For those who took the time to write us over the past few months, we thank you for your support.

In the meantime, we are looking for new editors or writers to take over the site. If you have an interest in consumer-related equities and are looking for a platform to express your ideas, feel free to e-mail us.

Thank you again.

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The Consumer Stock Network Best Ideas List: The Buckle (BKE)

This week, we continue with our list of favorite consumer stocks. Given the significant number of headwinds facing consumers right now (record-high gas prices, declining home values and the corresponding "wealth effect," as well as lingering credit concerns), we concede that this space may not be appropriate for all investor classes in at the present time. That being said, we still believe there are a number of compelling investment ideas to be found in this sector.

Instead of a long-winded recap of the names, we've decided to release the names one-by-one and provide a brief summary. After we finish revealing our favorite stocks, we will pull together the list into an equal-weighted portfolio and compare our performance to a number of benchmarks over the next year. We may also adjust the list periodically, as there may be better investment opportunities that arise in the coming months.

Today, we add teen-oriented apparel retailer The Buckle (NYSE: BKE) to the list.


Investment Highlights

  • Under the radar stock. In our opinion, The Buckle's stock doesn't garner the same attention that other mall-based competitors such as Aeropostale (NYSE: ARO), American Eagle (NYSE: AEO), Abercrombie & Fitch (NYSE: ANF), J. Crew Group (NYSE: JCG), and The Gap (NYSE: GPS) do. One reason for this is the company's relatively small market cap ($1.5B compared to the peer group average of about $3-$4B), but with virtually no stores in the Northeast US, it is easy for the Street to overlook the company (in fact, there are only a handful of analysts covering the stock). Buckle stores are often located in secondary and tertiary markets where there are only a limited number of apparel options for a fashion-starved audience - a key reason behind the company's excellent sales trends as of late. As awareness of Buckle increases, we expect institutional shareholders to gravitate toward the stock and move its price upward.
  • Appropriate brand name/private label merchandising mix. The company employs a dual-merchandising strategy, where 70% of the assortment are brand names highly sought by the teen audience (Lucky Brand, Hurley, Affliction, Guess, Quiksilver/Roxy, among others) and the remaining 30% represents in-house private label brands. The brand name items drive customers to the stores, while the private labels represent a key margin driver. While we would prefer a bit higher proportion of the private label brands, similar merchandising strategies have worked for the top mall-based apparel retailers in the past.
  • Costs well controlled. Instead of costly marketing programs, The Buckle keeps its advertising expense budget to about 1% of total sales (compared to 3%-4% for some other national retailers) and allows its reputation for quality rand-name merchandise to drive traffic. When a company can still generate sales growth in the low 30% range (as The Buckle did in 1Q08) with minimal marketing costs, it has a profound effect on the bottom line. Furthermore, the minimalist approach to advertising frees up capital to be used on other important matters, such as inventory management and distribution.
Investment Risks
  • Rising production costs. Most apparel and footwear retailers are feeling the negative impact of rising Chinese labor costs as well as higher input prices. Thus far, The Buckle has been successful passing these costs to its customers, but considering the pressures facing the US consumer, there may be a time where this becomes more challenging. That said, The Buckle's target audience is more resilient (or more oblivious, perhaps) to price inflation than "head-of-household" consumers; given the high demand for its fashion brands (especially the denim segment, which represents just over 40% of sales), we believe the company has additional room to increase pricing, if necessary.
  • Valuation. Like some of the other names on our Top Ideas List, valuation is a bit of a concern because the stock has rallied quite nicely since January lows around $31. However, for a high-growth, well-managed company and an under the radar stock, we believe a modest premium is warranted. The stock currently trades at just under 16x the consensus fiscal 2009 estimate of $3.07, roughly in-line with the peer group. With continued earnings outperformance, a somewhat resilient customer base, and increasing investor awareness, we could envision this stock in the mid-to-high $50 range, barring any additional "shock" type events in the economy.
For our mock portfolio purposes, we will assume our entry price on The Buckle was $48.51 (the price at the time of this post).

Previously on The Best Ideas List:
GameStop (NYSE: GME)
Gymboree (NASDAQ: GYMB)

Disclosures
Analyst Ownership? No
Analyst's Family Ownership? No
Analyst's Firm Ownership? No
Investment Banking Conflict? No
Other Conflicts? No



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The Consumer Stock Network Best Ideas List: Gymboree (GYMB)

This week, we continue with our list of favorite consumer stocks. Given the significant number of headwinds facing consumers (such as record-high gas prices, declining home values and the corresponding "wealth effect," and lingering credit concerns), we concede that this space may not be appropriate for all investor classes in at the present time. That being said, we still believe there are a number of compelling investment ideas to be found in this sector.

Instead of a long-winded recap of the names, we've decided to release the names one-by-one and provide a brief summary. After we finish revealing our favorite stocks, we will pull together the list into an equal-weighted portfolio and compare our performance to a number of benchmarks over the next year. We may also adjust the list periodically, as there may be better investment opportunities that arise in the coming months.

Today, we add children's apparel retailer Gymboree (NASDAQ: GYMB) to the list.


Investment Highlights

  • Children's apparel has an inherent replacement cycle. By nature, children's apparel needs to be replenished several times a year, usually by a mature female demographic with a propensity to spend on their children. Yes, the Gymboree brand carries higher price points than its publicly-traded specialty competition - Carter's (NYSE: CRI) and Children's Place (NASDAQ: PLCE) - and the mass channel private labels. However, the average Gymboree customer represents a high-end audience with limited exposure to rising gas prices and other negative macroeconomic factors. We also expect a modest sales boost in coming years from baby boomer retirees who will likely have more time and resources to devote on their grandchildren. With the combination of established brands that resonate with mothers everywhere (Gymboree and Janie and Jack) and still-emerging brands (Crazy 8) , we anticipate robust sales growth (at least mid-teens) through the balance of the decade and likely beyond.
  • Strong financial footing. When evaluating a consumer stock investment, the most important factors to evaluate are (1) top-line growth (including mature and new store growth), (2) the likelihood of sustained profitability and return on invested capital, (3) cash generation and flexibility, (4) debt requirements, and (5) inventory turnover. Gymboree generally passes the test on each of these considerations, with solid top-line growth, sector-leading operating margins and returns on invested capital (nearing 20%), ample cash on hand, a debt-free balance sheet, and inventory turnover over 4.0x (excellent for a mall-based apparel retailer).
Investment Risks
  • Valuation. Admittedly, we are a bit concerned about Gymboree's valuation, given the stock's impressive run this year (the stock has climbed back from a low of $27 in January to a recent close of just under $44). However, at about 14x forward earnings (the consensus fiscal 2009 estimate is $3.16, according to Yahoo Finance), we still find this stock relatively cheap to its peer group (about 15x, aided by Children's Place inflated valuation) and anticipated earnings growth (mid-to-high teens). As such, we would comfortable with owning Gymboree's stock into the high-$50 range.
For our mock portfolio purposes, we will assume our entry price on Gymboree was $43.76 (the price at the time of this post).

