Going Bullish on Boots - Especially Timberland

by: Wall Street Strategies

By Brian Sozzi

There are key factors that are warming up for boot makers that in the aggregate may make 4Q earnings a perfect storm of sorts (in this essence, a perfect storm is a good thing). Puns aside, the outlook for boot makers medium-term is positive, a result of: (1) the marrying of style and innovation to a usually rugged footwear category; (2) extreme winter weather in important European boot distribution countries, Russia, Poland, Germany, and the U.K.; and (3) colder than historical average weather for this point in the year in the U.S., which comes at a time of improving consumer confidence and trend in the category (mostly in men's) that create probabilities for higher full-price sales and stronger than planned reorder activity.

Style and innovation are two words usually not synonymous with boots. Any product from Apple (NASDAQ:AAPL) surely can boast a sense of elegance and a level of innovation that changes a person's quality of life (for the good or the bad). Yet, many boot makers have brought style and innovation to the category this season. The main trends I see, outside of a touch more style from the omnipresent Uggs for women and kids, are within the men's category and revolve around the classic chukka.

Some designers are playing off the military chic theme occurring in apparel, while others have elevated the chukka to a position in which a pair could be warn proudly to work. The overall presentation of apparel in the mall supports the uptake of boots; skinny jeans tucked into the boot donned by a button down plaid shirt, a cable sweater, or a form fitting knit. The men's boot category is not basking in all the fun, however. Women's duck boots from Coach (NYSE:COH) and Decker's Outdoor (NASDAQ:DECK) (maker of Uggs) are front and center on the tables at leading department stores, and one can't help but to have recognized the increased popularity of rain boots this past fall. After all, who wouldn't want a pair of Jimmy Choo branded Hunter rain boots? The Jimmy Choo Hunter rain boots at Nordstrom (NYSE:JWN), coupled with a pair of Welly fleece liners, plus NYC sales tax, has a consumer invested into a $310 purchase in what amounts to a molded pair of rubber. Rain boots at one time were meant for puddle frolicking, but with a pair of these pricey Jimmy Choo Hunters with comfy liners, I think a dance around a NYC puddle would be in order.

Regarding pure innovation, don't look any further than Columbia's (NASDAQ:COLM) Bugathermo boot, which retails for $325. It's a winter boot that has a built-in, rechargeable (using a USB chord) heating system. Classic Reebok pumps have nothing on these babies.

This brings me to one of many points in this musing. Boots are investment pieces, and it's these products that are perceived as such that have been the predominant driver of discretionary consumer spending in 2010. Consumers aren't necessarily back in the malls loading up on the same sweater or pair of jeans in different colors or washes. Rather, that hard earned, or well saved, cash is getting plunked down for products that offer value beyond an attractive price on a recycled piece of paper (aka, price tag). I have seen this play out at Coach in the last two quarters and the litany of 3Q earnings reports from luxury goods companies. So boots as investments is a plausible notion to grab onto, and evident in the increased points of distribution at the likes of Saks (NYSE:SKS), Nordstrom, and Bloomingdales both online and in brick and mortar stores.

The other ingredient to my perceived perfect storm scenario for boot makers is none other than Mother Nature herself. It's always difficult to say that the arrival of cold weather globally is an uber positive for boot companies. In years gone by, distributors planned for unseasonable weather in terms of their inventory investment, so the increased demand is met with appropriate inventory, therefore capping upside potential to sales and earnings for boot makers. However, current inventory at retail, while higher than holiday 2009, is still being planned with an eye towards caution and below the prior cycle peak. If the Great Recession taught anything to retail management teams it's that a tighter focus on margins is more beneficial than flooding the market with inventory to chase a sale. In the current environment, if a retailer floods the channel with inventory, ala Sketchers (NYSE:SKX), the product turns into a commodity, demand falls, and it takes three quarters to clear through the marked down inventory. Good luck selling that strategy to investors. Timberland (NYSE:TBL) only recently seemed to be on a never ending campaign to clean up inventory of its iconic yellow boot.

