CHS - Shoe Carnival: An Excellently-Priced Prospect

Summary

• Shoe Carnival may not have the greatest operating history, but results in recent years have been encouraging.
• The firm is experiencing some weakness this year, but the overall picture for investors looks promising.
• Given how cheap SCVL shares are, realistic downside risk looks very limited at this point in time.

Footwear is incredibly important. It has been for thousands of years. Not only is footwear necessary for the protection of our feet, it has also morphed into an important fashion statement for many individuals. One company that has dedicated itself to providing footwear to its customers is Shoe Carnival ( SCVL ). With a sizable retail footprint and a burgeoning e-commerce operation, the company has done well to grow its revenue and profitability over the past few years. This came even as the number of stores it has in operation has really struggled to grow. Most recently, the company has seen some weakness on both its top and bottom lines. But even if we assume that this week and guidance matches management's expectations for the current fiscal year, shares are priced at levels that should be considered attractive for value-oriented investors. In all, this has led me to rate the business a 'strong buy' right now, reflecting my belief that it will likely generate returns that comfortably outperform the market for the foreseeable future.

Sizing up Shoe Carnival

As I mentioned already, Shoe Carnival operates as a player in the footwear space. More specifically, the company has fashioned itself as one of the largest family footwear retailers in the US. As of this writing, the company has 395 stores spread across 35 states as well as Puerto Rico. And at present, the company controls two key brand names that it focuses on. The first, and largest, of these is its hallmark Shoe Carnival brand. This is a retail concept that aims to combine competitive pricing with a high-energy in-store environment aimed at exciting its customers. The company does this through a number of features such as playing upbeat music, offering customers the ability to spin a gameshow-style wheel and a mic-person who runs and announces in-store specials. These specials can include contests and games, as well as short-term deals aimed at encouraging customers to buy the product rapidly for the fear of missing out if they don't. Generally speaking, these stores are about 10,900 square feet in size and carry roughly 25,700 pairs of shoes each. Inclusive of the company's online sales that are provided in close proximity to their physical stores, these retail outlets average about $3.5 million in sales annually for the business.

Separate from this, the company also has another brand called Shoe Station. This was acquired in late 2021 in exchange for $70.7 million. Although Shoe Carnival has been around since 1993, the acquisition of Shoe Station was the first in its history. As of the end of the company's latest fiscal year, the Shoe Station retail outlets totaled just 21 locations in all. However, these stores generally have a larger footprint, averaging 16,700 square feet apiece and carrying around 43,300 pairs of shoes per location. Unlike the Shoe Carnival outlets, Shoe Station mostly caters to the more affluent family footwear customer. And, like the Shoe Carnival brand, it also has an e-commerce side to the enterprise.

Operationally speaking, the management team at Shoe Carnival head start a pretty good job growing the company. Between 2017 and 2019, sales inched up from $1.02 billion to $1.04 billion. Because of the COVID-19 pandemic, sales dropped to $976.8 million in 2020. But this decline was short-lived, as evidenced by the fact that sales in 2021 came out to $1.33 billion. Although the company did acquire Shoe Carnival last year, that purchase contributed just $16.6 million to the company's top line for that period. The surge, instead, was driven by a couple of factors. For starters, the number of stores in the company's portfolio did grow, inclusive of the aforementioned purchase, rising from 383 locations to 393. Having said that, the company also benefited from a 35.3% rise in comparable store sales.

One concern that investors would be right to have would be whether or not the increase in sales was attributable to increase pricing. After all, inflation will eventually ease and prices will likely come down. Seeing sales increase because of higher pricing could result in pain when this occurs. Fortunately, investors don't need to worry about this because, in 2021, the company benefited mostly from a 37.5% increase in physical store traffic. Management, in turn, attributed much of the rise in sales to improved inventory selection, a more focused promotional strategy, and the return of its customer base to a normal lifestyle that resulted in additional walking and, as a result, greater demand for footwear. Some of the increase was also driven, management believes, by prior consumer-based government stimulus.

With this rise in revenue, we also saw improved profitability for the company. Between 2017 and 2019, net income for the business grew from $18.7 million to $42.9 million. Profits dropped to $16 million in 2020 before skyrocketing to $154.9 million last year. Other profitability metrics followed a similar trajectory. Ultimately, operating cash flow ended up climbing from $40.3 million in 2017 to $147.9 million last year. If we adjust for changes in working capital, the trend would have been even more consistent, with the metric rising from $52.5 million to $231.1 million. Meanwhile, EBITDA for the company was also on the rise, climbing from $66.6 million to $232 million over the same timeframe.

Although the general picture so far has been positive, we have seen some weakness now that we are into the 2022 fiscal year. Revenue in the first half of the year, for instance, came in at $629.8 million. That's down from the $660.7 million generated the same time last year. Although the number of stores in operation increased further to 395, comparable store sales dropped by 13.8%. Management attributed this decline to weaker sales associated with athletic shoes. But this seems to have been less of a question of demand and more of a question of supply. According to management, in the second quarter of this year alone, inventory levels for athletic shoes were down by 25.7% compared to what they were the same quarter of the 2019 fiscal year. That resulted in decreased athletic sales in the amount of 12.9%. Meanwhile, non-athletic shoe categories were up by 30.8% in the latest quarter, indicating strength in demand.

With sales falling, profitability has followed suit. In the first half of the year, net income came in at $55.8 million. That's down from the $87.5 million generated the same time last year. Management attributed much of this to higher costs, such as freight and fuel costs, as well as to the deleveraging effect of lower sales on buying, distribution, and occupancy costs. Other profitability metrics followed suit. Operating cash flow dropped from $79.8 million to $8.9 million. Though if we adjust for changes in working capital, the decline would have been more modest, with the metric falling from $124.7 million to $100.1 million. Meanwhile, EBITDA for the business also declined, dropping from $118.3 million to $74.2 million.

When it comes to the 2022 fiscal year as a whole, management expects sales of between $1.29 billion and $1.34 billion. At the midpoint, that would imply a slight year-over-year decline. Earnings per share, meanwhile, should be between $3.95 and $4.15. This should translate to net income of roughly $112.6 million. If we apply the same year-over-year change for that to the other profitability metrics, then we should anticipate adjusted operating cash flow of $168 million and EBITDA of $168.6 million. Using these figures, we can see that the company is trading at a forward price to earnings multiple of 6, a forward price to adjusted operating cash flow multiple of 4, and an EV to EBITDA multiple of 3.6. As you can see in the chart above, these numbers are higher than with the company is trading at if we rely on 2021 figures but it's lower than what the company is trading for if we rely on 2019 figures. As part of my analysis, I also compared the company to five similar firms. On a price-to-earnings basis, these companies ranged between a low of 6.8 and a high of 11.2. Using the price to operating cash flow approach, the range is between 4.2 and 24.2. And when it comes to the EV to EBITDA approach, the range is between 5.7 and 7.1. In all three scenarios, Shoe Carnival was the cheapest of the group.

Takeaway

Based on the data provided, Shoe Carnival seems to me to be a quality operator in its space. Although the company is facing some pain this year, the pain and question seems to relate more to inventory problems than it does demand. Even with this pain, shares are trading at low prices, on both an absolute basis and relative to similar firms. And on top of this management school of reaching 400 stores by the end of this year and their goal of completely modernizing their existing locations by the end of 2024, and I cannot help but to rate it a 'strong buy' at this time.

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