Previously on The Best Ideas List:
GameStop (NYSE: GME)

Disclosures
Analyst Ownership? No
Analyst's Family Ownership? No
Analyst's Firm Ownership? No
Investment Banking Conflict? No
Other Conflicts? No





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The Consumer Stock Network Best Ideas List: GameStop (NYSE: GME)

Since it is a relatively slow retail news week, we thought it might be worthwhile to publish a list of our favorite consumer stocks. Given the significant number of headwinds facing consumers (such as record high gas prices, declining home values and the corresponding "wealth effect," and lingering credit concerns), we concede that this space may not be appropriate for all investor classes in at the present time. That being said, we still believe there are a number of compelling investment ideas to be found in this sector.

Instead of a long-winded recap of the names, we've decided to release the names one-by-one and provide a brief summary. After we finish revealing our favorite stocks, we will pull together the list into an equal-weighted portfolio and compare our performance to a number of benchmarks over the next year. We may also adjust the list periodically, as there may be better investment opportunities that arise in the coming months.

We'll begin today with video game retailer GameStop (NYSE: GME).


Investment Highlights

  • Opportune hardware/software cycle timing. Historically speaking, video game retailers are the most profitable during the second and third years following a major hardware platform release. Software presents much higher margin opportunities than the consoles they are played on because they are easier to mass produce and require fewer input costs. The latest round of consoles were released in late 2005 or early 2006, meaning that we are currently in this "software sweet spot". Coupled with an impressive line-up of already released and upcoming titles, we expect video game retailers to continue to post excellent profitability over the next 12 months.
  • Economic stimulus check benefit. In our opinion, the Street is overlooking a key consideration of the economic stimulus payments - the age of potential recipients. Individual taxpayers with an adjusted gross income of less than $75,000 will receive the full $600 rebate (joint taxpayers with less than $150,000 will receive $1,200). Yes, The majority of economic stimulus checks will be sent to lower- and middle-income families who will likely spend excess funds on basic necessities or service personal debt requirements. However, there is also large number of stimulus check recipients between the key video-game playing ages of 18-35 that don't necessarily have to worry about housing payments or gas price inflation. Coupled with the recent and upcoming release of highly-sought titles, strong sales should persist for several quarters to come.
  • Leisure activity substitute. Given the recent attention on soaring gas prices, we also expect discretionary spending on travel and other leisure activities to be down substantially this summer (and likely into the back half of the year). As a result, consumers will likely substitute lower-priced leisure activities and we believe video game retailers (especially those with family-friendly titles) could be a key beneficiary.
Investment Risks
  • Valuation. Unlike most retailers and other consumer-related stocks, GameStop's stock has held up reasonably well over the past year. At 19x the consensus fiscal 2009 estimate of $2.38, the stock may be too expensive for some investors, even those willing to give the stock a premium valuation. However, the recent pull-back presents an opportune entry point and we believe there could be some upside to the full-year numbers due to the reasons we outlined above, meaning the stock would be more attractive using forward multiples.
  • Longer-term competitive threats. A few years from now, we are concerned that, like movies and television shows, video game purchases and rentals will be a largely online experience. However, the average consumer does not have the in-home bandwidth or storage capabilities to download large video game files at this time, and we believe GameStop has at least a few years of protection before facing a serious online competition. That being said, we welcome increasing efforts by GameStop to expand its online game sales operations.
For our mock portfolio purposes, we will assume our entry price on GameStop was $44.63 (the closing price as of June 10th).

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of Directors or an advisor or officer of the Subject Company. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Company.
No
Analyst or household of analyst owns shares in Subject Company. Yes, we hold a small long position in GameStop
Analyst or household of analyst owns options warrants, or futures in Subject Company.
No




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Site Update

We apologize for a lack of posts over the past week, but we've had our hands full working on a few side consulting projects. Even though it will probably be a slow week for retailer news - outside of new economic data, the most noteworthy event may be the Piper Jaffray Consumer Conference - we'll try to publish a few new posts this week, including a look at the best-positioned stocks for the next six months.

Posted in Labels: | 6 comments

Shoe Carnival: Weathering The Retail Storm

We were pleasantly surprised by the 1Q08 results that Shoe Carnival's (NASDAQ: SCVL) released yesterday. The company delivered sales of $162M (comparable store sales fell 4.9%) and EPS of $0.38, better than what we had anticipated in our preview post. The stock also fared much better than expected, rising almost 7% to $13.93.

With so much noise in the marketplace regarding consumer constraints (especially Shoe Carnival's moderate-income family audience), its easy to forget that there are smart, seasoned management teams that have weathered difficult economic climates before. Though it can be argued that retailers haven't seen an environment this challenging in over fifteen years, we believe Shoe Carnival's management has done an admirable job keeping margins at somewhat respectable levels. A few areas in particular stand out from the quarter, including expense controls (SG&A on a dollar basis came in flat to 1Q07 at $39M) and inventory management (flat on a per door basis).

While 1Q08 was encouraging, are there enough compelling reasons to initiate positions of Shoe Carnival at current levels? We don't expect the climate for value-conscious consumers to improve materially anytime soon and the company faces several headwinds in the coming months, including inflationary production cost pressures from Southern China factories (management estimates an average cost increase of between 5%-15%), operating expense deleverage stemming from negative comps, and additional marketing spending intended to improve the in-store environment and customer service. Additionally, women's non-athletic category trends remain sluggish industry-wide, and there are few reasons to expect a significant reversal in the back half.

That being said, Shoe Carnival also has a few things working in its favor. We expect the back-to-school season to be a positive catalyst, as it represents a time when footwear purchases are more of a necessity purchase for families rather than a discretionary buy. Furthermore, there is mounting evidence that athletic footwear may be returning to favor. With the merchant team's recent collaboration with key vendors like Nike, New Balance, Rockport to create a more compelling product for African-American and Hispanic customers and added exposure of the Olympic games, the athletic category could drive unexpectedly strong 3Q08 results. The balance sheet remains clean, allowing the company to open 20-25 new stores this year (including 10 or so in new markets) and potentially take market share form other struggling competitors in this channel.

Assuming comps remain in the negative low-to-mid single digits and there is only a modest drop-off in new store contribution due to the cautionary consumer environment, full-year sales should come in around $660M (roughly flat to a year ago). Gross margins will likely fall somewhere between 40-60 basis points due to increased promotional activity and occupancy/distribution expense deleverage. Despite aggressive cost cutting, there should also be SG&A expense deleverage due to the opening of additional stores and additional marketing investments. Based on these assumptions, we anticipate full-year EPS to come in somewhere between $0.82-$0.87 (We have not factored in additional share buy-backs into our assumptions).

