Shoe Carnival: No Party in 2007 - But Cheap

I HATE retail stocks, who doesn’t? If you look at my holdings, it is pretty evident that I am not a fan of the sector. Despite my macro concerns, I am well aware of the potential for babies in the bathwater. As I wrote in October (13 Extremely Oversold Consumer Stocks), I created a screen to identify potential bargains. 3 of those names were from the shoe sector, certainly out of proportion with their representation in the sector. As you can see in the table below, the three stocks have performed well relative to the broad market and to the Consumer and Retail sectors in general:

Of course, the only reason that the three stocks have outperformed is that SHOO announced that it is in talks to “enhance shareholder value”. Still, though, the other two stocks have performed pretty much in line with the market. Having taken a closer look (and actually having made a purchase at DSW), I think that Shoe Carnival (SCVL) (13.90, $180mm) is way too cheap and worth considering for investment despite not facing favorable fundamentals.

SCVL operates a chain of 293 shoe stores in the Midwest, South and Southeast that sells to the entire family. They describe their strategy as employing value pricing, which makes sense if you look at where they operate: Strip centers in lower middle class neighborhoods. Make no mistake; Cary Bradshaw won’t be buying her Manolos here!

Let’s face it; this company is probably facing a lot of headwinds. The industry is suffering from declining same-store sales. My investment thesis certainly wouldn’t count on some big turnaround in the near-term, but there are a number of reasons to consider this as a low-risk way to buy a company that has delivered 13% compound EPS growth over the past decade and generates free cash flow.

The Stock is Cheap

No matter how one looks at this stock, it is cheap. On a PE basis, the stock trades at 12X “depressed” FY08 and 9X FY09. On a P/B basis, the stock trades at 0.9X book (100% tangible). On a P/S basis, the stock trades at .28X. Finally, on an EV/EBITDA basis, it trades at a measly 3.5X:

There Are Several Defenses

Having reviewed the 10-K and familiarized myself with some of the history of the company, I learned that this company has a conservative Midwestern culture (based in Indiana). The Chairman’s family owns 30% of the stock, which indicates that shareholder interests are most likely aligned with management’s. There hasn’t been a single share of stock sold by insiders in the past 11 ½ months, with the last sales at about $27 in small size. The shoe industry is interesting in that while the timing of purchases is certainly discretionary in the short-term (perhaps why sales are suffering now), ultimately there is a replacement necessary, especially for kids (17% of sales). So, in the weak economy that I expect, a shoe retailer has the potential to be somewhat defensive. The balance sheet and cash flow of the company offer defense as well. The company has generated positive free cash flow (CFO – CapEx) despite opening stores at the rate of about 10% per year. While the company doesn’t own its real estate, the balance sheet is pristine. First, Equity is $200mm, which is up 3% from a year ago (which is up 6% on a per-share basis, as the company has repurchased stock). Cash stands at $15mm, and there is no debt. One of the things to watch out for with respect to retailers is unhealthy inventory growth. In the case of SCVL, inventory is up just 3% from a year ago on sales growth of 5%. Looking back to two years ago, the sales are up 4% while inventory is up 2%. No apparent problem there! Looking at the big picture, we have a company whose earnings estimates are falling amidst weak industry conditions, but there doesn’t appear to be a glaring problem with the company. The strong balance sheet and the history of positive cash flow should give comfort. The company has had negative EPS only once it its 15-year history as a public company (1996), suggestive of minimal potential devaluation of the book value.

Technicals

The stock is very oversold, though it has the potential to have put in a low already at 12.80. The 13 area was resistance in 2001, support in 2003 and then in 2004, and resistance again in early 2005. Tax-loss selling could be an issue for the next 40 days. More imminently, the company reports on 11/20. The report will most likely not be pretty, but it could serve as a potential opportunity to pick up some shares. I fully expect to see the analysts take down their numbers significantly. As of 9/30, the 5 top holders (FMR, DFA, Entrust and Barclays and Bonanza) owned over 35% of the company, with none reducing significantly in Q3 (though there was a seller of 3% of the company). Short-interest has increased recently and represents about 6 days of trading volume and 9% of the shares outstanding (though a higher amount of the shares excluding the Weaver Stake and the 5%+ holders).

Conclusion

There is nothing particularly exciting about SCVL, but it is so cheap that it deserves a look. Perhaps it is too early to buy, but the downside seems quite limited and the stock should command some attention in 2008 due to the defensive characteristics that I cited. As anyone who owned Restoration Hardware (RSTO) knows, sometimes it doesn’t pay to wait for a good chart or improving fundamentals. In this case, the stock is much cheaper and has a much stronger balance sheet. This is an industry that has been consolidating for years. I might just add some after they report.

Disclosure: No position in any stock mentioned in this article

Comments

[AlanBrochstein]

I just listened to the call. I think that the management team appears to be very thoughtful. While they have perhaps not been watching the big picture closely enough, they have made some organizational changes that should address it. One of the most interesting revelations is that their weakness in same-store-sales is primarily related to the absence of their traditionally strong ethnic customer base. As far as looking at the numbers, they are hurt to a great degree compared to 2006 due to a calendar shift apparently. Bottom-line, this company is trading below tangible book value, has set the bar pretty low (perhaps not low enough) and should not generate a significant loss per share next year (though the current estimates are still to high in my opinion). It is probably a little early to get in for a big move, but the bottom should be near. I purchased some stock on Wednesday 11/21 and will look to add more in the future when the bottom in s-s-s declines appears to be in sight.

[shoedog]

You need to look at the differences between the older stores doing over 3mm and the new stores doing under 2. The old stores have a loyal customer base who don't look for fancy displays, just value. After all, the basic customer SCVL started with was blue collar joe earning his money an hour at a time. The new stores look like someone's mental image of a boutique where upper class people shop. They don't do any volume. They don't have near the bottom line as the older stores. Wise up. As the older stores are closed and more new less profitable stores open, the numbers are going to get worse and worse. This company is headed for a major shakeup in the next 2 years. Putting a financier in charge of a retail operation makes no sense. Put a retail person in charge who actually is willing to SEE who the customers are and what makes them want to shop a particular chain and see what might happen.