Thursday, September 16, 2010

Common Stock Analysis of Collective Brands (PSS) (Formerly Payless Shoe Stores) - Alpha

Collective Brands (PSS - $12.50 on Sept. 2, 2010) was a Topeka Kansas company founded in 1956 with a strategy of selling low-cost, high-quality family footwear on a self-service basis. It was bought by May Department Stores in 1979, went public again in 1996, and in 2007 bought Stride Rite (a Mass. Shoe company started as Green Shoe in 1919). PSS is one of the largest shoe retailers in North and South America, with 4,500 stores selling 140 million pairs of shoes and 40 million accessories in 2009. Its wholesale division is PLG, selling shoes to a range of stores in North America. Here’s how the company defines its strategy in its 10-K:

“We seek to compete effectively by getting to market with differentiated, trend-right merchandise before mass-market discounters and at the same time as department and specialty retailers but at a more compelling value. North American stores are company-owned, stores in the Central and South American regions are operated as joint-ventures, and Middle East stores are franchised. Stores operate in a variety of real estate formats. Approximately a quarter of the company-owned stores are mall-based while the rest are located in strip centers, central business districts, and other real estate formats. We also operate® where customers buy our products on-line and store associates order products for customers that are not sold in all of our stores. At year-end, each Payless ShoeSource store stocked on average approximately 6,700 pairs of footwear. We focus our marketing efforts primarily on expressive moms and expressive self-purchasing women ages 16-49. These consumers use fashion as a means of expressing their personalities, but also place importance on low prices. They tend to have household incomes of less than $75,000 and make a disproportionately large share of household footwear purchasing decisions. We believe that over one-third of these target consumers purchased at least one pair of footwear from our stores last year.”

Here are the financials:



Key Stats:

-Cash-flow generating healthy retail company, selling the staple of shoes - trades at cheap levels and is paying off debt. Fair Value range of shares between $32 to $40.

-Health of the core business: Seems positive but needs further investigation by talking to store managers (esp. in intl. locations). Most of the PPE seem to be in store fixtures, not the actual real estate which they tend to lease (financials are not fully clear about this). So the real value of the PPE is prob. less than the book value. All their inventory is made abroad (China, Vietnam, etc.). SG&A has held consistently around 29%-30% since 2006 – not worried about that (recent gross margins at 35% are at the high end though – not sure if this is cyclical or a positive trend). Turnover slowed because their assets went up (growth of book value) but sales basically stayed flat or slightly decreased (peak was $3440mn in 2009 and the TTM is $3320mn).

-Negative same store sales growth has slowed: This has flattened as of Q1 2010, going from -5% in Q1 2009 (the worst) to -1% (total net sales were up 2%, as US sales fell by 4% but international sales were up by 18%). COGS were down and margins up. The biggest question is PSS’s relative competitive position compared to discounters like Walmart, Target, etc. (do people go to a special shoe store for cheap shoes, or are they happy buying them on a discount store trip?). This isn’t a shoe business (like Nike or Asics), but a shoe retail store business.

-Earnings don’t matter much, cash does: The numbers are volatile. The margins and earnings are about par with the comps, but this business is selling much more cheaply. After hitting a low in May 2009, cash balances are coming back up. More importantly, OCF and FCF are holding up quite well. Total current assets at $1050 is about equal to total liabilities and LT debt at $1150. The company has been paying off debt steadily.

-The business is cheap: Then you have the net book value of PPE at $450mn, along with an OCF of $310mn and FCF of $210m. This is for a current equity market cap of $914mn (as of Sept. 10, 2010).

So basically, for $914-450= $464mn in equity invested, you’re getting $210mn of FCF a year. A pretty decent return of 45%. Even at the full $914mn, you’re getting 23%.

-Current CEO is a Cole Hahn and JCrew vet – he knows branding.

- Recent big strategic investor is Blum Capital in SF, whose MO is to take a large stake for 3-5 years and then work on building value over that period.

- Sales uncertainty: The biggest question is whether intl. sales growth can keep strong and domestic sales decline can be stemmed. The retail shoe business isn’t going anywhere, though, and Payless/StrideRite own the bottom end of the market (strategy is to focus on “expressive women”, i.e. moms and young women who want cheap but fashionable shoes for themselves and their kids). People still have to buy cheap shoes in a recession (millions of working class people go to PSS’s stores). Still some uncertainty about this large topline risk.

-Some valuation risk, maybe not enough of an asymmetric bet: Tangible book value is close to 0 (does BV matter anymore?), they've been experiencing negative same store sales growth over the last 3 years, margins stink (and have stunk for the last 4 years). So, all you're getting is current earnings. This quarter earnings are $0.83 per share, and last year they were $0.59 so let's go with the more conservative number. Simply annualizing that and applying a PE of 6 (treating this as a utility with no growth prospects), we get a fair stock price in the area of $14.16. If they get a couple of good quarters and people get optimistic, I could easily see investors applying a PE of 12 with earnings of $.90 which would produce a stock price of $43.20. So, potentially plenty of upside, but the true economics are not attractive. I wouldn't consider this a value investment unless I could it buy it for <$9. On the positive side, customers are very spread out, and average price increases in a year were 4-6% (pretty strong), as same store sales fell 2-3%.

- Company's cost structure is bad: It has high fixed costs and low margins. It may take little to send them on to a road of bankruptcy, despite a strong cash position (a risk for all companies with such debt levels, though PSS is paying off its debt fairly quickly and the maturity wall doesn’t seem to be a problem).

-We anticipate a high change (60-70%) of a general US stock market sell-off, making the business even cheaper (a 40% FCF return on market value would be perfect).

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