Investment recommendation: Much like our investment recommendation for Brown Shoe (NYSE: BWS), we encourage investors to at least evaluate Shoe Carnival's stock at its current valuation. We would be inclined to wait for near-term pull-back as the marketplace factors in what will likely be lackluster 2Q08 results, but build positions in the high $13 range (representing about 16x forward earnings). Given the headwinds outlined above, we do not recommend this stock for momentum investors, but investors with long-term horizons could be rewarded by taking advantage of Shoe Carnival's relatively inexpensive valuation.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of Directors or an advisor or officer of the Subject Company. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Company.
No
Analyst or household of analyst owns shares in Subject Company. No
Analyst or household of analyst owns options warrants, or futures in Subject Company.
No

Despite Near-Term Pressures, DSW Remains A Compelling Investment

Earlier this morning, DSW (NYSE: DSW) reported 1Q08 results that were essentially in-line with expectations. The company generated $0.23 per share, missing the consensus estimate by a penny, and reiterated its full-year earnings guidance range of $0.75-$0.85.

At first glance, management's fiscal 2009 EPS guidance range (representing a 30%-38% decrease y/y) seems overly conservative. However, the company faces stiff headwinds from not only the deleveraging effect that negative single-digit comps will have on the occupancy expense line item, but also e-commerce channel development costs and IT improvements. Because of these incremental expenses, management expects operating expenses to increase by at least 200 basis points throughout the balance of the year (or more than 22.5% of sales), making it incredibly difficult to outperform earnings expectations. Disciplined inventory management should offset some of the impact, but we doubt it will be enough for the company to significantly exceed its outlook for the year.

In a somewhat curious move, the company also announced that President Peter Horvath left his position to become the Executive Vice President of Business Integration at Limited Brands (NYSE: LTD). We believe the company is still in good hands - Vice Chairman and Chief Merchandising Officer Debbie Ferrée is one of the best in the business, and Chief Financial Officer Doug Probst has done an exceptional job directing the company's financials - and there should be no shortage of qualified suitors to fill the open position. However, Mr. Horvath was partially behind the recent e-commerce, IT, and supply chain initiatives, and we wonder whether or not there will be any execution delays as a result of this management transition.

Investment recommendation: Is DSW right for your portfolio? It depends on your investment horizon. Considering the current state of the consumer and the 200 bps of SG&A deleverage that the company will likely incur this year, we really don't see management raising its EPS forecast anytime soon, especially when you factor in 2Q08's difficult comparisons. Although discretionary retailers have rebounded from their April lows, we believe the market is skittish enough about gas prices and other economic headwinds to keep valuation multiples in check for the foreseeable future. We expect the stock to remain range bound (up or down a few percentage points) over the next several months with very few catalysts - positive or negative - to drive compelling trading opportunities.

That being said, there are a number of reasons to like this company, and we find the stock appropriate for long-term growth and value investors alike. The company offers a wide assortment of popular footwear brands at discounted prices and a new aesthetically-pleasing shopping environment. There is increasing awareness of the DSW brand (just ask any female shopper between the ages of 24 and 45) and the company has sufficient room to grow its store base as smaller competitors falter in the current environment. Recent supply chain capabilities should keep inventory levels appropriately positioned, and the new e-commerce channel adds another way to satisfy customers. DSW's balance sheet is debt free and unit-level ROIC (return on invested capital) remains in the mid-to-high teen range. It may take some time - we don't see the stock returning to the $20 level until late this year or even early 2009 - but DSW presents an intriguing long-term investment case, especially if another footwear industry cycle emerges during the next 12-18 months.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of Directors or an advisor or officer of the Subject Company. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Company.
No
Analyst or household of analyst owns shares in Subject Company. No
Analyst or household of analyst owns options warrants, or futures in Subject Company.
No

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Forecasting Footwear: A Look at DSW and Shoe Carnival's 1Q08 Results

It's a holiday-shortened trading week, but there are a number of retailers reporting 1Q08 results in the coming days. We're going to take a look at a few footwear retailers today, as this has been one of the most volatile sectors in retailing over the past month and seen a fair amount institutional shareholder turnover.

DSW (NYSE: DSW)
DSW will report full 1Q08 results Thursday morning before the market opens and host a conference call at 8:00 am EST (Dial-in: 800-706-7748, Pwd: 70368480). Management already reported 1Q08 sales of $366M and a same-store sales decline of 5.4%, and introduced full-year EPS guidance ($0.75-$0.85) that fell well short of analyst expectations. The stock has been subsequently penalized by the market, falling from $15 to its current price in the low $13 range (16x-17x the midpoint of the fiscal 2009 guidance).

Generally speaking, when a retailer adjusts its earnings forecast in a quarterly sales release, there will be few surprises on the conference call to act as a catalyst for the stock. However, expectations for retailers are so low right now, even a modest earnings surprise can trigger a meaningful stock price appreciation.

Is there a chance that DSW beats the $0.24 consensus estimate? Possibly - the company employs a low-cost operating model and has a history of outperforming earnings expectations, even after reporting tepid sales figures. Markdown activity was relatively prominent during the quarter, but DSW stores usually take heavier discounts during 2Q as a part of the company's semi-annual clearance sale. Television advertising remains a key part of the company's marketing campaign, but we believe management has increasingly used its loyalty program to communicate with customers in a cost-efficient manner.

That being said, even if quarterly earnings were to surprise to the upside, we doubt that management will make any changes to its full-year earnings guidance (issued just a few weeks ago). Accordingly, we expect the stock will likely be range bound (up or down a few percentage points) following the conference call, barring any other significant company announcements

Investment recommendation: Using its historical trading range of 18x-23x forward earnings, DSW's stock appears relatively cheap at its current valuation. However, past multiples are less applicable in this environment, and we believe the current stock price reflects more realistic growth expectations. There are a number of reasons to like this company: a compelling "fashion at a value" consumer proposition; increasing brand awareness; a shift away from the "big white box" format to an aesthetically-pleasing layout that invokes similarities to Urban Outfitter's (NASDAQ: URBN) Anthropologie concept; exceptional merchandising personnel; and improved supply chain capabilities. But considering the challenges facing the footwear industry, including a lack of dominant fashion trends to drive customers into stores and rising Far East production costs, expect lackluster sales and earnings trends throughout 2008 and likely into 2009.

Unfortunately, there really isn't a clear-cut investment strategy for DSW. We remain upbeat on the company's overall business model and growth opportunities, but prospective investors need to have a longer investment horizon before considering a position in DSW. Short sellers may also want to look elsewhere, as the stock is already trading close to its trough valuation and may not offer enough downside risk.

Shoe Carnival (NASDAQ: SCVL)
Shoe Carnival is also set to release 1Q08 results on Thursday morning, with a conference call scheduled for 2:00 pm EST (Dial-in: 877-879-6209, Pwd: 2850426). Analysts forecast sales of $164.8M and earnings of $0.37 per share, according to Yahoo Finance.

