DSW Inc. (NYSE:DSW), which stands for Designer Shoe Warehouse, is one of the largest discount shoe retailers in the US. The company operates 430 stores in 42 states and also sells its merchandise online. Its strategy is to offer a large assortment of some 24,000 pairs of shoes of various styles for both men and women through its warehouse style showrooms. Customers freely browse the store to try on different styles from the shoes displayed without needing to request salespeople to fetch proper sizes. Its business model is to leverage its large purchasing power and pass through the 20-30% savings to consumers. Despite the highly competitive nature of the retailing industry, the company’s value and convenient offerings provide a unique market position that allows it to defend against the onslaught of newly formed ecommerce companies, as indicated by its stable market share. DSW shoppers value the ability to see, touch and try on shoes as part of their shopping experience.
Similar to clothing, shoes are a seasonal business. The recent extreme weather, a very seasonally warm Fall, has impacted sales much more than management’s efforts to weatherproof the operations. We see this weather issue as temporary, but it did significantly contribute to the almost 50% decline in share price since April, and provide an opportunity to invest in DSW. In any typical year the business is very profitable and generates high level of free cash flow.
On a longer term note, we endorse the company’s investment in technologies to expand its online business, improve inventory management, and reduce future store opening needs. Having the “omni-channel” capability, where customers can order online and have the items shipped to one’s house or picked up at a nearby store, provides the advantage that many other competitors do not have. Furthermore, better technologies will enable the company to carry shoes suitable to local market demands. Better inventory management also means lower markdowns. More importantly, if the online strategy succeeds, DSW will be able to reach a larger market without having to build new stores, all of which should allow DSW to improve its profitability and increase operating margins 150-200 basis points over the next two years.
From a financial perspective, DSW is trading at about $23.50 a share as of November 27, 2015, with a very strong balance sheet with net cash and investments of $5.24 per share. We think in a normal year, DSW has a $2.50 a share earning power, which provides a mid-case NAV target of $40, a level it traded at earlier in the year.
From Third Avenue Management (Trades, Portfolio)'s Small-Cap Value Fund fourth quarter 2015 portfolio manager commentary.
