Description

Genesco (NYSE: GCO) is a highly attractive stock with significant optionality to improve its long-term value for shareholders.  Importantly, the business is performing well and the important back-to-school season is above last year’s levels.  The stock appears remarkably cheap trading at 3.4x our estimate of current fiscal year EBITDA.  We see the following opportunities to drive value:

• Buybacks – Genesco has been significantly reducing its share count over the last six and a half years buying back $555mm of stock and reducing the share count by 11mm shares or 50% ($48.9mm of this buyback happened in the last three months and there is $55mm to go on the current authorization).  Given the current net debt situation of near zero we think GCO could easily borrow $200mm to $300mm and execute a leveraged recap which would drive significant value.

• Monetize real estate – Genesco owns 5 distribution center / fulfillment center properties which we believe could be monetized in a sale leaseback to generate after-tax proceeds of $135mm which could be used to further reduce shares outstanding.

• Portfolio optimization – Genesco has two businesses which could be easily sold – Johnston & Murphy and Schuh.  Our view is these two businesses could generate after-tax proceeds of $260mm which could be used to further reduce shares outstanding.

• Sale of Genesco – Given the current equity value of Genesco we believe that both private equity and strategics would be interested in buying this business.  Strategics could likely bid more aggressively, given the synergies, and we see CAL, DSW, SCVL, FL and WWW as most likely.

Despite Genesco’s solid performance across all four of its concepts, structural and operational improvements compared to pre-COVID, and strong balance sheet, Genesco stock remains one of the cheapest in terms of valuation in the footwear retailers universe. GCO stock has recently been beaten down ~25% since the week before Q2 earnings, when the Company reduced full year guidance by ~10%. The stock is currently trading 33% off its 52-week high of $73.72, and we believe the risk/reward is highly favorable at these levels especially given the first three catalysts listed above which could provide enough of a value unlock to buyback nearly every outstanding share at current levels.  Genesco is not a sexy business, but it is very exciting if you want to make money and the market-cap is large enough that funds can find liquidity to establish a reasonable stake.

Business overview:

Genesco owns a strong and diverse portfolio of footwear concepts: Journeys, Schuh, Johnston & Murphy, and a small Licensed Brands business selling footwear mainly under the Dockers® and Levi's® brands. The core business Journeys is an innovative retailer of footwear for teens and kids both in the mall and online and has proven resilient in economic downturns. We continue to see Journeys top of mind for kids to young adults when it comes to branded footwear, and these are customers whose feet sizes are ever changing and generating recurring revenues. Ever changing feet is an extremely important point for two key reasons: #1 it drives recurring sales even if a shoe still had remaining life, and #2 it means that many young customers are unsure of their exact shoe size which means going to physical stores is important to get the “right” fit.  Genesco generated $2.4 billion in net sales and $195m in Adj. EBITDA over the most recent fiscal year (FY 2022).

Nashville-based Genesco was incorporated in 1934, sells footwear in more than 1,400 retail stores in the United States and Canada, as well as in UK and Ireland, principally under the names Journeys, Journeys Kidz, Johnston & Murphy, and Schuh. The company also sells footwear at retail and wholesale under its Johnston & Murphy brand and under the licensed brands segment.

• Journeys – footwear retailer, 65% of FY 2022 revenue

• Journeys, Genesco’s largest operating segment, is one of the dominant US fashion focused shoe retailers targeting the 13–22-year-old demographic

• In addition to the core Journeys business, GCO launched Journeys Kidz in 2001, which caters to younger children ages 5-12

• At the end of FY 2022, Journeys Group operated 1,135 stores averaging ~2,000 square feet, located primarily in malls and outlet centers

• Assortment

• Journeys sells a variety of highly sought after branded merchandise across a wide range of price points

• Key brands including Vans, Converse, Adidas, Crocs, and Dr. Martens

• Journeys strong relations with its vendors have historically enabled the company to leverage favorable unit allocations and price and product diversification

• Schuh – footwear retailer, 18% of FY 2022 revenue

• Schuh is Genesco’s second largest business and is considered Journeys’ counterpart in UK and Ireland

• Like Journeys, Schuh sells shoes to 16-24-year-old customers through 123 stores (a mix of street and mall locations) averaging ~4,825 square feet

• Schuh sells a broad range of branded casual and athletic footwear, in addition to a meaningful private label offering

• Ecommerce LFY 24%; Now 43% (highest ecom of all segments)

• We recently visited Schuh locations in UK – we saw well-assorted inventory, strong traffic, convenient locations and appealing store designs

• Johnston & Murphy – footwear brand, 10% of FY 2022 revenue

• Johnston & Murphy is Genesco's third largest operating segment and sells a broad range of dress and casual footwear and accessories mainly to men in the 35-55 age group

• Brand was established over 170 years ago and has made custom designed shoes and/or boots for every President since President Fillmore in 1850

• At the end of FY 2022, Johnston & Murphy operated 167 retail stores averaging ~1,900 square feet and are located in both mall and street locations, with a concentration in higher-end malls and airports

• Johnston & Murphy shoes are also distributed through the company's wholesale operations to both nicer department and independent specialty stores, totaling around 1,200 doors

• Retail prices for Johnston & Murphy footwear generally range from $100 to $250

• Over the years, GCO has taken several initiatives to rejuvenate the brand by cutting unprofitable wholesale doors, improving product quality and design, and enhancing profitability