In our opinion, the consensus estimates seem a bit aggressive. Based on 1Q08 sales results from Collective Brands (NYSE: PSS), Brown Shoe Company (NYSE: BWS), and DSW (NYSE: DSW), comparable store sales will likely be in the negative mid-single digit range. Assuming new store contribution rates remain relatively stable, we expect total 1Q08 sales will likely decline 3%-5% ($157-$161M). Merchandise margins should benefit from new urban-themed products from Nike, New Balance, and Rockport, increasing penetration of the skate category, and an expanding women's non-athletic portfolio. However, merchandise margin improvement should be more than offset by heavy promotional activity, rising Far East production costs, and the deleveraging effect of negative comps on buying, distribution and occupancy expenses. As such, we anticipate that 1Q08 EPS will also come in below the $0.37 Street estimate.

In February, management decided that it would discontinue quarterly and yearly earnings guidance, citing "difficulties in the economic environment and the uncertainty of the effect on consumer spending." Accordingly, there is a wide range of published estimates - the current FY09 consensus earnings estimate is $0.89 per share, but analysts project anywhere between $0.75 and $1.05. Management will likely provide some color regarding forward expectations on Thursday's conference call, but it is unlikely that they provide an official guidance range. If the company's earnings miss (even by a modest amount), we believe the revised estimates will gravitate toward the low-end of Street range. Using the current forward earnings multiple of approximately 14x, this would imply a new stock value in the mid $10 range - a sharp discount to the present stock price.

Investment recommendation: Longer-term, we view Shoe Carnival as an attractive investment vehicle. Though it is known largely for its child-friendly shopping environment, the company has taken great strides in recent years to refine its assortment, including a greater emphasis on higher-margin women's footwear. The company has also added new merchandising talent to bolster other categories, and inventory management practices remain a strong suit. With just under 300 stores, we believe there is also ample room for new store growth (including entry into several high growth western U.S. markets). We attribute much of the current sluggishness to macroeconomic and cyclical footwear industry issues - not company-specific factors - and we believe investors with a
three-to-five year horizon will be rewarded.

However, we would wait to initiate or add to positions until after Thursday's results. In fact, given the potential downside risk that we outlined above, the stock could be an intriguing short opportunity for those investors willing to take on a bit more risk. The stock has already retreated from a recent high of $15 in early May, but could fall further after a lackluster earnings report later this week.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of directors or an advisor or officer of the Subject Companies. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Companies.
No
Analyst or household of analyst owns shares in Subject Companies. No
Analyst or household of analyst owns options warrants, or futures in Subject Companies.
No

Has The Other Shoe Dropped? Examining Brown Shoe's Prospects

Amid persistent consumer headwinds, Brown Shoe (NYSE: BWS) posted weaker-than-expected 1Q08 results earlier this morning. Sales of $554M (a decrease of 2.1% y/y) fell short of expectations, and EPS of $0.05 (after adjusting for office relocation costs and insurance recoveries) missed the low-end of guidance by a few pennies. The stock is down a few percentage points midway through today's trading session.

Management painted a cautious picture for the rest of the year as well, citing a lack of catalysts to drive customer traffic, fewer wholesale reorders, and increased promotional activity. Full-year sales are now forecast to be in the range of $2.43-$2.48B (an increase of 3%-5% versus a year ago) with a comparable-store sales decline between -1% and -3%. The revised earnings per share outlook is $1.29-$1.53, but included $0.11 of office relocation costs and a $0.15 one-time benefit from insurance recoveries (suggesting an adjusted earnings range between $1.25-$1.49). In the Q&A segment of this morning's conference call, CFO Mark Hood indicated that the low-end of the revised guidance assumes that the consumer environment will remain as difficult as it has been, while the high-end implies a rebound in the consumer environment.

The wholesale segment represented a mixed bag. Higher-end brands like Franco Sarto, Etienne Aigner, and Carlos have held up well in the department store channel, and Dr. Scholl's continues to be a top seller at Wal-Mart (NYSE: WMT). On the other hand, sales of Brown Shoe's moderately-priced footwear brands remain sluggish with little evidence of an immediate turnaround. We are encouraged by recent brand additions and extensions (including last week's partnership with Fergie and this morning's announcement about the Gretta Footwear Brand), but gross margins will likely be pressured by increased vendor allowances over the next few quarters.

Despite weak store traffic and conversion rates, there are actually a few reasons to be optimistic about the retail segment in the back half. Although families continue to cut back on discretionary spending, the back-to-school season (beginning in late July) traditionally represents a time when footwear purchases are more of a necessity. Based on recent sales patterns, there are also some early indications that athletic footwear is slowly returning to favor. Coupled with exposure from the Olympic games, the athletic category could be an unexpected positive catalyst for the Famous Footwear chain later this year. Inventories remain relatively clean (down 4.7% on a per store basis), mitigating markdown risk to an extent, and initial Naturalizer retail stores opened in China have been well received.

Investment recommendation: Though near-term prospects look bleak, we encourage investors to take a closer look at Brown Shoe's stock as the volatility dies down today. At just over 10x the mid-point of the revised earnings guidance range, we believe much of the negative news has been priced in and the stock represents a bargain to its historical trading range of 13x-18x. Brown Shoe may lack the momentum that the fast money crowd desires, but long-term investors may be rewarded by gradually building positions over the coming months. The stock seems to have found support in the mid-$14 range, and barring a complete economic collapse or an unforeseen "shock" event, we do not see the stock falling below its January lows around $12.

Though we did not anticipate a reduction in full-year estimates this early in the fiscal year, we generally believe that Brown Shoe possesses better visibility than pure-play footwear retailers because of orders coming through its wholesale business. Management has set the bar relatively low for the remainder of the year, and we believe that the current guidance ranges are achievable. Although there are a number of challenges facing the company in upcoming periods, Brown Shoe has an established retail/wholesale/e-commerce platform that greatly reduces operating results volatility.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of directors or an advisor or officer of the Subject Companies. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Companies.
No
Analyst or household of analyst owns shares in Subject Companies. No
Analyst or household of analyst owns options warrants, or futures in Subject Companies.
No

Previewing Brown Shoe's 1Q08 Results

Brown Shoe Company (NYSE: BWS) will report full 1Q08 results next Wednesday before the market opens. Management will host a conference call later that morning at 9:00 am EST (Dial-in: 866-308-5110, Pwd: 46813068). The Street anticipates sales of $574M and earnings of $0.07 per share, according to Yahoo Finance.

Is there a trade to be made in advance of next week's announcement? There isn't a clear-cut answer, but let's walk through the relevant issues.

Based on consensus estimates, it looks like the Street is assuming that 1Q08 results will come in toward the low-end of guidance, which calls for sales of $575-$585M, comps between -3% and -5%, and an EPS range of $0.07-$0.11. Considering that rivals Collective Brands (NYSE: PSS) and DSW (NYSE: DSW) both reported comps in the negative mid single-digit range, we believe that the sales estimates are probably reasonable, if not a bit aggressive. Management's previous earnings forecasts have also been generally reliable, aided by a resilient multi-channel approach (retail/wholesale/e-commerce operations spanning a wide range of price points), a shift away for lower margin private label wholesale products, and superior inventory management practices. If earnings were to miss, we do no believe they would come in below the low-end of the guidance range by more than a penny or two.

