Designer Brands Inc.: Q3 Earnings Could Be Huge

Summary

• The company flexed mix towards athleisure wear, now accounting for ~50% of products as opposed to ~35% in 2019 in a bet on continued "casualization".
• I believe this has immensely paid off in the past quarter.
• Expectations into the print may be pessimistic owing to a number of recent factors/news.
• However, it's more difficult to evaluate DSW's future in the long term.

Bruce Bennett/Getty Images News

Company Overview

Designer Brands, Inc (NYSE:NYSE:DBI) is a designer, producer, and retailer of footwear and other accessories (handbags, etc.) for a primarily female audience. The Company operates through three segments: the U.S. Retail segment, the Canada Retail segment, and the Brand Portfolio segment.

DBI operates the DSW Warehouse, Shoe Company, and Shoe Warehouse USA and Canada banners through its nationwide stores and e-commerce websites.

Roger Rawlins has been CEO since 2016, and has held several positions at the company. The CFO is Jared Poff, who has also held several finance positions at the company and previously worked as Treasurer at Big Lots. Jay Schottenstein has served as executive chairman for DSW since 2005 (current CEO of American Eagle).

Revenue Generation

The U.S. Retail segment is just the DSW Designer Shoe Warehouse (DSW) banner, including its United States stores and e-commerce site. The company doesn't break down e-commerce vs physical store revenue, only by men's vs. women's vs. kids.

The Canada Retail segment operates The Shoe Company, Shoe Warehouse, and DSW banners through its Canada stores and e-commerce sites.

The Brand Portfolio segment designs, develops, and sources seasonally-focused fashion footwear and accessories through Camuto LLC, a wholly-owned subsidiary of the Company. Brand Portfolio segment distributes its branded products through www.vincecamuto.com. Through Camuto Group and partnership with Authentic Brands Group (ABG), DBI has a 40% stake in ABG-Camuto, a joint venture that acquired several intellectual property rights, including Vince Camuto, Louise et Cie, and others.

Thesis

DBI has faced troubles during the pandemic that have placed downward pressure on the company. To name a few, DBI faced a significantly larger YOY % sales drop compared to the industry owing to depressed dress demand, gave up on dividend payouts (no plans to reinstate), lost NIKE as a vendor, and provided guidance for 2H '21 to be in line with 2H '19, compared to most other retails projecting a beat. For these reasons, I believe the price to be depressed and expectations to be pessimistic for Q3 earnings.

I consider Q3 '21 to have had stronger results than anticipated, especially in regard to athletic sales and find it likely that the company beats revenue, EBIT, and EPS estimates. Due to the "casualization" of America in the pandemic, the company flexed the mix towards athleisure wear, now accounting for ~50% of products as opposed to ~35% in 2019.

This pivot has already shown some success in the first two quarters. DBI beat revenue estimates by ~8% both quarters and athletic wear accounted for 58% of sales in early 2021 versus 47% of sales in 1H '20 and ~34% in 2H '19.

15% of Fall 2019 assortment had buys of 5000+ units compared to 45% of Fall 2021, indicating DBI's pivot has been extremely successful and SKUs are narrowing into the right inventory.

Despite the company's visibly older and female customer base, the company has decided to lean into this and is continuing to expand into athleisure and kids products despite losing NIKE as a vendor. I consider the fears around NIKE's loss to be overblown. At first glance, losing arguably the biggest vendor in sporting shoes that accounted for ~5% of DSW sales is a major hit.

However, this may actually help the company's relationship with other vendors, who are eager to fill the gap in DSW stores. Also, DSW caters to heavily older females (69% of customers are female) who are less likely to prioritize brand name when it comes to athletics, and 84% of DSW sales come through the loyalty program, so this customer base is relatively sticky.

Source

Assuming that athleisure sales company-wide have doubled from pre-pandemic 2H19, and extending sales mix from Q1,2 '21 (58% athleisure), we achieve an implied ~9% top-line Q3 beat. Customers are also resurging demand for boots and other seasonal wear, so athleisure could even drop as a % of the mix, providing additional upside.

Source: DBI Investor Relations

DSW has well-positioned itself to take advantage of whatever trends its consumers may pick up. Even though management claims it isn't their "long-term desire to be that heavily penetrated" in athletics, they have acquired that customer. And as customers get back into social occasioning, DSW will be able to retain the athletic customer now and get back into ones that buy dress and seasonal with their loyalty program and targeted advertising.

