Description

Long – Caleres (CAL)

Caleres (CAL) is a diversified global footwear manufacturer and distributor comprised of a retail segment, Famous Footwear, and a wholesale segment, Branded Portfolio.  The Company is misunderstood by the market as a low growth footwear retailer, but is in fact a grossly undervalued “sum-of-the-parts” story. We believe Caleres is on the precipice of a sales inflection at Famous Footwear and a margin recovery at the Branded Portfolio.

Same-store-sales should inflect positively for Famous Footwear in 2019, beginning in the second quarter, as the Company laps material weakness related to two of its top five brands from last year.  Similarly, Branded Portfolio is at the very nascent stages of improving profitability, and the recent acquisition of Vionic Shoes in October 2018 will materially enhance Branded Portfolio’s longer-term EBIT margin profile and growth trajectory.

We believe CAL represents a very unique risk-reward as the whole Company trades in-line with footwear retail peers even though half its business is a branded portfolio whose comparable companies trade at almost twice the multiple.  The entire Company trades at 5.8x 2020 EV/EBITDA, in-line with footwear retail peers at 5.7x despite the fact that CAL’s wholesale segment, Branded Portfolio, represents 46% of total sales and 48% of total EBIT, and its comparable companies are valued at 11.1x EV/EBITDA.  As the market better understands the inherent value in the Branded Portfolio segment, the valuation upside is material. Our sum-of-the-parts analysis suggests a $36.54-$49.44 fair value range, 39% to 89% higher than the current stock price. This upside potential is further supported by our consolidated 2020 P/E and EV/EBITDA fair value, implying $44.35 and $45.88, respectively, or 69% and 75% higher than the current stock price.  

Moreover, we expect the stock will trade towards our sum-of-the-parts fair value as both segments begin to execute on their turnarounds in the coming quarters.  Our 2020 EBITDA estimate is $266 million, compared to the Street at $225 million. Furthermore, although we think CAL’s misunderstood business model could attract an activist investor, we are not dependent upon this occurring, as we believe the Fall 2019 Investor Day will serve as a form of “self-activism,” as the Company formally presents the inherent value of its separate parts.

Famous Footwear Same-Store-Sales Inflection   

The Famous Footwear segment constitutes 54% and 52% of total Company sales and EBIT, respectively.  Famous Footwear ended 2018 with 992 stores. We anticipate Famous Footwear will continue to close a net 30 stores annually going forward as it better optimizes its store fleet and removes unprofitable locations.  Over the last four years, Famous Footwear reported annual same-store-sales of positive 0.6% to 1.9%.

We believe Famous Footwear is on the verge of a sales turnaround in the coming months.  In 2018, Famous Footwear same-store-sales ranged from negative 0.8% to positive 2.8%, which included an approximate 360 basis points same-store sales headwind from two of its top five largest brands.  We estimate Nike (NKE) and Skechers U.S.A. (SKX) were both down between 12% to 15% in 2018, implying an approximate $65 million sales headwind. Likewise, because the NKE product geared toward the family mid-tier channel lacked any innovation and newness from prior years, CAL was forced to take steep markdowns to clear old inventory in preparation for new product hitting stores in January 2019.  Moreover, we believe the new NKE and SKX product will begin to have a meaningful impact on Famous Footwear’s same-store-sales in April 2019, and build momentum throughout 2019. If NKE can improve to positive high-single-digit growth in 2019, which we believe is potentially conservative, then that alone adds 400 basis points to Famous Footwear same-store-sales in 2019, in addition to materially elevating consolidated gross margins as it laps the markdown clearance in 2H 2018.  

Importantly, we estimate Famous Footwear same-store-sales have been consistently running around 3.0% over the past 18 months, excluding weather impacted periods and the aforementioned NKE and SKX headwinds.  Therefore, due to the NKE and SKX tailwinds and core run-rate of 3.0%, we expect a material Famous Footwear same-store-sales inflection in 2019 to positive 4.0% to 6.0% from the previous four years of annual same-store-sales of 0.6% to 1.9%, and anticipate valuation to expand as the same-store-sales acceleration unfolds.  Every multiple of EBITDA expansion for the retail segment adds $2.74 of value per share.

Branded Portfolio Benefitting from Recent Acquisitions and Brand Transformations

The Branded Portfolio segment constitutes 46% and 48% of total Company sales and EBIT, respectively.  This segment consists of 17 unique brands, with industry leading assets like Sam Edelman, Vionic Shoes and Naturalizer.  Moreover, according to the most recent NPD Data, Caleres has six of the top 25 footwear brands. Historically, sales have grown at a 5.9% annual rate over the last four years, with outsized growth of 11.5% over the last two years.  Moreover, over the past four years, EBIT margins ranged from 6.4% in 2018 to as high as 8.4% in 2016. We believe that Branded Portfolio EBIT margins can recover to prior peaks over the next few years and potentially reach 10.0% over the next 2-4 years driven by Vionic’s contribution and an Allen Edmonds turnaround.

