Skechers USA Inc. (SKX, Financial) is a shoe manufacturer and holds a niche in the casual footwear market. For my previous coverage on Skechers and why it looks attractive, I refer the readers to this article. The gist of the buy pitch was as follows:
There were two points I was critical about in the previous article.
But in the end, I concluded that the stock is very cheap from a value perspective as it sells for less than its working capital and almost 0.6 times its tangible book value.
On a sales perspective Skechers is not very cheap . It sells for a P/S of 0.4 (annual report 2011). In the last decade its average net margin has been around 4%. So, on a sales basis the current price does not offer us a margin of safety per se (assuming a P/E=10).
Given that we do not have a good margin of safety in terms of sales, the question is if the management can turn the company around and stop the losses which Skechers is going through or they will end up wasting a lot of money on the turn-around? Furthermore, as judging management is an incredibly difficult task, should I hold a company which does not offer me a very good margin of safety? Notice that Skechers does not have a very good record as a profitable company in terms of OCF and FCF (they have been net income position for the 8 times out of the last 10 years).
Keeping this in mind, we start by gathering some data for judging the management. First, Mr Greenberg has been CEO of Skechers since 1993. Also, all six key executives have been in their positions since 1998 (or before). In short, no one has left an executive position since 1998.
The year 2010 was a record year for Skechers. Its toning shoes were selling like hot cakes and in hopes that the product will continue selling quite well, Skechers built a big inventory. Let us look at the situation in numbers:
Strike 1: If we look at the inventory-vs.-total asset figures, we see that Skechers was being quite aggressive about the sales. It had large part of its assets in inventory. Comparing it with Nike (NKE, Financial), we see that Nike has around $2.5 billion inventory with quarterly sales of around $5 billion (also Nike has never been OCF negative in the last decade).
Management clearly knows that it had made a mistake in accumulating so much inventory in the toning category and is aggressively trying to sell those. Management is not amenable to accept it as a loss by writing it down.
We hear about the international expansion Skechers is doing, mainly in Japan. Skechers has 319 company-owned retail stores and 32% of the sales come from outside U.S. In the third quarter, Skechers opened 11 domestic and 3 international stores including SKECHERS Fitness store in Chicago suburb and their fourth SKECHERS store in Greater London. Also, Skechers considers its licensing division as an additional profit channel for the company.
During the Q&A session the CFO Mr Weinberg mentioned that they expect the sales to be down in Q4 as they have a totally new line of footwear which is just going in and is testing very well.
Plus 1: Mr Weinberg does not forecast how much the fourth quarter sales will be down. The analysts ask for a number around 350-360 million and he comments “could be.” No one knows the future and it is futile to guess what could be the sales in the future.
Mr Weinberg further forecasts that there will be $60 million which they will get as a tax credit. This is true if we look at the fourth quarter conference call. Furthermore, he also says that they will wait and try to move the toning inventory as they are in no hurry. They have cleaned up a good part of it and will wait for the spring as it moves sales in the winter.
In the fourth quarter we see that sales are down considerably. They are almost half of what they were in fourth quarter 2010. Even the most dramatic analyst expectation was above this figure. The shares fell around 4%.
The new line was delivered in the fourth quarter and Skechers is very confident that it will be able to lift sales. Furthermore, it expects to transform the Japanese business to a wholly owned subsidiary from a third party distributor.
Mr Weinberg adds: "2011 was a challenging year with the shift in footwear trends, but we are pleased with the advancements we have made in our product offering and in the management of our inventory levels, which decreased by $172 million year-over-year. We believe our cash position of $351 million, our reduced inventory levels, along with the opening of our more efficient North American distribution center in November 2011, our significantly reduced selling expense plan, as well as an expected tax refund receivable of approximately $52 million, provides us with the necessary liquidity to position us well for the back half of 2012. We will be working toward reducing our operating expenses relative to top line revenues in the back half of the year, and believe the only planned spending increases this year will be for the opening of 18 to 20 company-owned stores and the launch of our subsidiary in Japan as we look to build this market to be our largest subsidiary. "
- Skechers has a very good balance sheet. Working capital exceeds the current market cap. It has $248 million in cash and $343 million in total liability. It can weather the vagaries of the economy very well.
- Skechers also has a significant insider holding. It has 11.3 million class B shares (54% are held by Gil Schwartzberg and another 38.1% are held by management) and 38.5 million class A shares (13.7% are held by Mr. Schwartzberg and 12.7% are held by the management). The management is not selling or buying any substantial amount of shares at the moment.
- Skechers seemed like a company that was going through a bad year after its toning shoes fell from grace in 2010. I was hoping that Skechers should recover within a year or so.
There were two points I was critical about in the previous article.
- The FCF has been very uneven. Skechers had five years with negative FCF in the last decade (2001-2010). Out of these five, three times it has been OCF negative — a very big no-no for a long term value investor.
- The executives pay themselves around 1 million shares every year. This is a 2% dilution from one year to another (Skechers has around 49 million shares). This year was no different.