Short interest is also extremely high at around 13.5%, which may contribute to further upside if my Q3 thesis proves true.

A final green flag is the recent sizeable insider buying by Jay Schottenstein, executive chairman of DBI and CEO of American Eagle. In mid to late September, he indirectly acquired a significant amount of DBI shares, doubling his position of 3.3 million shares to 6.7 million shares. To quote Peter Lynch, "insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise."

Source: MarketBeat

Risks/Bear Thesis:

Supply headwinds are probably the only major concern for DSW in the near term. Incremental freight headwinds (Q2 doubled the ~5M of Q1), labor costs, and increasing supply chain challenges along with inventory receipt delays combine to potentially trouble margins in 2H '21. This raises questions as to how DBI can compete with purely online retailers. Even so, the company has produced gross margin expansion (comps up ~350 bps from 2Q19). That said, the company "over-ordered" on athletics in a bet that the sector outperforms, one that I believe has paid off this quarter.

Another (but less important to this thesis) risk is that longer-term uncertainty exists around the previously core section of the business-dress and seasonal. Women's dress comps down ~40% to 2019, and men around 30%, which is offsetting the success of the athletics business. I don't see this as a risk for Q3 as managers have claimed that seasonal wear (boots specifically) outperformed. However, as DSW was created around a specific customer base, they may have longer-term work to do in converting their brand into one that's known to offer a wider selection.

Digital sales will likely outperform physical footwear stores, and COVID-19 has accelerated consumers' move to online retailers. It's likely that department stores and specialty retail will likely continue losing share, so DSW needs to ensure that their loyalty program and consumer base make the digital switch as well.

DBI didn't provide revenue or bottom-line guidance for the second half of 2021. However, management provided additional color on its earnings outlook where it expects 2H 2021 EBIT to meet 2H 2019 levels of roughly $56 million, in line with the Street's expectations into the print. While this is lower than most other retailers, this also could imply that management is confident in its ability to flex opex and marketing spend in line with gross profits to ensure consistent margins. Revenue guidance has historically been in line or slightly above expectations.

Financials and Valuation

The pandemic certainly pressured DBI financially. Per the Q3 '20 earnings call, fixed-cost store infrastructure is not as productive as it once was. Accordingly, DBI plans on aggressively negotiating exits of worst-performing store locations, planning to shutter 10-15% of locations over the long run.

Source: UBS

As shown above, DBI has underperformed sales-wise compared to most other specialty retailers in the COVID recovery. This can be mostly attributed to DBI's emphasis on designer and dress shoes into the pandemic, for which demand has been muted due to the "casualization" of America, clearly a result of the pandemic work-at-home movement. In response, DBI is heavily shifting into the athletic and kids space for the first time, which as I have mentioned, seems to be paying off, and may especially do so in Q3.

DBI carries a significant debt load, around $1.08B of long-term debt and $770M of current liabilities. While interest payments haven't historically been significant to the bottom line, this may change. The company maintains a $250M Term Loan, for which the effective interest rate is around 11%. In August 2020, DBI replaced a Credit Facility with an ABL Revolver, which provides a revolving line of credit of up to $400.0 million, of which $294.7 million is available for borrowing. Both carry higher interest rates than their predecessors.

Current financial obligations are also somewhat suspect. Accounts receivable is lower than accounts payable. Excluding inventory and all operating lease assets and liabilities, current assets total $300M and current liabilities totals $580M. The remaining ABL revolver funds should just about cover current financial obligations, so DBI shouldn't need too much further debt load or share dilution. However, it does make sense to suspend dividend payments, share repurchases, and shutter some of the worst-performing stores, which DBI can and has done.

My valuation is based on a Gordon-Growth DCF model. The EBIT projection derivations can be found at the bottom of this pitch I derived a price target of $23, implying around 70% upside. However, note that this pitch greatly revolves around my conviction that DBI beat Q3 earnings, and is, therefore, more short-term focused, so the DCF is mainly just for directional purpose (ensure there's still room to move up).

Source: Author Created

Source: Author Created

Analyst’s Disclosure: I/we have a beneficial long position in the shares of DBI either through stock ownership, options, or other derivatives. 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.