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Investment Thesis
Shoe Carnival (NASDAQ:SCVL), a footwear specialty retailer, has nearly 20% of its market capitalization in cash on its debt-free balance sheet yet trades at a discount to its peers, due to minimal analyst coverage. With record quarterly results generated in the second quarter and free cash flow reigniting again, this retailer is poised to deploy capital to aggressively repurchase stock, increase its dividend, and fund capital expenditures to remodel its store base. As the outlook for fiscal 2022 become clearer, we expect SCVL shares to re-rate higher over the next 12 months. Our base case $43 price target represents more than 25% upside. Our bull case $50 target represents almost 50% appreciation, while our bear case $25 valuation implies roughly 25% downside.
Company Overview
Shoe Carnival is a rapidly growing footwear specialty retailer for the entire family and operates 378 stores in 35 states and Puerto Rico. 95% of stores are located in power strip centers, co-locating with Kohl's (KSS), Target (TGT), Burlington (BURL), Five Below (FIVE), Ross Dress For Less (ROST), and various TJX Companies (TJX) concepts, including T.J. Maxx, HomeGoods, and Marshalls. SCVL primarily merchandises major national branded dress, casual, and athletic styles. SCVL grew sales with a 4.9% compounded annual growth rate from 2000 through 2019, including 11 consecutive years of comparable store sales growth prior to the pandemic.
Source: Shoe Carnival investor presentation
Long-Tenured Board Leadership, High Insider Ownership
The highest ranking leaders are long-tenured and have been very successful in effecting Shoe Carnival's growth strategy. Clifton Sifford, vice chairman, has been with Shoe Carnival for nearly 25 years, beginning as a SVP - General Merchandise Manager and having served as CEO for 9 years through September 2021. J. Wayne Weaver has been chairman of the board for more than 33 years. Weaver was previously president and CEO of Nine West Group, building that footwear brand into prominence. Sifford and Weaver have good company. Kerry Jackson, chief financial officer, has led finance and treasury for SCVL for 25 years. The Sifford and Weaver families are heavily invested in SCVL, owning 1% and 35% of the shares outstanding, respectively. In our view, the interests of the board are aligned with those of shareholders, given this owner-and-operator model.
New CEO Offers Fresh Perspective
On October 1st, Mark Worden became CEO as part of Shoe Carnival's strategic succession plan. Worden joined the retailer three years ago after a 25-year career in brand management and was most recently president and chief customer officer. We think by Worden serving as CEO with only three years tenure with Shoe Carnival, SCVL now effectively has the best of both worlds: long-tenured leadership on the board combined with a CEO who offers a fresh perspective.
Underserved Customer Niche: Working Class Families With School-Aged Children
The core customer demographic for Shoe Carnival is a working class family with school-aged children. 84% of customers have a household income below $100,000, including 30% below $30,000, and 74% of customers are 55 or younger, including 52% between 36 and 55. SCVL customers seek value for brand name footwear and appreciate a one-stop shopping destination for the entire family in a specialty store format. In our view, there are few, if any, direct competitors. For this demographic, the alternative is shopping at big box off-price retailers where the selection for brand names is treasure hunt style and significantly limited. These competitors include Burlington, Marshalls, T.J. Maxx, and Ross Dress For Less. Since SCVL customers desire brand names, they are unlikely to shop for footwear at Walmart or Target, and Kohl's is likely too up market (i.e. too expensive).
Source: Shoe Carnival investor presentation
Fun Shopping Experience & Limited Direct Competition Cultivate Strong Customer Loyalty
Shoe Carnival enjoys a loyal customer base, by benefiting from few direct competitors, and perhaps more importantly, providing a fun, unique, and engaging shopping experience. For example, brick-and-mortar stores led by "mic-people" offer a spin-n-win wheel game, in-store contests, and hot deals to encourage purchases and increase units per transaction.
Shoe Carnival has earned very strong customer loyalty, with membership in its "Shoe Perks" program increasing 10% in fiscal 2020 to more than 26 million customers, per the 2020 Annual Report. For fiscal 2020, these customers generated 70% of total sales. Even more impressive is that Gold members account for only 10% of Shoe Perks (roughly 2.6 million customers) yet they contribute to 42% of overall company sales. Moreover, profit margin generated by Gold members expanded 180 basis points and their average order value increased by $5.50.
Growth Strategy
Shoe Carnival has a simple growth strategy designed to attract new customers, grow same-store sales, and increase store productivity:
- Expand the digital business
- Re-model stores and build clusters in existing states
- Refine customer relationship management
Expand The Digital Business
Shoe Carnival was relatively late to embrace digital commerce. Up until 2012, there was no e-commerce, and after 7 years, digital amounted to a mere 6% of overall sales in fiscal 2019. However, the pandemic essentially forced an acceleration by necessity in digital investments and management's focus, including strategically allocating 70% of its advertising budget to digital media. As a result, 19% of sales in fiscal 2020 were digital. Management's goal is to grow digital to at least 20% of total sales by fiscal 2023.
