Description

Description

Wolverine World Wide (WWW) is a competitively advantaged, LDD% earnings compounder that is recession resistant. Recent one-time earnings miss and trade war headlines have disrupted valuation, creating an attractive entry point. The Company generates HSD% FCF yield and has started to become more aggressive with their buyback activity.

Business Description

WWW is a branded footwear manufacturer with strong brands that are primarily purpose built (i.e. outdoors, work) and not so much fashion driven. Some of their top brands include: Merrell (~25% of sales), Sperry Top-Sider (~15%), Saucony (~15%) and Keds (~5%). While reputation varies by brand, WWW’s brands are generally known for being highly functional.

The Company’s distribution is largely through the wholesale channel (~87% of sales) with the remainder sold through ecommerce (~9%) and own stores (~4%). Manufacturing is done primarily through third parties and substantially all units are sourced from Asia Pacific.

The Company has stated that the incremental 10% tariff on Class 4 items from China, which includes footwear, will have a relatively minimal impact on the business in both the short and long term. Over the last 5 years, WWW has implemented a Strategic Action Plan to migrate product out of China and has accelerated this effort more recently due to tariff negotiations. For 2020, the Company expects to only import ~7.5 million pairs of shoes, which is less than 10% of total global pairs sold. This is expected to drop further to ~3.5 million pairs by 2021

Thesis

1. Competitively advantaged, recession resistant compounder

• Brand and product innovation are WWW’s primary competitive advantages, as evidenced by the company’s market‐leading positions and ability to maintain share as consumer demand shifts online
  1. The Company’s market share on Amazon is ~6% which is equal to its overall total market share
  2. Having great brands creates a barrier to entry in online retail due to placement algorithms. Amazon and Google will place products at the top of the search list that have received the most interest/clicks historically. WWW’s brands have historically led the market and make it difficult for new competitors to show up at the top of search results
  3. NPD and Footwear Distributors and Retailers of America (FDRA) did a proprietary survey of 100+ brands, and Merrell was the brand with the highest brand loyalty rating out of all brands surveyed
• The footwear industry has consistently grown at ~3%. Wolverine’s brands are largely not fashion‐oriented, enabling the company to steadily compound in‐line with the industry in revenues, and grow EPS historically at a ~9% CAGR
• During the Great Financial Crisis, EBIT declined by only ~mid‐single‐digits % while margins were maintained or improved

2. Growth inflection point nearing after a multi-year period of restructuring and macro headwinds

• WWW underwent 3 major restructurings in the last 5 years, meaningfully improving margins while increasing long‐term growth investments. During this period, sales growth was negative as the company closed or sold underperforming stores and brands

• With these restructurings behind them, the Company should be able accelerate EPS growth from HSD% to low‐teens % driven by industry growth, eCommerce share gain and harvesting prior investments (the Global Growth Agenda)

• Macro headwinds: from 2015 to 2016, the global retail industry went through a recessionary period of soft consumer demand, higher inventory levels at retailers, increasingly competitive promotional environment and multiple retail bankruptcies, some of which occurred in subsequent years

3. Valuation is disrupted due to temporary factors

• Valuation became depressed in early May 2019, as the stock declined ‐28% after announcing Q1 ’19 earnings. The stock has recovered somewhat since.
  1. Wolverine’s average P/E (last 7 years) was 15.6x versus now trading at ~12.3x. Historically, the company traded in‐line with Steven Madden (SHOO), but now SHOO trades at a ~63% premium to WWW
• We believe the revenue miss, which caused the stock to decline is driven by temporary factors. But what ultimately gets us comfort with valuation is that even if the revenue decline is the first sign of macro weakness, equity returns are compelling here if you are willing to hold through the cycle
  1. The revenue miss was largely driven by a late start to the spring season and international distributor bankruptcies which are both one-time in nature

4. Uniquely positioned amongst consumer brands as Amazon/eCommerce takes share from brick & mortar retailers

• Shoe demand is much more brand‐driven than other consumer goods, which enables companies with strong shoe brands like Wolverine to preserve its brick‐and‐mortar market share on online portals like Amazon
  1. Consumer behavior is to search for shoes by brand vs searches for apparel are often by category or type (“red dress”). This suggests that consumers are looking for a specific brand of shoe when purchasing online.
• Margins received through the online channel (Amazon) are equal to margins through the brick‐and‐mortar channel
1. Unlike other consumer brands, WWW does not provide a discounted product to Amazon, and so the Company retains product margins
2. WWW sells both through Amazon Marketplace (i.e., 3rd party) and to Amazon directly as a wholesaler (i.e., 1st party)
3. Most consumer brands are not able to sell on Amazon Marketplace, but given WWW’s brand strength, they were able to arrange with Amazon to sell its liquidation inventory on Marketplace

Risks

1. Amazon execution issues may have benefited Wolverine’s eCommerce (Brand.com) growth in 2018, which may create a difficult comp in 2019

• Amazon’s shoe demand suffered in 2018 due to an operational misstep that led to an under‐inventoried position and significant out‐of‐stocks. This issue was fixed for 2019, but may have benefited Wolverine’s 2018 eCommerce growth, which accelerated from 20% in 2017 to 30% in 2018
• We assume WWW’s eCommerce growth decelerates from 30% in 2018 to 20% in 2019 in the base case

2. Retail customer bankruptcies

• If sporting goods or department store retailers go bankrupt, it could cause temporary disruption as inventory is liquidated and consumers shift to other channels
• During the “retail apocalypse” of 2017, when many retailers (e.g., Sports Authority, Sports Chalet, Gander Mountain, etc) went bankrupt, WWW’s adjusted sales still grew, albeit slowly (i.e., ~1%)

3. Environmental liability is worse than expected

• WWW used 3M’s Scotchgard to process leathers from the late 1950s to 2002 (in 2002, 3M changed its Scotchgard formula). In 2018, the Michigan Department of Environmental Quality (MDEQ) developed new criteria to test drinking water, and due to this, filed a civil action against Wolverine. MDEQ claims that Wolverine’s disposal of solid waste resulted in releases of a chemical (per and polyfluoroalkyl) that exceeded cleanup criteria concentrations
• WWW has filed a third-party complaint against 3M, seeking remediation and other costs to defend against MDEQ
• The Company has recorded a liability of $31mm in anticipation of environmental remediation costs for the site responsible for this solid waste
• It is difficult to assess any possible further damages, but (1) given the problem originated from 3M’s product, 3M will possibly share in some of these damages and (2) the $ size of the remediation costs are manageable and (3) that liability was recorded without accounting for recoveries from insurance and 3rd parties

4. WWW may have over‐earned in 2018 due to 2 consecutive favorable winters

• Given 2 cold winters followed by 2 warm winters and a program to reduce inventories, WWW may have earned very high margins resulting from low markdowns and closeout sales on winter boot business given the tight inventories and out of stocks. In addition, it may have skewed the annual product mix more heavily to boots which are higher price point and margin. This may be a greater risk as they increase inventories this year
• The Company had a program to reduce inventory levels anyway. In addition, the limited inventory may have resulted in foregone sales of high price, high margin boots in season offsetting some of the benefit of higher realizations

5. WWW states they are actively looking for acquisitions and that they have $1.25 billion of liquidity so there is the risk they overpay or purchase an asset that is unattractive

• Management has stated they are looking for brands with heritage, of a meaningful size, in all geographies and not necessarily in footwear. They said they are also considering bags and apparel
• Management is known for being conservative so should have a solid reason if they diversify away from footwear

Catalyst

Earnings results