• Licensed Brands – footwear distributor, 7% of FY 2022 revenue

• Genesco’s smallest segment that accounts for 7% of net sales

• Genesco designs and sells shoes under licensed brands including Dockers®, Levi's®, and G.H. Bass®

• Dockers® (exclusive) and Levi's® branded shoes under license since 1991

• G.H. Bass® branded shoes under license since 2015

• Also have licenses for FUBU, STARTER (exclusive) and ETONIC (exclusive)

Genesco is now a much healthier business compared to pre-COVID:

• During the most recent fiscal year Genesco grew revenue 10% compared to pre-pandemic levels, and achieved an operating margin of 6%+, well above previous levels

• As its digital strategy continues to improve, GCO represents an example of the best retail configuration and a strong omnichannel retailer with a solid brick and mortar store base

Genesco Digital Sales and Penetration:

• Genesco has taken multiple steps to refocus on its core footwear businesses

• In 2018, Genesco divested its struggling hat business Lids for $100 million in cash and used net proceeds as well as FCF to buyback ~25% of shares outstanding at that time, leaving Genesco as a leaner and more focused footwear business

• Over the past 5 years, Genesco has closed 255 underperforming stores to rationalize its store fleet. At the same time, rent expenses have significantly come down as Genesco would simply close a location if numbers don’t pencil. They have also cut lease terms shorter on renewals, leaving more flexibility in the future

• H1 FY 2023 – 115 lease renewals with a 17% reduction in rent expense with a shorter average term of 2.5 years

• FY 2022 – 192 renewals with a 17% rent reduction

• FY 2021 – 123 renewals with a 23% reduction in cash rent

• FY 2020 – 58 renewals with a 28% reduction in cash rents – new term 1.5 years

• FY 2019 – 160 renewals with a 11% reduction in cash rents – new term 3 years

• FY 2018 – 170 renewals with a 15% reduction in cash rent

• As Genesco’s business is performing better, the Company has been returning substantial capital to shareholders and we believe they are going to continue to do so. Over the past 6 quarters, GCO repurchased 15% of outstanding shares, with $55 million repurchase authorization remaining, which can further shrink the Company’s share count by 10% at the current share price

• Genesco’s strong balance sheet also provides flexibility and options. At the end of Q2 FY 2023, Genesco only had $4 million net debt on balance sheet. As the Company sells inventory through back-to-school and holiday seasons, we believe Genesco will likely have more than $100 million of net cash by year end (even if they exhaust the remaining $55mm of share repurchases during Q3 and Q4). This makes Genesco, in our view, likely to do more buybacks including considering launching an additional accelerated share buyback program at current attractive stock price levels

• It appears that management is in agreement that GCO’s shares represent an attractive investment, following the recent sell-off as CFO Tom George just bought 2,300 shares on September 7, 2022 at $45

• Finally, Genesco’s value can be further enhanced by eliminating its conglomerate structure. We believe that divesting Johnston & Murphy, as well as Schuh, can unlock Genesco’s SOTP value, and help management focus on the core Journeys business in North America

Valuation

• We have employed several valuation methodologies including trading comparables, DCF, and SOTP. All valuation methodologies yielded a similar outcome – GCO shares are trading at a discount to fair valuation, and offer significant upside from here

• Genesco is currently trading at 3.6x CY 2023E EV / EBITDA (consensus)

• Peers: Given the positioning of GCO as a fashionable footwear retailer, we think GCO shares are best compared to a specialty retail peer group with majority of exposure to footwear. Our group includes Boot Barn, Designer Brands, Foot Locker, Shoe Carnival, DICK'S Sporting Goods, Hibbett, Caleres, Crocs, Deckers Outdoor, Wolverine World Wide, Steven Madden, and Skechers. GCO shares are currently trading at a 40% discount to the group median of 5.8x 2023E EBITDA. In the peer group above, we believe Designer Brands, Foot Locker, and Caleres are the closest peers. GCO shares are currently trading at a 22% discount to the median of these three core peers. Given GCO's strong retail presence and continued momentum, we believe shares are attractively valued relative to a comparable group mean valuation. Valuing GCO’s at these peers’ multiple translates into a $63-79 stock or 28-60% upside

• DCF: Our discounted cash flow analysis returns a share price of $84, reflecting 71% upside from current levels

• A FY2023E sum-of-the-parts valuation analysis supports a similar outcome where by the end of FY2023, GCO stock should be ~$89/share, or ~80% upside

Catalyst

• Buybacks – Genesco has been significantly reducing its share count over the last six and a half years buying back $555mm of stock and reducing the share count by 11mm shares or 50% ($48.9mm of this buyback happened in the last three months and there is $55mm to go on the current authorization).  Given the current net debt situation of near zero we think GCO could easily borrow $200mm to $300mm and execute a leveraged recap which would drive significant value.

• Monetize real estate – Genesco owns 5 distribution center / fulfillment center properties which we believe could be monetized in a sale leaseback to generate after-tax proceeds of $135mm which could be used to further reduce shares outstanding.

• Portfolio optimization – Genesco has two businesses which could be easily sold – Johnston & Murphy and Schuh.  Our view is these two businesses could generate after-tax proceeds of $260mm which could be used to further reduce shares outstanding.

• Sale of Genesco – Given the current equity value of Genesco we believe that both private equity and strategics would be interested in buying this business.  Strategics could likely bid more aggressively, given the synergies, and we see CAL, DSW, SCVL, FL and WWW as most likely.