A quarterly earnings miss would probably trigger a modest pull-back in the stock price, but the impact would be much more severe if the company made any downward revisions to its annual guidance range. However, management set relatively conservative full-year targets (sales of $2.50-$2.55B (y/y growth of 6%-8%) , comps of 0% to -2%, and EPS of $1.52-$1.62) that took the challenging consumer environment into consideration. Besides, 1Q is typically one of the softest earnings quarters for a footwear retailer, and given the relatively wide ranges, it is probably too early in the year to make material changes to the full-year the guidance.

A less likely (but still possible) scenario that investors should be aware of is a short squeeze. Footwear has been one of the most beleaguered sectors in retailing over the past year, as shown by the one-year charts of Brown Shoe and its competitors, Collective Brands, Shoe Carnival (NASDAQ: SCVL), and DSW. With a still tumultuous economy, a lack of strong fashion trends to drive customers to the stores, and higher overseas production costs, institutional short interest remains exceptionally high (13.5% of the float at the end of April). However, with extremely low expectations for quarterly results, retailers only need a modestly positive earnings surprise to trigger short squeezes (such as Collective Brands earlier this week). While we believe that this is a less likely scenario when Brown Shoe reports, investors should at least be aware of the possibility.

Investment recommendation: In our opinion, Brown Shoe represents an excellent long-term investment. The company has a strong presence across multiple channels and price points, making operations more consistent than its peers. There are ample sales growth opportunities through new brand extensions and joint ventures in China and Japan. Despite increased production costs, the company should bolster margins over the coming years through more efficient operations, higher-margin wholesale sales, and continued inventory practices. At just 10x times the mid-point of management's fiscal 2009 earnings outlook ($1.57), we believe the stock is a relative bargain to an expected low-teen earnings growth rate.

That being said, we would be inclined to wait until after Wednesday's release before building or adding to positions. While retailers have come back into favor a bit recently, we believe the likelihood of a lackluster quarterly report outweighs the chances of a positive earnings surprise. Shorting is an option, but we are concerned about the heavy short interest that is already out there. Sit tight for now, and more attractive buying opportunities should present themselves in the coming weeks.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of directors or an advisor or officer of the Subject Companies. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Companies.
No
Analyst or household of analyst owns shares in Subject Companies. No
Analyst or household of analyst owns options warrants, or futures in Subject Companies.
No

Looking For Another Ann Taylor

Monday morning, Ann Taylor (NYSE: ANN) surprised the Street by increasing its 1Q08 outlook. Despite a total same-store sales decline of 4.3%, management raised its quarterly EPS forecast range from $0.35-$0.40 to $0.45-$0.47 (the previous consensus estimate was $0.36). Ann Taylor's LOFT stores, which cater to a more casual audience than the namesake brand, reported relatively strong comps of +0.7%, while Ann Taylor stores reported a comp decline of 11.5%. The announcement triggered a 26% surge in the stock, which remains in the mid-$28 range after Tuesday's close.

Honestly, we were shocked when we the saw this announcement because there have so few reasons to invest in women's apparel retailers over the past twelve months. Though few men will admit it, the mature female consumer often represents the primary decision maker in a household. Confronted by a deteriorating economic situation with gas and food price inflation, housing market woes, and a tightening credit situation, she will likely be first member of the household to cut back on discretionary purchases. While some management teams attribute recent weakness to a lack of inspiring fashion trends, we believe this reason is the single biggest factor behind the sluggish traffic at Ann Taylor and its rivals over the past several quarters.

So what did Ann Taylor do differently this quarter? Sure, comparable-store sales were relatively strong at LOFT stores. However, the segment recorded a 9% decrease in the year ago period, indicating that the 1Q08 comp number was inflated a bit. In our opinion, Ann Taylor's sales figures do not really show any evidence of a meaningful inflection in customer traffic trends. Tax rebate and stimulus checks could help to reverse this in the coming periods, but we believe these funds will generally be used to purchase consumer staple products, not discretionary items.

Instead, it appears that Ann Taylor's excellent inventory management was the primary driver behind 1Q08 earnings outperformance. Total inventory levels were down 15% per square foot at the quarter, with Ann Taylor and LOFT inventories both down "significantly" according to management. Clearly, lower inventory levels are preferred when store traffic is weak, as it reduces the amount of markdowns that a company must take to clear merchandise off shelves.

We went back and checked management commentary regarding inventory on the 4Q07 conference call to determine whether there were any potential clues to signal yesterday's earnings surprise. We found that in-store inventories per square foot were down 7% and 34% at Ann Taylor and LOFT, respectively, and that management repeatedly stressed tighter inventory buys in light of economic challenges. Granted, in-transit inventories were up due to the earlier timing of Easter and Chinese New Year, but there were a few indications that lower inventory levels could protect margins during the quarter.

Given this information, we started to wonder if there could be any other potential earnings surprises among mature women's apparel retailers. It is safe to assume that sales were lackluster across much of the sector; Chico's FAS (NYSE: CHS), Limited Brands (NYSE: LTD), and Talbots (NYSE: TLB) already reported negative comps, and our recent store checks indicated weak traffic at other chains. We do not anticipate strong earnings any of the aforementioned companies due to the de-leveraging effect of negative comps on margins (though, in fairness, Talbots did indicate modest gross margin improvement on better inventory controls).

That leaves us with Coldwater Creek (NASDAQ: CWTR) and Christopher & Banks (NYSE: CBK). Both companies had relatively clean inventories heading into the quarter (Coldwater Creek's was down 9% on a per square foot basis, while Christopher & Banks was 22% lighter on a per store basis). Both management teams reduced store growth plans for the year, thereby saving on store pre-opening costs. However, we believe any positive impact on margins will be effectively offset by negative double-digit comps and limited expense leverage opportunities. Sadly, Ann Taylor may have been an anomaly this quarter.

One other notable item from Monday's press release was the announcement that the company will not pursue a new concept targeting the "modern boomer" segment. Investors should welcome this news, as it should free up capital that can be used for higher-return projects. Despite industry claims to the contrary, we believe the modern boomer audience has too many apparel choices right now, leading to increased industry competition (and in some cases, elimination - Gap's (NYSE: GPS) Forth & Towne concept being a prime example). However, we believe plans to launch a LOFT Outlet chain this summer are prudent. A reoccurring theme from last week's sales announcements was strength at outlet locations, a trend we expect to continue as long as average consumers are feeling pressured.

Investment recommenda
tion: Unfortunately, we believe the positive news has already been priced into Ann Taylor's stock, which is now trading at 15x the midpoint of management's fiscal 2009 earnings range of $1.80-$1.90 (essentially in line with long-term earnings growth estimate). Existing shareholders may want to use yesterday's rise as a profit-taking opportunity, while prospective investors should probably wait until after the May 22nd conference call before building positions. There is still a great deal of negativity surrounding this sector among institutional shareholders, and we are curious why management did not raise its full-year guidance after reporting such a strong quarter. That being said, Ann Taylor possesses several competitive advantage over its peers and could prove to be the most promising investment opportunity in a challenging sector.