But in the end, I concluded that the stock is very cheap from a value perspective as it sells for less than its working capital and almost 0.6 times its tangible book value.
On a sales perspective Skechers is not very cheap . It sells for a P/S of 0.4 (annual report 2011). In the last decade its average net margin has been around 4%. So, on a sales basis the current price does not offer us a margin of safety per se (assuming a P/E=10).
| 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | |
| Net Margin % | 4.92 | 4.98 | -1.42 | 2.56 | 4.44 | 5.89 | 5.43 | 3.85 | 3.80 | 6.77 | -4.18 |
| Operating CF | -2 | 117 | 12 | 33 | 76 | 26 | 101 | -22 | 115 | -47 | - |
| FCF | -33 | 102 | -9 | 17 | 62 | -2 | 70 | -94 | 75 | -130 | - |
Given that we do not have a good margin of safety in terms of sales, the question is if the management can turn the company around and stop the losses which Skechers is going through or they will end up wasting a lot of money on the turn-around? Furthermore, as judging management is an incredibly difficult task, should I hold a company which does not offer me a very good margin of safety? Notice that Skechers does not have a very good record as a profitable company in terms of OCF and FCF (they have been net income position for the 8 times out of the last 10 years).
Keeping this in mind, we start by gathering some data for judging the management. First, Mr Greenberg has been CEO of Skechers since 1993. Also, all six key executives have been in their positions since 1998 (or before). In short, no one has left an executive position since 1998.
The year 2010 was a record year for Skechers. Its toning shoes were selling like hot cakes and in hopes that the product will continue selling quite well, Skechers built a big inventory. Let us look at the situation in numbers:
| 09-2010 | 12-2010 | 03-2011 | 06-2011 | 09-2011 | 12-2011 | |
| Revenue ($m) | 557 | 456 | 478 | 436 | 414 | 283 |
| Inventory ($m) | 327 | 399 | 376 | 326 | 238 | 226 |
| Total assets | 1,230 | 1,305 | 1,332 | 1,348 | 1,248 | 1,281 |
Strike 1: If we look at the inventory-vs.-total asset figures, we see that Skechers was being quite aggressive about the sales. It had large part of its assets in inventory. Comparing it with Nike (NKE, Financial), we see that Nike has around $2.5 billion inventory with quarterly sales of around $5 billion (also Nike has never been OCF negative in the last decade).
Conference call Q3-2011
Let us now turn towards the third quarter conference call.Management clearly knows that it had made a mistake in accumulating so much inventory in the toning category and is aggressively trying to sell those. Management is not amenable to accept it as a loss by writing it down.
We hear about the international expansion Skechers is doing, mainly in Japan. Skechers has 319 company-owned retail stores and 32% of the sales come from outside U.S. In the third quarter, Skechers opened 11 domestic and 3 international stores including SKECHERS Fitness store in Chicago suburb and their fourth SKECHERS store in Greater London. Also, Skechers considers its licensing division as an additional profit channel for the company.
During the Q&A session the CFO Mr Weinberg mentioned that they expect the sales to be down in Q4 as they have a totally new line of footwear which is just going in and is testing very well.
Plus 1: Mr Weinberg does not forecast how much the fourth quarter sales will be down. The analysts ask for a number around 350-360 million and he comments “could be.” No one knows the future and it is futile to guess what could be the sales in the future.
Mr Weinberg further forecasts that there will be $60 million which they will get as a tax credit. This is true if we look at the fourth quarter conference call. Furthermore, he also says that they will wait and try to move the toning inventory as they are in no hurry. They have cleaned up a good part of it and will wait for the spring as it moves sales in the winter.
In the fourth quarter we see that sales are down considerably. They are almost half of what they were in fourth quarter 2010. Even the most dramatic analyst expectation was above this figure. The shares fell around 4%.
Conference call Q4-2011
Skechers has come out with a new range of products called Skechers GORun. The initial response, according to Mr Greenberg, has been very strong. They have also done a Super Bowl commercial starring spunky French bulldog Mr Quiggly and Dallas Mavericks owner Mark Cuban which is creating a lot of buzz.The new line was delivered in the fourth quarter and Skechers is very confident that it will be able to lift sales. Furthermore, it expects to transform the Japanese business to a wholly owned subsidiary from a third party distributor.
Mr Weinberg adds: "2011 was a challenging year with the shift in footwear trends, but we are pleased with the advancements we have made in our product offering and in the management of our inventory levels, which decreased by $172 million year-over-year. We believe our cash position of $351 million, our reduced inventory levels, along with the opening of our more efficient North American distribution center in November 2011, our significantly reduced selling expense plan, as well as an expected tax refund receivable of approximately $52 million, provides us with the necessary liquidity to position us well for the back half of 2012. We will be working toward reducing our operating expenses relative to top line revenues in the back half of the year, and believe the only planned spending increases this year will be for the opening of 18 to 20 company-owned stores and the launch of our subsidiary in Japan as we look to build this market to be our largest subsidiary. "
