Description

Payless Shoesource, the nation's leading retailer of shoes, sells for 4.7 times EBITDA and 6.8 times after netting out sustaining CAP EX. Using traditional LBO economics, the company generates an after tax Internal Rate of Return of 35% per year at the current price. And, the company is gradually taking itself private, having repurchased nearly half of its outstanding shares in the last 4 years. This is a cash flow machine.

The major problem with Payless is its modest growth potential. The base business can only grow about 3% per year. It is adding new outlets through an outsoucing arrangement with Shopko, whereby Payless is managing the Shopko shoe departments. And, its Parade of Shoes operation is showing modest promise. Nevertheless, this is not a fast growing business. However, the excess cash flow generation (all of the earnings are free cash flow) can continue to be used to buy back stock. If all of the roughly $120 million in free cash is used to repurchase stock, the company can retire nearly 11% of its shares per year without taking on any incremental debt. On top of the 3% top line growth, this generates EPS growth of 14% per year. With a highly capable management team that has guided this business to remarkably stable margins and high returns on capital employed in a tough economic environment while succesfully competing with the likes of Walmart, one can rest assured that the Payless brand is a true franchise. With the stock selling for only 9.5 times estimated 2000 earnings, this is clearly worth a look.

Catalyst

Strong cash flow. Recent Dutch tender. Ongoing stock repurchase. Gradual privatization.