As for the rest of the space, we would avoid building positions anytime soon. This is a cyclical industry, and there will be a time when outdated wardrobes will lead to strong demand for women's apparel. However, the target audience for women's apparel is still focused on cutting back on discretionary purchases, meaning that it will probably take a at least a quarter or two before this space becomes an attractive investment opportunity. Short selling may not be the right move either, as most of the group is already trading at or near all-time low multiples and may not provide enough downside to incentivize bearish investors. Our advice: avoid the space altogether for now.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of directors or an advisor or officer of the Subject Companies. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Companies.
No
Analyst or household of analyst owns shares in Subject Companies. No
Analyst or household of analyst owns options warrants, or futures in Subject Companies.
No

Impulse Items

A few quick links from the world of consumer stocks...

Feel free to e-mail us with any tips, questions, or comments regarding consumer stocks at rjhottovy@consumerstocks.net

Update on the Collective Brands/Adidas Trademark Infringement Case

Collective Brands (NYSE: PSS) CEO Matt Rubel responded to last week's unfavorable federal court ruling in which the company was found guilty of trademark infringement and ordered to pay $305M in damages to adidas AG. In a letter to shareholders, Rubel discussed why he believes that the jury's ruling was "unjustified and excessive," and disclosed that the company will file motions asking the court to set aside the verdict, enter a judgment in its favor, order a new trial, or greatly reduce the jury's award.

Two key points from Rubel's letter:

  • The total award of $305M (including $137M of Payless profits and $137M in punitive damages) is ten times the amount of actual damages found ($30.6M) and exceeds the profits that Payless ShoeSource made on its two- and four-stripe shoe styles by 15 times. Though our scope of patent and trademark infringement case is limited, we don't ever recall seeing a jury award of this magnitude.
  • If the decision stands as ruled, it may also give adidas exclusive rights to all two- and four-stripe footwear designs. Payless is by no means the only footwear retailer with a private label that resembles adidas' three-stripe design (look around the footwear department at any mass merchant retailer). A ruling like this could potentially give adidas a monopoly on all striped shoe styles, which would have grave consequences across the industry as a whole.
As we discussed last week, the final outcome of legal disputes like these are virtually impossible to predict. Even though management provided compelling evidence as to why the jury award should be reduced, investors should not assume this will happen when forming an investment thesis or valuation assumptions. The only certainty in this matter is that the company will incur additional litigation expenses, leading to additional margin pressures in coming quarters. There is also the matter of the ongoing K-Swiss (NASDAQ: KSWS) trademark battle taking place in California. We anticipate the K-Swiss legal team will use findings from the adidas case to augment its own arguments, likely requiring additional litigation costs on the part of Collective Brands.

On a positive note, Rubel reported that the company is set to announce 1Q08 sales of $932M (a decline of 2.5% y/y) and EPS of $0.61-$0.67, beating current consensus analyst estimates. Management also expects EBITDA to exceed $100M - almost 11% of sales - which is a solid figure given the current challenges facing the footwear industry. While the 1Q08 results are encouraging, they do come with a grain of salt. The 1Q08 results do not include the impact of additional litigation expenses (the 1Q08 impact should be minimal - it is future quarters we are more concerned with) and an $0.08 tax benefit stemming from earnings generated in lower-tax international jurisdictions (largely South America). Excluding the positive tax effect, 1Q08 earnings would come in roughly equivalent to the analyst consensus of $0.54 per share.

Investment recommendation: The stock is up almost 12% in today's trading session to $11.50, due largely to the better-than-expected 1Q08 earnings results. Using the previous consensus calendar 2008 (fiscal 2009) EPS estimate of $1.12 plus the $0.10 upside from the 1Q08 results (comparing the midpoint of the $0.61-$0.67 range to the previous consensus of $0.54), the stock is now trading at 9.5x times forward earnings, roughly in-line with long-term earnings growth expectations. We remain upbeat on the prospects for the combined Payless/Stride Rite/Collective Licensing platform, and admire the merchandising creativity that Rubel has assembled under the Collective Brands umbrella. However, we still characterize Collective Brands as a long-term investment that will require patience on the part of the investor. Even longer-horizon value investors may want to wait until after the 1Q08 conference call (June 4th, 5;00 pm EST) to build or add to positions - there is a chance that negative commentary regarding the overall state of the footwear industry or ongoing litigation could bring the stock price downward.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of Directors or an advisor or officer of the Subject Company. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Company.
No
Analyst or household of analyst owns shares in Subject Company. No
Analyst or household of analyst owns options warrants, or futures in Subject Company.
No

Friday Tutorial: Examining the "Calendar Shift" Phenomenon

Yesterday, we had a few questions from clients regarding the "calendar shift" mentioned in our April Sales Review and reported by a number of media outlets, so we figured it would be a good time to introduce a quick tutorial on the subject.

Most retailers report results using the National Retail Federation 4-5-4 calendar to report monthly, quarterly, and annual results. Under this convention, the year is divided into 52 weeks, with each quarter having 13 weeks. The first month a quarter features four weeks, the second month contains five, and the final month of a quarter has four weeks. Each annual, quarterly, and monthly period has the same number of Saturday and Sundays (typically, the busiest shopping days) to keep year-over-year results somewhat consistent. Easy enough, right?

However, the retail calendar isn't as straightforward as it sounds. The first issue is the problem of the "53-week year. " We'll let the The National Retail Federation FAQs 4-5-4 Calendar explain:

"Due to the layout of the 4-5-4 Calendar (52 weeks x 7 days = 364 days), which results in one remaining day each year, and the occurrence of Leap Year, it is sometimes necessary to add a 53rd week to the end of the calendar for sales reporting purposes only. This occurs approximately every five to six years, though this is not always the case. 1995, 2000, 2006, and 2012 are all 53-week years."
Obviously, having an extra week can have a significant impact on a retailer's sales and expense growth rates. Fortunately, there will not be another 53-week year until 2012, so we'll skip over the impact that this can have on investment decisions for now.

The second issue, and the one we believe that is more pertinent to retail investing, is the effect that a calendar shift can have when using year-over-year comparisons. When a company reports results for a given period (i.e., monthly or quarterly sales), there can be several inconsistencies in the reporting periods from one year to the next. A period may contain a significant sales holiday one year - Easter and Christmas, in particular - only to have it "shift" out of period the following year (or vise versa). This can create situations where year-over-year growth figures are inflated or deflated, and can have a material impact on the price of the stock.

Let's take April 2008, for example. According to the National Retail Federation, April 2008 was four weeks long starting April 6th and ending May 3rd (April was the final month of the first quarter for most retailers), while April 2007 ran from April 8th to May 5th:

Source: National Retail Federation
Note: Green shaded boxes indicate a Sales Release Date. Black boxes indicate a Holiday.

