By The Valuentum Team
Steven Madden's (NASDAQ:SHOO) brand strength and debt-free balance sheet are two of its most valuable qualities, in our opinion. The firm boasts the leading position in US women's fashion footwear through its various brands. Diversifying by brand has been key over the past decade, however, as the Steven Madden brand now accounts for less than 60% of total revenue compared to 86% in 2005. The company has diversified its product offerings as well, and accessories (handbags, belts, cold weather accessories and sunglasses) now generate ~22% of total revenue.
We love Steven Madden's balance sheet health. As of the end of the second quarter of 2016, its cash, cash equivalents and marketable securities position stood at nearly $200 million and it held no debt on the books. This gives the firm meaningful financial flexibility as it continues to pursue growth opportunities, including geographic expansion, brand diversification, wholesale opportunities, and the proliferation of its e-commerce presence. Management believes it has a long runway of growth ahead of it in its international operations, which currently account for only 11% of net sales.
Steven Madden is well-positioned for continued growth, in our view, but its success is tied to its ability to accurately predict fashion trends and the disposable income level of consumers. Both of these factors can create volatility in its operations, but we like the cushion the firm has sitting on its balance sheet in the form of a net cash position. It offers a lot of necessary financial flexibility that may be required in the event of a prolonged fashion misstep, which may be an inevitability in its line of business. Let's take a deeper look at the company's investment considerations as we work to find just how attractive shares may be.
Steve Madden's Investment Considerations
• Steven Madden designs, sources, markets and retails fashion-forward footwear for women, men and children. The firm distributes products through retail stores, its e-commerce website and through special distribution arrangements across the globe. The company was founded in 1990 and is based in Long Island City, New York.
• For 2016, Steven Madden is expecting net sales to increase 2%-4%, and diluted earnings per share are expected to be in the range of $1.93-$2.03. Comparable store sales growth in its retail division has been solid in recent quarters.
• Steve Madden has a number of growth initiatives. The firm is targeting $200 million in international sales by 2017, up from ~$150 in 2015; a 10% operating margin it its Dolce Vita brand, up from ~7% in 2015; a 10% operating margin in its Retail segment, up from ~7% in 2015; and combined sales in its Men's/Kids segment, up from $167 million in 2015.
• The company's international potential may represent its best expansion opportunity. Steve Madden has strong momentum in Asia, UAE, and Mexico, and expects to add both free-standing stores and concessions in these regions.
• Since fiscal 2008, sales have advanced at a 17% CAGR, and earnings per share have jumped at a 21% CAGR. We attribute most of this expansion to the company's significant brand strength.
Economic Profit Analysis
In our opinion, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital.
The gap or difference between ROIC and WACC is called the firm's economic profit spread. Steven Madden's 3-year historical return on invested capital (without goodwill) is 36%, which is above the estimate of its cost of capital of 10.8%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT.
In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Steven Madden's free cash flow margin has averaged about 9.5% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG.
The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Steven Madden, cash flow from operations decreased about 13% from levels registered two years ago, while capital expenditures fell about 6% over the same time period.
We think Steven Madden is worth $33 per share with a fair value range of $26-$40.
The margin of safety around our fair value estimate is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 4.4% during the next five years, a pace that is lower than the firm's 3- year historical compound annual growth rate of 4.6%.
Our model reflects a 5-year projected average operating margin of 14.1%, which is above Steven Madden's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2.8% for the next 15 years and 3% in perpetuity. For Steven Madden, we use a 10.8% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $33 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph above, we show this probable range of fair values for Steven Madden. We think the firm is attractive below $26 per share (the green line), but quite expensive above $40 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Steven Madden's fair value at this point in time to be about $33 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Steven Madden's expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $45 per share in Year 3 represents our existing fair value per share of $33 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.