We think SCVL's goal is conservative (i.e. essentially maintain fiscal 2020 results) and expect digital to be at least 25% by fiscal 2023, the result of new customer-friendly digital features and long-lasting customer preferences ("the new normal"). SCVL partnered with Klarna, a "buy now, pay later" payment platform that enables customers to pay for purchases with four installments interest-free. In addition, to broaden its digital merchandise assortment, SCVL built-up its vendor direct-ship program, whereby some footwear is only offered on digital platforms and directly shipped to customers, thereby also reducing inventory risk. Moreover, SCVL offers ship-from-store, if digital order fulfillment is more efficient that way than from the central distribution center, as well as "buy online, pick-up in store" and "Shoes 2U," a program that ships orders to customers' homes if the item is unavailable at the time a customer is in a store.
Re-Model Stores And Build Clusters In Existing States
For a retailer that operates in 35 states, Shoe Carnival has a relatively small store base with less than 400 stores. As a result, unlike many other retailers, that are undergoing significant real estate rationalization programs to close underperforming stores, SCVL is instead focused on re-modeling its stores to achieve greater store productivity. (In fiscal 2021, SCVL expects to close less than 10 stores.)
The strategic plan is to modernize two-thirds of the store base, representing approximately 260 stores, during the next three to five years. The vast majority of this activity will be store remodels and to a lesser extent store relocations (i.e. upgrading to better locations) and new store openings. Up until this point, SCVL re-modeling was done for 1% to 4% of stores each year. Therefore, this new plan represents a seismic shift in priorities, and we think positions SCVL for sustainable growth. Based on the 2Q:F2021 earnings release, the first 100 store to be modernized will be completed by Spring 2022.
In addition to store re-models featuring an updated, contemporary design, locations with the best potential will also gain a NIKE (NKE) shop-within-a-shop. There are already 100-plus stores that feature this NIKE shop, and the plan is to double that amount through fiscal 2023. NIKE is a strategic partner for Shoe Carnival and its single-largest vendor.
We anticipate Shoe Carnival will add new stores modestly, as historically the retailer has benefited from a measured approach. Within this strategy, the first step is to fill-in store clusters in its existing 35 states, as clusters create fixed-cost economies of scale. Beginning in fiscal 2024, we expect SCVL to enter states on the West Coast and in New England.
Refine Customer Relationship Management
Shoe Carnival's customer relationship management system is already very strong, having built the Shoe Perks loyalty program to more than 26 million customers. However, as earlier mentioned, given that these customers generate 70% of total sales, management believes that enhancing customer relationship management will enable SCVL to retain current customers and attract new ones. For example, per the 2020 Annual Report, stronger customer relationship management supports customer retention by enabling individualized shopping opportunities and experiences, identifying high-value customers through data analysis, and creating effective digital marketing communications. Therefore, we expect that new investments in customer relationship management will yield continued annual Shoe Perk membership increases in the 5% to 10% range.
2Q:F2021 Results
In August, Shoe Carnival reported second quarter results that beat expectations and simultaneously significantly raised guidance for the full-year. SCVL reported record quarterly sales of $332 million (with same-store sales growth of 11% and 26% compared to fiscal 2020 and 2019, respectively), record quarterly gross margin profit of 40.9%, and record quarterly net income of $44 million.
On the earnings conference call, leadership attributed the exceptional second quarter results to strong demand for merchandise driven by a more normalized back-to-school season, improving macroeconomic factors, and the easing of COVID-19 restrictions (nearly 20% of the store base is located in Texas and Florida).
Moreover, what impresses us even more than the second quarter results is management's confidence in the outlook for the second half of 2021. In the second quarter report, management commented that same-store sales jumped 60% for the first three weeks of August (i.e. first three weeks of its third quarter) compared to 2020 and increased 23% compared to 2019. This is quite impressive, given the two-year comparison to the pre-pandemic period.
Earnings Model
Source: Company SEC filings, The Bulls Bay proprietary estimates
For fiscal 2021, our model is based on Shoe Carnival's current guidance, which estimates net sales to be $1.21 billion to $1.23 billion and EPS to be $4.35 to $4.50. We think management's guidance is conservative and designed to beat-and-raise. With a similar approach, during the second quarter conference call, management indicated that it was broadly raising general guidance (fiscal 2022 and beyond) for operating margin to be 8%, up from its prior goal of 6%. However, we think management was too cautious in this case, especially given that guidance for fiscal 2021 implies a solidly double-digit operating margin. In our view, this approach detracted from the stellar second quarter results and significant upward guidance revision, and confused investors and analysts.
Our estimates for fiscal 2022 and 2023 are based on continued strong performance on the top-line, albeit decelerating from fiscal 2021, as 1H:F2022 benefits from the continued economic reopening prompting demand for new footwear (work, school, travel, social events) and beginning in 2H:F2022 business trends somewhat normalizing. Nonetheless, we expect, even in a "normal" environment, Shoe Carnival will benefit from new customer acquisition, continued customer loyalty, reduced promotional activity, and the modernization of its store base. Therefore, our model assumes operating margin to be roughly 12%.