The black box in April 2007 (April 8th) represents the Easter holiday, a day that most retailers are have reduced shopping hours or are closed altogether. This means that April 2008 had one additional shopping day than April 2007, which likely inflated growth rates in monthly sales reports. Many retailers will disclose how much of an impact this day had on results (for instance, Children's Place (NASDAQ: PLCE) reported same-store sales of 15% for April 2008, but noted that 3% of the increase was due to having an extra shopping day in the period on its pre-recorded monthly sales call), but many investment decisions are made based strictly on the headline sales growth number. Clearly, if the headline number looks strong, even if it was aided by an extra shopping day, the stock will likely trade to the upside during that day's trading session.

Generally speaking, you should not make an investment decision (either long or short) based solely on the timing of a calendar shift; long-term fundamentals are much more important for making an investment decision. However, it is amazing how often calendar shifts are forgotten (or altogether misunderstood) among the investment community. Before making your next retail stock investment, make sure you have a firm understanding of the calendar for upcoming reporting period. If the current period features a beneficial calendar shift, it may be time to make that investment now. However, if there is a negative calendar shift, you may be able to purchase that investment at a lower price following the next reporting date.

Links
If you have any topics you would like for us to examine in future tutorials, feel free to e-mail us at rjhottovy@consumerstocks.net

Posted in Labels: | 3 comments

April Sales Review

We're taking a quick look at this month's retail sales winners and losers this morning. In general, April retail sales numbers were healthy, aided by a calendar shift (an extra day in April compared to last year's period), easy comparisons (April weather was damp and cool across much of the country a year ago, keeping consumers out of stores), and anticipation of tax rebate and economic stimulus checks. Teen and children's apparel retailers led the way, mass merchants and non-discretionary retailers were strong, while women's apparel and footwear retailers continued to languish:

Winners:

  • Teen apparel retailers - Almost universally, teen apparel retailers sales were quite strong in April. Abercrombie & Fitch (NYSE: ANF), Aeropostale (NYSE: ARO), and The Buckle (NYSE: BKE) all reported same-store sales above 20%, and sales at American Eagle Outfitters (NYSE: AEO) were also solidly positive. After a disappointing March, we believe Spring Break and early summer shoppers, coupled with the easy comparisons a year ago, generated the strong April sales results. That said, teens are a extremely fickle group to satisfy - preferences are constantly evolving. Which is the right stock for you out of the aforementioned group? We're partial to The Buckle because it doesn't get the same publicity as others in this space (we've owned it in the past, but don't hold a position now), but each of the companies are well-run companies with relatively strong merchant teams. Our advice: wait for the upcoming 1Q08 earnings announcements (retail expectations are still tepid at best, and a pull-back is possible), then buy the teen retailer that with the best comparable inventory position (i.e, the lowest comparable inventory levels, year-over-year).
  • Children's Place (NASDAQ: PLCE) - Children's Place reported solid sales growth of 24% during April (the four-week period ended May 3), including 15% comps (8% transaction growth, 7% average ticket). This brings total 1Q08 sales growth to 12% and comps of 5%. According to the sales call, outlet locations were a key driver of strength. With last week's divestiture of the Disney Store business, we expect much more stability in future results due to the natural replacement cycles associated with children's apparel. The stock has rebounded nicely from January lows, but we believe there is still room for appreciation. We would accumulate until the mid $30 range.
  • Urban Outfitters (NASDAQ: URBN) - Urban Outfitters continued its strong sales trend, posting 1Q08 sales growth of 25% and comparable-store sales growth of 10% (10% at Urban Outfitters, 10% at Anthropologie, 19% at Free People). Anthropologie remains one of the strongest brands in retail, fueled by an upscale target demographic with a propensity to spend (a slightly younger, more fashion-conscious audience than women's apparel retailers we will discuss in a minute). Urban Outfitters' assortment continues to improve, aided by its "broad and shallow" inventory approach. With the ability to further raise initial mark-up (IMU) through sourcing improvements, increased attention to reducing occupancy expense, and improved point-of-sale (POS) systems and planning/allocation systems, we expect profitability to remain in the mid-to-high teens over the foreseeable future. That said, the stock is already trading at a peak forward earnings multiple (around 30x, using consensus estimates), and the company faces more difficult comparisons than most retailers in the coming periods. We remain upbeat on Urban Outfitters, but would wait for pull-backs to initiate or add to long positions.
Losers:
  • DSW (NYSE: DSW) - Footwear remains one of the most challenged sectors in retailing, and DSW's 1Q08 sales are further evidence of this trend. The company reported a 3% sales increase in the quarter, with comparable-store sales growth of -5%. Additionally, management revised its full-year guidance downward, saying that it now expects full-year comps in the negative mid-single digits and EPS between $0.75-$0.85 (management had previously provided a 1H08 outlook calling for negative comps and EPS of $0.68). We still find DSW a unique concept among footwear retailers, offering nearly 300 high-end brands at value prices. The "big white box" stores that company has been known for will gradually be replaced by a enticing new format reminiscent of Anthropologie. However, the truth is that it is a difficult time for footwear retailers - 3+ years of strong sales has left the industry with over-supply and insufficient demand, there is a lack of strong footwear fashion trends driving traffic to stores, and increasing production costs in China are pressuring margins. Although the stock is trading at trough multiples, we believe footwear investors must have a long-term horizon until there is better visibility (long positions paired with covered calls may be appropriate, as we do not expect much appreciation in the coming months).
  • Women's apparel retailers - By and large, women's apparel retailers like Limited Brands (NYSE: LTD), Talbots (NYSE: TLB), and Stein Mart (NASDAQ: SMRT) reported disappointing 1Q08 sales results. April was a better month for some, but largely a function of the extra day in the reporting period compared to last year's period. Generally, this group has underperformed since late summer 2007, and we really have seen little evidence (based on store visits, surveys, and conversations with management) to indicate that a turnaround is imminent. If you are a deep value investor looking for a bargain, at least side with the companies in this group that have clean balance sheets (i.e., debt free). Otherwise, we would stay out of these names altogether. Buying opportunities will present themselves, but now is not the time.
Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of directors or an advisor or officer of the Subject Companies. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Companies.
No
Analyst or household of analyst owns shares in Subject Companies. No
Analyst or household of analyst owns options warrants, or futures in Subject Companies.
No

Thoughts on the Collective Brands/Adidas Verdict

Yesterday, Collective Brands (NYSE: PSS) - formerly Payless ShoeSource - announced that a federal court in Oregon had ruled against the company in a lawsuit with adidas AG. As a result, the court ordered Collective Brands to pay $305M in damages. Collective Brands' management believes the verdict was "excessive and unjustified," and will ask the the court to set aside the verdict or overturn it.

