RCKY - Rocky Brands: In For A Rocky Ride

Summary

• RCKY’s relatively decent yield on offer and cheap forward valuations make it something worth considering.
• Yet some key financial metrics have turned sour.
• The macro backdrop isn’t conducive for a discretionary play either.

Let not your expenditure exceed your income. - Plautus

Company Description

Rocky Brands, Inc. ( RCKY ) is a US-based manufacturer and marketer of footwear and apparel. The company’s notable brand names include Rocky, Durango, Georgia Boot, Muck, Ranger, and Lehigh. RCKY operates under three segments:

1. Wholesale- This is the largest segment by far, contributing ~80% of group sales, and involves the sale of footwear and accessories to different types of retailers.
2. Retail- This is the B2C part of the Rocky Brands business where products are directly sold to consumers via their website, outlet stores, marketplaces, etc. This accounts for ~17% of the business.
3. Contract Manufacturing- Rocky Brands also undertakes customized manufacturing orders, primarily from the US military and the private label channel.

Should You Be Looking To Buy Rocky Brands?

Whilst there are a few attractive reasons to consider Rocky Brands at this juncture, I’m afraid the headwinds take on greater prominence.

Let me first start with what’s good about the RCKY story.

Firstly, I like the forward valuations on offer; admittedly a large part of this is on account of weakness in the share price this year (rather than any pronounced upgrade in the forward EPS). Just for some context, on a YTD basis, the RCKY stock has grossly underperformed its counterparts in the small cap space, delivering returns that are more than 2x lower than the Vanguard Small Cap ETF ( VB ).

This means RCKY can now be picked up at a forward P/E of less than 10x, this is 30% lower than the stock’s long-term average of over 13x.

Small-cap stocks are also not noted for their dividend prowess as they are typically channelizing their excess cash into organic and inorganic initiatives but at the current share price, RCKY’s yield of 2.31% is not bad at all as it is a good 80bps higher than what you get from the popular small-cap ETF-VB. Crucially, at this price point, it is also 45bps higher than the stock’s own historical average yield of 1.86%.

Whilst the above facets of the RCKY story make it look like an enticing proposition, there are some other macro and micro data points that make me wary.

You can slice and dice it however you want and try and paper over the cracks by picking out certain resilient segments within RCKY’s portfolio, but at the end of the day, this company sells products that are discretionary in nature, and I don’t believe it is the right time to pursue something like this when economic conditions for the consumer appear to be turning.

Firstly, I worry about the signs in the labor market; as noted in The Lead-Lag Report, the recent level of monthly job openings saw a decline in pretty much all the states across the US, except for Georgia and Ohio.

My subscribers would also note the PWC survey I recently shared with them, which showed that 50% of employers are planning to scale down the labor count in their organization. In fact some retail peers of RCKY are responding to the difficult environment in their own way by curtailing hiring.

When employment conditions drop, expect this to be reflected in a tighter wallet; a barometer of consumer spending- the PCE, appears to be flattening out over the last couple of months, and I’d imagine it's just a matter of time before a declining trajectory gets underway.

The other day, I also shared the survey results of a study conducted by Statista on the timeline of The Lead-Lag Report; worryingly that survey noted that categories such as "Clothes" would be one of the prime areas where US Consumers would look to dial back on. This certainly does not bode well for RCKY’s portfolio of goods.

And I say this because the company has unfortunately ended up building quite a huge inventory position (supply chain pressures eased last quarter, and inflationary pressures pushed up the aggregate inventory bill) where it grew by 101% YoY! Just for some perspective, RCKY's days in inventory are at its highest point in 10 years!

With demand conditions likely to be so weak, I don’t quite see the merit in RCKY’s decision to hike prices from the 1 ^st of September; if anything, we could see a situation where you see the level of promotions go up to get rid of the excess inventory.

The build-in inventories has also put pressure on RCKY's Free cash flow position; note that this too has hit a 10-year record and has been in negative territory for a few quarters now.

You also have a scenario where financial conditions are getting dearer by the day; as noted in The Lead-Lag Report, Powell is well aware of the “pain” that businesses could face but his priority is very much inflation control and this will likely prompt further rate hikes.

Under these circumstances, I’d like to think that something like an RCKY would be viewed unfavorably by the investment community, particularly as its financial debt as a % of EBITDA is close to 5x now, and is at its highest point in 5 years!

Conclusion

Finally, as noted in The Lead-Lag Report, whilst small-caps may have displayed some resilience in the initial wave of the bear market, of late it’s nothing to shout about. RCKY with its relatively weak fundamentals and outlook may end up as one of the prime candidates for the small-cap focused short-selling pack.

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