In addition, given the strong free cash flow (operating cash flow minus capital expenditures) that Shoe Carnival generates, we anticipate continued share repurchases to spark further EPS growth. Our model assumes that SCVL will spend $46 million, buying back more than 1 million shares, to complete its current share repurchase program and subsequently authorize another buyback program. For context, during 1H:F2021, SCVL generated $68 million in free cash flow, compared to $50 million in fiscal 2020.
Valuation
Source: The Bulls Bay proprietary estimates
Based on a comparative valuation, Shoe Carnival trades at a discount to its peer group. In our view, given SCVL's minimal direct competition as a destination specialty retailer for working class families, Shoe Perks loyalty program as a core competitive advantage, and debt-free balance sheet, we think SCVL deserves to trade at least in-line with peers with a 8x multiple. However, we think a 9x multiple is warranted in this case, since SCVL also carries $164 million in cash and marketable securities, or $5.70 per share. This represents almost 20% of the company's market capitalization. Therefore, we value SCVL shares at $43 per share, based on 9x our F2022 EPS estimate of $4.74.
Our $43 price target for SCVL represents our base case. We think there is upside to our estimates, provided that fiscal 2022 net sales growth is better-than-expected (i.e. no deceleration) or more shares are repurchased than in our model. Conversely, we think there is downside to our estimates, provided that fiscal 2022 net sales growth is worse than expected or even flat, gross margin erodes faster than we expect from fiscal 2021 levels, share repurchases are less than expected, and/or the economic environment hurts consumer spending.
Source: The Bulls Bay proprietary estimates
Catalysts
F2022 Guidance
As earlier discussed, we think many investors are waiting on the sidelines for management to provide fiscal 2022 guidance. With fiscal 2021 being a record year, these investors are questioning whether this year represents "peak earnings" or whether Shoe Carnival's operational improvements can yield further growth. Therefore, we think the most significant catalyst would be better-than-expected guidance for fiscal 2022.
More Share Repurchases
Prior to the pandemic, a key component of SCVL's capital allocation was share repurchases. However, no share buybacks were done in fiscal 2020 in order to preserve cash. In 2Q:F2021, the company resumed repurchasing shares, buying $4 million worth of stock at average price of $34. For context, SCVL repurchased $46 million and $38 million of stock in fiscal 2018 and 2019, respectively. Therefore, we think the completion of the $46 million remainder on its current share buyback authorization and the authorization for a new program would be key catalysts.
Additional Dividends
We think a dividend increase would be another important catalyst. The current dividend is $0.07 per quarter, yielding less than 1% annualized. In our view, given the free cash flow generation combined with nearly $6 per share in cash held, SCVL could easily double its dividend and/or issue a special dividend.
Risks
Vendor Concentration
We think heavy reliance on one or two suppliers is a double-edged sword. In fiscal 2020, NIKE accounted for 33% of net sales while Skechers (SKX) generated 10%, resulting in these suppliers being responsible for almost half of overall sales. While NIKE is a strategic partner, especially with plans for more than half of the stores to feature a NIKE shop-within-a-shop, we think there is elevated risks for merchandising and logistics to be so reliant on one brand. Nonetheless, with NIKE specifically, SCVL could benefit competitively from NIKE pulling back from certain retailers.
Supply Chain Bottlenecks
While management appeared very confident on the 2Q:F2021 conference call when discussing how supply chain disruptions from Asia have been mitigated for the fourth quarter (holiday season), there was uncertainty about the implications for 1Q:F2022. As a result, there is a risk that supply chain issues are worse than expected to begin next year. However, our channel checks indicate that the supply chain situation appears likely to improve not worsen after the holiday season.
Economic Stagflation or Recession
With a focus on working class families as its core customer demographic, there is heightened risk for Shoe Carnival that softening macroeconomic conditions could cause customers to pullback discretionary spending on footwear. However, on the most recent conference call, management indicated that families receiving monthly child tax credit payments have partially fueled recent same-store sales increases.
Conclusion
SCVL is an exceptionally well-managed footwear specialty retailer with a debt-free balance sheet and nearly $6 per share in cash. Therefore, instead of trading at a discount to its peer group, Shoe Carnival should trade a premium, as almost 20% of its market capitalization is represented by cash. While there is some investor uncertainty as to whether fiscal 2021 is "peak earnings" for this specialty retailer, we suggest that management has built a longer runway for growth, based on digital growth, store remodels, and its customer loyalty program that accounts for more than two-thirds of net sales. We expect shares to re-rate higher and appreciate at least 25% to $43 (our base case) over the next 12 months. The asymmetric risk/reward profile is underscored by our bull case yielding nearly 50% upside to $50, while our bear case implies roughly 25% downside to $25.