The verdict is the result of December 2001 lawsuit in which adidas accused Payless of "trademark and trade dress infringement, unfair competition, deceptive trade practices and breach of contract" for selling unauthorized footwear featuring its trademarked "three-stripe" logo.

Legal battles are always challenging from the perspective of financial analysis. If the verdict stands as ruled, the $305M penalty is a serious blow to a company that already took on significant debt to finance the acquisition of Stride Rite last year. Considering the company has $232M in cash, $936M of debt, and $702M of equity on its balance sheet, a payment of this magnitude materially changes its capital structure and its valuation. That said, the penalty does seem excessive ($305M is almost 10% of consolidated 2007 revenues of $3.0B), and there is a chance that the verdict will be overturned or settled for a reduced penalty payment

Another concern is that this ruling will set precedent. A quick review of the "Legal Proceeding" section of Collective Brand's 10-K filing indicates that K-Swiss (NASDAQ: KSWS) has filed a similar trademark lawsuit in California. We would expect K-Swiss' legal team to use the findings from this case to augment their own complaint.

It is virtually impossible to predict how legal matter like these will be resolved, but they are always expensive and will certainly weigh on the company's bottom-line. Collective Brands does not break out legal expenses in its filings, so it is difficult to tell how much of an impact an increase in legal activity will have. However, the company expenses legal costs as incurred, suggesting that there could be additional margin pressures in the upcoming quarters.

Investment recommendation: Following yesterday's pull-back, Collective Brands' stock is now trading at just 9.3x the consensus 2008 (fiscal 2009) EPS estimate of $1.12, a ten-year low (though historical multiples are less relevant here due to the Stride Rite acquisition). Though we are intrigued by the potential earnings power that the Payless/Stride Rite/Collective Licensing "hybrid" platform can have, including synergy opportunities and cost saving measures, we view the integration of the three businesses as a long-term project. The adidas penalty and the possibility of other unfavorable legal rulings further clouds the situation. A investment case could be made for deep value investors at current levels, but given the challenging footwear environment, we would advise individual investors to take more of a "wait-and-see" approach until there is better visibility.

Update: There are a handful of websites/blogs that go into more depth regarding the legal aspects of the case. We have linked to them below:

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of Directors or an advisor or officer of the Subject Company. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Company.
No
Analyst or household of analyst owns shares in Subject Company. No
Analyst or household of analyst owns options warrants, or futures in Subject Company.
No

Town Sports International: A Case of Overreaction and Opportunity

Last week, Town Sports International (NASDAQ: CLUB) reported better-than-expected 1Q08 results and reaffirmed its full-year outlook, triggering a 26% surge in the share price on Friday. Though we were a bit surprised that management's commentary was as upbeat as it was (we cautioned about the possibility of negative statements regarding local markets in our earnings preview post last week), we remain bullish on Town Sports International's (TSI) long-term prospects as well as the fitness club space as a whole.

The full-year sales guidance range $510-$520M seems reasonable (an 8%-10% increase year-over-year) if comparable club growth can remain in the mid single-digit range for the remainder of the year (a safe assumption given the high proportion of members that are enrolled in a one- or two-year "commit" structure, reliance on electronic transfer to collect dues, and an annual CPI-consistent dues increase to in September). While some analysts have cautioned about increasing cost pressures, we expect operating margins to remain at least flat to last year's 12% range, putting 2008 EPS near the high-end of management's $0.80-$0.84 outlook (not including potential upside from interest expense reductions or share repurchases).

Generally speaking, we believe TSI provides far more resiliency than most consumer discretionary stocks (i.e., retailers) due to (1) the subscription nature of membership packages; (2) solid, predictable club-level returns on invested capital; (3) margins that are greatly amplified by economy of scale benefits; (4) opportunities to double the club count in existing markets; and (5) relatively stable major market economies. In simpler terms, we believe extended membership structures will continue to generate stable revenue streams (aided by an increasing number of consumers that consider memberships a necessity rather than a discretionary expense), existing markets provide ample organic growth potential, and the regional clustering strategy limits competitive pressures and provides several levers (ability to overlap personnel, reduced hours of operation at some locations) to mitigate operating cost inflation.

However, TSI's stock has been anything but stable over the past twelve months, going from a high of $22 this time last year (a forward P/E of about 21x, excluding one-time items) to a low of $6 in April (a forward P/E of about 7x). Admittedly, the stock price decline was not completely unfounded - management warned about slowing membership growth at mature clubs on its 3Q07 conference call in November, there were reports of surging unemployment among NYC's financial firms (a key component of TSI's organic growth is corporate membership partnerships), CEO Bob Giardina left the company, and there was the threat of increasing competition in local markets - not to mention the slowdown in consumer discretionary spending. Moreover, there is a general stigma among institutional investors regarding fitness clubs due to the downfall and eventual bankruptcy of Bally Total Fitness.

We believe the aforementioned fears have been greatly exaggerated by the Street, and savvy investors can take advantage of this overreaction. November commentary regarding membership growth at mature clubs was a concern, but prudent given the rapidly deteriorating economic situation. However, the subsequent stock price correction indicated that the Street was valuing the stock using earnings expectations well below the revised guidance (recall that expectations were only reduced by a few pennies) or disproportionately low forward multiples (or both). Unemployment rates in NYC remained relatively stable (some analysts were using NYC unemployment rate assumptions as high as 7%, an excessively high number), and a relatively small percentage (10%-15%) of members in the area are employed by financial houses. There are always fears when key members of management depart, but new CEO Alex Alimanestianu has been with the firm for over 15 years and played a critical role in the development or acquisition of virtually every TSI club. Finally, competition will increase - LifeTime Fitness (NYSE: LTM), 24-Hour Fitness (Private), and LA Fitness (Private) will all have additional clubs in TSI markets in coming years - but we believe there is more than enough consumer demand for fitness clubs to support multiple competitors for years to come (just 20% of the urban population is currently enrolled in a fitness club membership).

Investment recommendation: All things considered, we believe the most appropriate investment strategy for TSI would be to initiate or add to a long position (buying the stock), but paired with put protection (purchasing sufficient put options to limit your downside risk). TSI has provided a intriguing case study in investor psychology over the past few months, and demonstrated that stocks don't always trade on fundamentals. While we have not ruled out the possibility of this happening again (hence the need for put protection), we find a handful of catalysts on the horizon that could drive the stock upward (the Analyst Day on May 21st, tax rebate and economic stimulus checks, ongoing legislature to make memberships more affordable and tax credits for corporate wellness programs). Considering that the stock is trading well below its historical mid-teen range (even using the most conservative earnings estimates), we believe TSI is undervalued and would be buyers at current levels.

Disclosures
Employee of The Consumer Stock Network, LLC is a member of the Board of Directors or an advisor or officer of the Subject Company. No
Analyst or household of analyst is a member on Board of Directors or serves as an officer, director or advisory board member of the Subject Company.
No
Analyst or household of analyst owns shares in Subject Company. No
Analyst or household of analyst owns options warrants, or futures in Subject Company.
No