K-Swiss: Shareholder-Friendly Management Taking Wise Steps

May.21.07 | About: K-Swiss Inc. (KSWS)

K-Swiss (NASDAQ:KSWS) is a shoe company that designs, develops, and markets sneakers for athletic and casual purposes. K-Swiss has been in business since 1966.

It has two main product strategies; one is its “classic” line of sneakers, which were the company’s first product. They have longer product cycles than normal sneakers and long product cycles reduce the markdowns on a sneaker. This makes it more attractive to retailers. K-Swiss keeps a large inventory of classics in its warehouse.
kswiss shoe
Its other product strategy is based on current consumer fashion trends. It does not keep a large inventory for these. Its goal is to take advantage of current fashion trends in the marketplace while minimizing risk. K-Swiss’ primary goal is to become the “retailers’ most profitable vendor,” meaning that through longer product cycle, it can maximize the effect of market expenditures and minimize retailers’ markdowns.

Industry

It operates in the athletic footwear industry, which is very competitive. Its biggest competitors are Nike (NYSE:NKE) and Adidas (OTCQX:ADDYY). Investment gurus who are bullish on Nike, and by extension the footwear industry, include Warren Buffett, Bill Miller, and Glenn Greenberg.

There are some issues with the economics though; people are worried consumers will slow their spending, being overextended in debt and with gas prices on the rise. To some degree, however, a recession cannot destroy the footwear industry because it meets one of the 3 basic needs of people, clothing.

Recent Developments
Its 1st quarter 2007 report was a mild disaster. Although it managed to beat Wall Street earnings estimates by one penny, it lowered full-year estimates due to significant obstacles in the domestic environment. It lowered its range from $1.20 to $1.50 a share for fiscal 2007 to $1.20 to $1.35 for fiscal 2007. Revenue guidance was also lowered slightly. Domestic revenues decreased 39.7% year over year.

Future orders (backlogs) also decreased significantly year over year. International revenues increased 29.2%. On the bright side, it does not see gross margin shrinking, it expects it to be between 46% to 47%, consistent with its recent results. It stated in its conference call that it will not clear out its inventories at any price; this will keep margins up but pressure sales down. This also will not damage brand reputation.

Its domestic business has been in a decline for the past few years, which is a concern because it accounts for the majority of its total revenues. Domestic revenue has fallen 20% over the past 2 years. Management said during the last conference call that inventories at domestic retailers have been going down and retailers will have to order more K-Swiss footwear in the near future. On the bright side, foreign sales have been growing rapidly, going from over $80 million in 2004 to almost $170 million in 2006.

It has recently put in significant resources into developing new products. Its target date for new products is the 1st quarter of 2008. K-Swiss is also currently working on opening retail locations. Its most recent openings have been in Asia. Its other big investments have been in Royal Elastics and Apparel which are planned to be key future growth drivers. Near-term trends do not seem to be positive with backlogs significantly down year over year.
Anna-Kournikova
Recently, Anna Kournikova has signed on to be the new spokesman of K-Swiss. The thinking behind hiring her as the new spokesman is that she is a tennis star and K-Swiss is a tennis shoe company. It makes sense, but she is more of a celebrity than a tennis star. It will definitely give K-Swiss more publicity, but will people looking for tennis sneakers more likely buy K-Swiss tennis footwear just because Kournikova is its spokesman? I highly doubt it.

Valuation
It's trading at a trailing price/earnings ratio of 14.74. Its earnings yield is 11%. It has $264 million of cash on its books. There is no debt. It's trading at a forward price/earnings ratio for fiscal year 2008 of 17.22. It's a great cash generator, cash flows from operations as a percentage of total revenue has been 14.4%, 18.5%, and 17.7% in the years 2006, 2005, and 2004 respectively. Its return on equity has been very strong, averaging over 25% over the past 5 years. It also pays a dividend of $.20 per year or a dividend yield of 0.7% per year.

Regarding its cash position, it's very conservative with the use of its cash. Acquisitions are not a priority, unless the acquisition is an attractive candidate. A deal just to do a deal is not something of interest. It plans on doing more future share repurchases. A good indicator of when to start buying K-Swiss stock will be when it starts buying back its shares in bunches. During its 1st quarter 2007 conference call, CEO Steven Nichols said that once it has a clearer picture of what 2008 will look like, and if it will be positive, it will aggressively start repurchasing its shares.

Management
Management is fiscally conservative and seems to be on the right path of expanding the company with its new investments. It also has been using its cash wisely by buying back K-Swiss outstanding shares. Its management is very shareholder friendly. Bonuses are based on Economic Value Added [EVA], which better aligns its interests with shareholders instead of regular bonuses based on EPS.

CEO Steven Nichols has been with the company since 1987. George Powlick, who is CFO and COO, has been with the company since 1988. Steven Nichols basically controls where the company goes because he, through a Family Trust, controls 92.4% of the Class B shares. Each Class B share is worth 10 votes compared to each Class A share.

Technicals
KSWS has been in a trading range the past few years mostly between $26 and $36 a share. The medium-term trend is down and the short-term trend is neutral. RSI and MACD are both neutral. KSWS is currently above the 50DMA but below both the 20DMA and the 200DMA. On the bright side, the 20DMA just crossed over the 50DMA, which could be a signal of a change of the trend. Recent volume has been mixed.

KSWS_05_20_2007

Conclusion
K-Swiss was growing rapidly until it starting experiencing issues in the United States. That has thrown its growth curve way off and currently domestic sales are still trending down. There are definitely short-term issues with K-Swiss, but I think management has taken steps to correct this downtrend in domestic sales with new products in the pipeline. Also, the retail stores, the apparel roll-out and the Royal Elastic subsidiary should provide growth.

Buying right now would not be terrible, but since its outlook for the rest of 2007 is not bright, there should be more downside on the way in the near-term. Once its domestic sales start to stabilize, and management starts to repurchase shares in big quantities, that could be a good entry point knowing that 2008 is the year management is planning for the big turn around.

Disclosure: I don’t have a position in KSWS.