Brands (New York Stock Exchange: DBI) manufactures and retails footwear in North America. The company operates retail chains called DSW Designer Shoe Warehouse and The Shoe Company, and shoe brands such as Jessica Simpson, Vince Camuto and Lucky Brand, as well as the recently acquired Topo Athletic. And the restrictions. The stock hasn’t performed very well in recent years – the stock has lost the majority of its value, and current earnings 2.26% return Doesn’t save back. In addition to the past few years of weakness, recently announced third-quarter results sent Designer Brands shares falling even further with a 33% drop in one day.
Designer Brands announced its Q3/FY2023 results on the 5thy December. The reported result and guidance came as a shock to the market, as can be seen on the stock chart – Designer Brands stock fell 33% in one day due to the report.
Reported results were very poor compared to expectations, with revenue missing $36.4 million, equivalent to about 4.4% of expected revenue. Comparable sales fell 9.3% year-on-year, reflecting the weaker macroeconomic position of designer brands. With lower-than-expected sales, the company’s earnings also saw a significant decline – with reported normalized EPS coming in at nearly half the expected value, with reported normalized EPS of $0.24 compared to $0.46 expected.
In addition, Designer Brands’ forecast for the full fiscal year 2023 was lowered, which also casts a shadow over the fiscal fourth quarter. Designer Brands’ previous guidance included EPS guidance of $1.2 to $1.5, and was updated to $0.4 to $0.7 with the third-quarter report, more than half of the median EPS guidance. Revenue forecasts were also updated, with Designer Brands’ organic sales growth guided to the high single digits rather than the previous mid-to-high single digits, and Keds acquisition revenues were guided to $60 million to $70 million from a previous estimate of $75 million to 85 million dollars. In my opinion, a massive 19% drop in KIDS guidance looks very worrying; Such a reduction in guidance does not seem reasonable and casts doubt on the current administration.
The company’s third-quarter earnings call provides some context for the weak financial performance. Like many other companies currently, Designer Brands identifies macroeconomic pressures as a negative factor, impacting consumer purchasing significantly. Combined with warm weather, consumer purchasing pressure has put pressure on the footwear market, which Designer Brands saw in the weak overall line; DSW’s seasonal footwear performance this quarter was mostly in line with the struggling industry.
Designer Brands also admits the company needs to improve its retail assortment – the poor performance is also partly due to weak focus on its retail offering. DSW’s new president, Laura Denk, put a lot of emphasis on DSW’s presentation in the earnings call, mentioning Nike’s return to its retail chain offerings with a strong start in sales. In my opinion, Laura Denk’s focus on the group looks great for the company’s financial future. I hope the greater focus will improve Designer Brands’ profitability and sales trend, although I expect the adaptation will take a long time before it materializes in the financials.
Long-term financial trends
Prior to the COVID pandemic, Designer Brands was able to consistently grow revenues – from FY 2005 to FY 2019, the company achieved a revenue CAGR of 6.1%. But after the pandemic, Designer Brands’ operations appear to have taken a more sustained hit. Revenues have not risen to pre-pandemic levels despite new acquisitions. I believe the revenue level likely indicates poor underlying performance in operations; Designer brands acknowledging assortment-related issues seems like a good first step to improvement.
Even before the pandemic, Designer Brands’ margin performance was poor. The growth was largely achieved at the expense of margins in the decade prior to the pandemic, as EBIT margins declined consistently from 11.3% in FY11 to 4.0% in FY19. The margin trend is very worrying in my opinion, as the Continuing annual margin decline beyond fiscal 2021 – Fundamental issues at Designer Brands’ footwear brands and retail group are likely to be quite ongoing issues that company management needs to address.
Opportunity to buy cheap or not?
Deteriorating earnings appear to have created cheap stocks on the assumption that the earnings trend rebounds; Its P/E ratio of 8.0 at the time of writing looks very cheap indeed. However, I don’t necessarily think that falling prices represent a very appetizing opportunity for stock growth, as fundamental concerns about an earnings recovery seem very reasonable. To better illustrate the valuation, I built a discounted cash flow model.
In the DCF model, I estimate that the company’s future is mostly in line with the long-term past after current macroeconomic pressures subside – after a 9% FY2023 revenue decline, I estimate Designer Brands will still experience only 1% growth in FY2024 After the year, I estimate a recovery back to modest growth with FY2025 revenue growth of 6% which gradually slows to a sustained growth rate of 2%.
As for spreads, I do not expect a very high range even as the macroeconomic situation improves. The long-term deterioration of Designer Brands’ margins looks worrying, and although Laura Denk’s focus on the DSW lineup could turn the tide, I don’t expect much as a baseline scenario before better financial performance emerges. As the macroeconomic situation improves, I estimate that the company’s EBIT margin will improve from the FY2023 estimate of 2.7% to 4.2% in FY2025, but will decline to a sustainable level of 3.8% thereafter. With lower overall growth, Designer Brands’ cash flow conversion should be fairly good.
With the aforementioned estimates coupled with a cost of capital of 13.49%, the DCF model estimates the fair value of Designer Brands at $8.26, about 7% below the stock price at the time of writing. The DCF model could still differ a lot in the actual financials, although the focus on group is the more notable variable in my view, which could improve Designer Brands’ EBIT margins from my estimates. Given the current weak financial conditions, I continue to tread carefully.
The weighted average cost of capital is derived from the capital asset pricing model:
In the third quarter of fiscal 2023, Designer Brands had approximately $8.8 million in interest expense. With the company’s current amount of interest-bearing debt, Designer Brands’ annual interest rate is 9.34% – Designer Brands’ interest rate appears to be quite high. However, the company uses a significant amount of debt, and I estimate that its long-term debt-to-equity ratio is 40%. For the risk-free rate on the cost side of stocks, I use the ten-year US bond yield of 3.90%. The equity risk premium of 5.91% is Professor Aswath Damodaran’s latest estimate for the US, released in July. Yahoo Finance rates Designer Brands beta at 2.01. Finally, I add a small liquidity premium of 0.3%, resulting in a cost of equity of 16.08% and a weighted average equity capital of 13.49%.
He stays away
Designer Brands reported weak third-quarter results. Although much of the result can be attributed to compressed consumer spending and warm weather that depressed seasonal footwear sales, it also appears that the company is suffering from company-specific issues. The current focus on DSW’s retail offering could improve the long-term trend of margin deterioration with a successful Nike relaunch, but until better performance shows up in the financials, I would remain cautious. At the moment, I think the stock price is fair as the DCF model suggests with mostly minor downside – at the moment, I have a Hold rating.
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