Moreover, the Vionic Shoes acquisition, announced on October 18, 2018 for $360 million, is a game-changing acquisition for CAL.  Vionic Shoes generated $180 million in sales in 2018 and double-digit EBIT margins, relative to consolidated Branded Portfolio of 6.4%.  Moreover, we estimate EBITDA margins are 18.0%, and project $225 million in sales and a $41 million EBITDA contribution in 2019. Assuming sales growth of 20.0% in 2020, which is in-line with its historical 5-year CAGR, we estimate 2020 Vionic Shoes sales of $281 million, or 20% of total Branded Portfolio sales, and EBITDA of approximately $51 million.  

Due to the material EBITDA upside potential from the Vionic acquisition and superior margin profile, we expect management to include annual EBITDA guidance going forward.  Reinforcing this point, the current Street 2020 EBITDA estimate for the consolidated Company is $225 million compared to our $266 million estimate, with the $41 million variance driven primarily by the Vionic Shoes acquisition, Branded Portfolio margin improvement in 2019 and 2020, as well as Famous Footwear’s same-store-sales acceleration and gross margin recapture.

Furthermore, Allen Edmonds represents approximately 10% of the Branded Portfolio and is currently operating at a trough EBITDA level.   However, the brand is undergoing a transition with a new keen focus on improved profitability. When CAL acquired the brand on December 14, 2016 for $255 million, we estimate Allen Edmonds had $170 million in sales and 10.0-11.0% EBIT margins.  In 2018, the brand struggled to drive profitable sales and was forced to increase promotional levels on a year-over-year basis. Despite higher promotions to drive volume, overall sales were disappointing and margins were materially impacted. We believe this drove a large part of the 120 basis points EBIT margin deterioration for Branded Portfolio in 2018.  Therefore, starting in December 2018, CAL decided to move away from heavy discounting, fully understanding that sales would drop from double-digit growth to low-single-digit growth, but operating margins would materially inflect positively. We view the ongoing transformation as vital for Allen Edmond’s longer-term brand health and a key initiative for expanding margins in 2019 and in achieving our Branded Portfolio 8.2% EBIT margin estimate in 2020.

Sum-of-the-Parts Valuation

We conducted a sum-of-the-parts analysis to better ascertain the underlying value of each segment.  We believe our sum-of-the-parts analysis is quite timely in the current market backdrop as several retailers, including Gap (GPS) and L Brands (LB), have either formally announced separating various business segments, or have a current activist pushing management to do so.  In addition, Genesco (GCO), a footwear retailer, recently announced its plan to divest its Lids segment after an activist investor became involved in the stock. As previously noted, we believe multi-branded or multi-segment business models are especially ripe for activism. Thus, we believe the Company will be proactive, engaging in “self-activism,” highlighting this value dislocation and opportunity during its Fall 2019 Investor Day and enacting a more aggressive share repurchase authorization, or going one step further and splitting the Company into two separate entities.

Footwear retail peers currently trade at 5.7x 2020 EV/EBITDA with a 4-year range of 3.6x to 7.1x and an average of 5.7x.  Footwear wholesale peers currently trade at 11.1x EV/EBITDA with a 4-year range of 7.1x to 11.9x and an average of 9.8x. Furthermore, CAL acquired Allen Edmonds for approximately 11.0x EV/EBITDA and Vionic Shoes for 12.0x, and per recent conversations with GCO management, we believe GCO could sell its Johnston & Murphy brand, a similar brand to CAL’s existing Branded Portfolio, for 10.0x to 12.0x EV/EBITDA.   

We estimate 2020 EBITDA is $130 million for Famous Footwear and $136 million for Branded Portfolio, and apply 5.0x to 7.0x for Famous Footwear and 10.0x to 12.0x for Branded Portfolio.  This equates to $36.54 to $49.44 per share, or 39% to 89% upside to the current stock price.

Conclusion

We believe CAL offers an extremely attractive risk-reward at current stock prices, which will be unlocked through a combination of Famous Footwear’s same-store-sales acceleration, Branded Portfolio margin improvement and the potential for an activist, or the Company at its Fall 2019 Investor Day, to unlock the inherent value dislocation.  Based on our sum-of-the-parts, the Branded Portfolio segment mid-point equity value is $28.20 per share, or 8% above the current share price. Therefore, we believe the market is materially miss-valuing the consolidated Company and assigning no value to Famous Footwear, which we believe is worth $11.84 to $17.74 per share. We believe CAL is worth $36.54-$49.44 as the inherent value hidden within the security is unlocked.  

Any forward-looking opinions, assumptions, assessments, or similar statements constitute only subjective views. This information should not be relied on for investment decisions and is subject to change due many factors, including fluctuating market conditions and economic factors.  Such Statements involve inherent risks, many of which cannot be predicted or quantified and are beyond our control. Future evidence and actual results could differ materially from those set forth in, contemplated by, or underlying these Statements, which are subject to change without notice.  In light of the foregoing, there can be no assurance and no representation is given that these Statements are now, or will prove to be, accurate or complete. We undertake no responsibility or obligation to revise or update such Statements.

Catalyst

1Q EPS 5/30 (estimate) and 6/4 FFANY meetings.  2Q EPS early September followed by Investor Day.