In this regard, the existence of, comparatively speaking, lean inventories at retail and harsh global weather conditions is welcoming news to the purveyors of boots. Severe snow and temperatures are abound in Europe, and tornadoes not of the economic kind have rocked Portugal and Spain. Here in the U.S., arctic air is spreading throughout just before the peak in the holiday selling season, which may only spark the rush to buy boots as gifts for family or one's self.

Now down to brass tacks. How are investors able to make money off the perfect storm scenario I have constructed? Sure, you could always go with the tried and true boot play, Decker's Outdoor. Further room to the upside is possible following a 154% year to date run for the stock given how strongly the business is trending. My channel checks have indicated new and classic Ugg boot styles, in addition to cold weather accessories, are flying off the shelves at leading department stores and Ugg's retail stores. Columbia Sportswear may be worthy of a glance in view of its strong balance sheet and exciting product line. But, the valuation on the stock is too rich for my blood. Timberland, trading at a discounted valuation relative to Columbia Sportswear and Decker's Outdoor, and its own historical mean on a P/E multiple basis, catches my value investor antennae.

Is everything going completely right at Timberland? Not necessarily, but I think the market has baked that into the stock's valuation. The company's classic yellow boot still casts a shadow over the successes being realized in other areas of the product portfolio. That classic yellow boot, so popular in the macho prep heydays of the late 1990s, has fallen out of favor with kids but incrementally in favor once again with construction workers getting called back to work in the U.S. and those in Asia that are building infrastructure. It's a sluggish sales category for Timberland despite management putting greater resources behind the product's design and development. The positive here is that Timberland's management has finally gotten inventory of the product under control. Higher leather and transportation costs in 2011, and continued ups and downs in women's boots, are also call outs. So where does my optimism on the stock arise?

1. Where Timberland boots are sprouting up: If you don't follow Timberland as closely as I do, it's natural to reason that the brand remains one stuck on the shelves at Sears (NASDAQ:SHLD). Times have changed, however. Although Timberland's women's boots are underrepresented at Nordstrom, Saks, and Macy's (NYSE:M) the men's category has garnered increased shelf space in stores and positioning on related websites. Nordstrom carries Timberland's environmentally friendly line Earthkeepers, selling at $170 a pop. The Counterpaine chukka sells for a cool $315. At Saks, Timberland has shipped exclusives, with the Tackhead chukka selling for $325. One common thread amongst user reviews on the Saks website is that the Timberland boots are "stylish." Even Macy's sells Timberland chukkas (price range: $90 to $125) and Earthkeepers ($145). Timberland is quietly changing the perception of its products in the marketplace. Retailers appear to be listening, and they only listen if the product is designed correctly for trend and the consumer is buying.

2. Weather in Europe: The countries in Europe experiencing nasty weather are where Timberland has momentum in its business, such as Central Europe and France. The Benelux region, challenging for Timberland in 3Q, is also under the grips of inclement weather, which may spur improved 4Q results. Europe as a whole is Timberland's highest operating margin business, ahead of the U.S. and Asia.

3. Asia: Timberland's Asia business is profitable and growing. While others in retail are operating at losses in Asia as they build infrastructure and giant flagship stores, Asia for the nine-months ended October 1, 2010, posted a strong 12.90% operating margin for Timberland. The company has 95 stores in Asia, and CEO Jeff Schwartz during a recent trip to China stated his intention to double the store base in the country. Timberland products sell at a premium price in Asia based on my observations.

In any investment, there are associated risks. As I mentioned, pockets of Timberland's product portfolio are moving along sluggishly, product costs will rise in 2011, and a new ERP system is being implemented that may trigger minor disruptions. However, with identifiable growth levers in the business product wise, a lean operating expense base post restructuring, and a higher margin European business being exposed to favorable weather for boot sales I think near-term earnings catalysts exist. I can't help but to think consensus forecasts are too low on Timberland as all the analysts, including yours truly, rate the stock a "Hold" or a "Sell". Moreover, let's not discount Timberland's cash rich, debt free balance sheet, which boasts an almost 3x current ratio and has produced uptrending ROA/ROE measures.

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