Description

Saucony (SCNYA/SCNYB) represents an excellent investment opportunity combining both strong earnings growth and under valuation relative to its assets. The company currently sells for a P/E of under 11 and at less than 80% of net current assets. Peter140 originally posted Saucony almost one year ago, but the company’s performance has materially improved since last year and the shares have become a much more compelling investment.

The company primarily sells running shoes that enjoy an outstanding reputation in the technical running market. Over the past nine months the company has literally “hit its stride” by significantly beating its earnings and revenue estimates. In the most recent quarter the company reported EPS of $.26, more than double the company’s estimate made at the end of the second quarter. The backlog at the end of the third quarter stood at $56 million which is up 16% from the same time last year. The company is very optimistic about the future and expects its growth to continue.

Valuation:

At about $8 per share and with projected EPS for this year of about .75, the company currently sells for a P/E of about 11. The stock’s current P/E is deceptive as the company’s balance sheet includes about $5 per share of cash. The company readily admits that $15 to $20 million of its $30 million cash balance is not necessary to run its business. If one removes about $3 per share of the cash balance in calculating the P/E, it drops to less than seven!

With $5 per share in cash the company has an immaculate balance sheet. It has a current ratio of 6.3 to 1 and no long-term debt. The company has about $10.40 per share in net current assets and thus is selling for less than 80% of its net current assets which is obviously very rare for a company as profitable as Saucony.

The company is currently evaluating how to use its excess and growing cash position. It is considering alternatives that include instituting a dividend or a strategic purchase. The possibility of management executing an ill-advised purchase appears to be mitigated by the fact that they own over 40% of the outstanding shares.


Summary of the Business:


Saucony designs and markets performance-oriented athletic footwear, athletic apparel and casual leather footwear. Their main products are:

o technical running, walking and outdoor trail shoes sold under the Saucony brand;
o athletic apparel, sold under the Hind brand name;
o shoes for coaches and officials and casual leather walking and workplace footwear, sold under the Spot-bilt brand name.

The company’s products are sold in the United States at more than 5,500 retail locations and at its 11 factory outlet stores and outside the United States in 29 countries through 20 distributors located throughout the world.

The business is organized into two operating segments. The Saucony segment consists of Saucony technical and Originals footwear, and Saucony apparel. The Other Products segment consists of Hind athletic apparel, Hyde Authentics footwear and Spot-bilt shoes for coaches and officials and casual leather walking and workplace footwear. In 2001 the Saucony domestic segment sales represented 65 % of sales and Saucony international represented 18% of sales. I will provide some more details on the Technical running shoe area, as this is the critical part of the business.

Although the company sells many standard or classic running shoes, it is the technical footwear line that is driving the company’s performance and growth. The company sells performance running, walking and outdoor trail shoes for athletes under the Saucony brand name, which has been marketed in the United States for over 30 years. A substantial majority of sales are in the running shoe category. The company designs and markets separate lines for men and women within most technical footwear categories. In keeping with its emphasis on performance, the company markets and sells its technical footwear to athletes who have a high participation rate in their sport of choice. The company addressed this market through its "Loyal to the Sport" advertising campaign. The company believes that these consumers are more brand loyal than those who buy athletic footwear for casual use. The suggested domestic retail prices for most of its technical footwear products are in the range of $50 to $90 per pair, with the top-of-the-line running shoes having suggested domestic retail prices of up to $130 per pair.

The Saucony brand is recognized for its technical innovation and performance. As a result of their application of biomechanical technology in the design process, the company believes that Saucony footwear has a distinctive "fit and feel" that is attractive to athletic users. During fiscal 2001, the company began to incorporate its newest proprietary footwear technology, Custom Ride Management, into its core technical footwear products. Custom Ride Management (CRM) technology allows the company to tailor shoes to the individual characteristics of a runner, including height, weight, foot size and gait cycles. By doing so, it allows athletes to select a level of cushioning or stability based on their need or preference. The company has received an excellent reception to its CRM product line this year.


Recent Performance:

The second quarter (6/30/02) performance was excellent. EPS came in at 25 cents per share versus the company’s earlier guidance of 15 to 18 cents per share. Strong business in the domestic technical category across all major channels of distribution fuelled much better than anticipated results.

In the most recent third quarter EPS came in at 26 cents per share versus the earlier guidance of 9 to 12 cents per share. Net sales were up seven percent from the previous year but EPS was up sharply from 6 cents in the previous year as gross margins increased from 32.7% to 35.7% and SG&A expenses dropped to 32.4% of sales versus 34.6% last year. Performance in the quarter was again driven by strong performance in the running and specialty market. Volumes were up slightly but the company was able to increase prices for its high quality product.


Outlook:

The company anticipates full year earnings for 2002 of 74 to 76 cents per share with the seasonally slow fourth quarter coming in at two to four cents per share. With a 16% increase in backlog versus last year the company is very optimistic about 2003. The company expects the CRM product to build on it good introduction in 2002 and increase market share. In addition, the company expects to introduce a significant new product in January, but has chosen not to provide any details for competitive reasons. Given the company’s recent record of significantly under estimating its performance, 2003 should be an excellent year.



Ownership and Trading

The company has two classes of shares: non-voting B shares (SCNYB) and voting A shares (SCNYA). The good news is that both classes of shares trade with the non-voting B shares being the more liquid of the two. The bad news is that both classes are fairly illiquid and require patience to purchase. Management owns 70% of the outstanding A shares and 20% of the B shares. Overall they own about 42% of shares outstanding.


Summary

In summary Saucony represents compelling value:

- An “adjusted” P/E of less than 7
- $5 per share in cash
- A share price equal to less than 80% of liquidation value.
- A highly regarded franchise in the technical running shoe market
- A high probability that performance will continue to improve.

The only possibly negatives here are the illquidity of the shares and the small possibility that management will make a poor purchase with its cash position

Catalyst:

There are several possible catalyst here:

- The Saucony story is clearly not out. Management has committed themselves to getting the story out. As an example, on November 1, CEO John Fisher opened NASDAQ trading in New York as management came to New York to market the company during the New York Marathon.
- There is a real possibility that company will begin to pay a dividend.
- The company has an attractive franchise that would be very attractive to a larger manufacturer.

Catalyst

There are several possible catalyst here:

- The Saucony story is clearly not out. Management has committed themselves to getting the story out. As an example, on November 1, CEO John Fisher opened NASDAQ trading in New York as management came to New York to market the company during the New York Marathon.
- There is a real possibility that company will begin to pay a dividend.
- The company has an attractive franchise that would be very attractive to a larger manufacturer.