SHOO - Steven Madden: Be Patient With This High Cash Generator

2023-06-28 12:32:41 ET

Summary

• Steven Madden has grown well in the last decade, positioned well for this to continue, although does face some risks.
• Its margins are good but when considering its cash flow conversion in conjunction, we believe SHOO is a strong performer.
• SHOO's brand has allowed the business to perform well as it has faced increased competition. We expect this will support resilient growth going forward.
• Relative to other footwear businesses, SHOO looks unattractive. However, it should be noted that this cohort includes several leading businesses.
• SHOO is trading at an attractive valuation but faces near-term headwinds. We suggest patience.

Investment thesis

Our current investment thesis is:

• SHOO is an attractively positioned business, exploiting trendy designs to provide affordable products to the masses (who are increasingly influenced by a homogenized view of fashion).
• SHOO has good margins, decent growth, and a resilient supply chain supporting its financials.
• SHOO is trading at an attractive discount to its historical average trading multiple but we believe patience is warranted, as near-term weaknesses unwind.

Company description

Steven Madden ( SHOO ) is a prominent fashion footwear brand known for its trendy designs, high-quality products, and strong brand presence.

The company has achieved remarkable success in the footwear industry by consistently delivering fashionable and affordable shoes to a diverse consumer base.

Share price

SHOO's share price has underperformed in the last decade, as the business has struggled to generate significant financial progression while facing increased competition.

Financial analysis

Presented above is Steven Madden's financial performance for the last decade.

Revenue & Commercial Factors

SHOO's revenue has grown at a CAGR of 4%, with relatively consistent growth until Covid-19, with subsequent gains being slightly more erratic based on pandemic-related disruption.

Business Model and Competitive Positioning

SHOO operates as a designer, wholesaler, and retailer of fashion-forward footwear and accessories. The company looks to bring trending and popular designs to consumers, seeking to marry the designs of high-fashion houses and its extensive supply chain. SHOO essentially operates as a "fast fashion" brand, which is defined as "inexpensive clothing produced rapidly by mass-market retailers in response to the latest trends" by the Oxford Dictionary.

SHOO primarily operates as a wholesale business, selling its footwear and accessories to retailers. This is a traditional approach in the industry, reducing the marketing and customer-reach burden.

Although SHOO is known for its women's footwear, the company also sells a range of products to men and children, as well as handbags and accessories. This transition has been quite successful for the business, allowing it to achieve scale economies, utilize its brand for expansion, and provide a related product.

Steve Madden's business model is based on designing and sourcing footwear, manufacturing through third-party suppliers, and distributing products through multiple channels, including wholesale accounts, company-owned stores, e-commerce platforms, and licensing agreements.

Licensing agreements with various partners allow Steve Madden to expand its product portfolio and reach new customer segments.

In our view, SHOO's key competitive advantage stems from its brand. The company has developed an association for edgy, fashion-forward designs that resonate with style-conscious consumers. This "edgy" / "loud" / "out there" fashion is currently in trend and so the business benefits well from its association in the affordable segment.

In conjunction with this, SHOO's ability to quickly identify emerging fashion trends and swiftly bring them to market is critical to its success. In the affordable segment, consumer loyalty to brands is lower and so SHOO's success thus far is a reflection of its continued ability to stay in tune with trends.

Further, SHOO offers a diverse portfolio of footwear styles, catering to different age groups, preferences, and occasions. The company's approach is quantity over quality, which given the segment targeted, is the correct approach. Production is generally low-cost and so increasing the number of products supports winning customers.

Finally, a discussion on retail is not complete without acknowledging the effectiveness of marketing. In the modern day, this is dominated by social media coverage, with brands increasingly utilizing Instagram and Tik Tok. Our view is that SHOO's weakness is on display here, as its current social media engagement is low. The company is currently getting <1k likes per post on Instagram, relative to a follower base of 2.9m.

Fashion Industry

The fashion industry has experienced significant development in the last decade, driven by changing consumer trends and e-commerce. The development of e-commerce has contributed to increased competition, as online-only businesses are able to provide consumers with greater choices and convenience (deliveries). Further, these businesses have been far more aggressive with marketing due to reduced overheads. Additionally, we have seen consumers increasingly demanding trending products. Although this has been beneficial for SHOO's current strategy, we have also seen the rise of fast fashion brands that can do it cheaper and quicker than SHOO, such as Shien, PrettyLittleThings, and boohoo ( BHHOF ). We believe this is the primary reason for SHOO's slower growth rate, as increased competition forces increased spending to win customers, and every dollar spent is shared among a greater number of businesses.

As quickly as fast fashion has risen, there could be an equally rapid decline. Consumers are increasingly demanding sustainable and ethically sourced products, as socio-economic views contribute to fears about the impact of consumption on the environment. In 2020, McKinsey found that consumers overwhelmingly cared about buying sustainably. A recent study by NielsenIQ has found that 78% of consumers believe a sustainable lifestyle is important to them. We believe this could contribute to slowing demand or pressure for SHOO to incur increased costs in order to improve its supply chain.

International markets offer significant growth potential for SHOO. The business has a strong presence in the US but has a significant runway to develop overseas. Given its designs are inherently tied to global fashion, we suspect the business could perform well.

Economic & External Consideration

Current economic conditions represent a near-term risk to the business. With high inflation and elevated rates, consumers are facing pressures on their finances, encouraging a reduction in discretionary spending. Retail notoriously performs poorly during weaker economic conditions due to the ease with which consumers can forego spending.

In the most recent quarter, SHOO experienced a 17.1% decline in sales Y/Y. This is a reflection of the company's reliance on the wholesale channel, which is hesitant about inventory levels given the economic conditions. We suspect underlying demand is far better than this (although still down).

We believe conditions will remain difficult for 3-5 more quarters, as although inflation is declining, there is further time required until it reaches a sustainable level. This does not mean we expect sales to decline to this level, far from it, but growth may not materially occur.

Margins

SHOO's margins have remained relatively stable across the last decade, with EBITDA-M fluctuating between 11% and 16% (Excl. Covid-19 impact).

The most recent decline relative to FY22 is a reflection of inflationary pressures in conjunction with sticky costs as revenue has declined. Given these effects will subside once conditions improve, we suspect SHOO will see margin improvement in the coming 12-24 months.

Balance sheet & Cash Flows

Despite the slowing demand, SHOO has done a good job of maintaining a strong inventory level, with turnover increasing at Mar23 to 5.7x, compared to 5.2x at Dec22. This still remains below pre-Covid levels and so continues to act as a drag on cash.

SHOO's free cash flow is impressive and relatively consistent. This is due to its focus on wholesale, reducing the capex requirements and pressure to hold inventory for sale.

These cash flows have funded both dividends and buybacks, which have been consistent throughout the period.

Outlook

Presented above is Wall Street's consensus view on the coming 5 years.

Analysts are forecasting a continuation of the company's mild growth in the coming 5 years, which based on its commercial profile looks reasonable. We believe upside is possible through improving its marketing activities.

In line with our view, Analysts are expecting margin improvement from the current year onwards, likely pricing in economic recovery in conjunction with a resurgence in wholesale demand.

Industry analysis

Presented above is a comparison of SHOO's growth and profitability to the average of its industry, as defined by Seeking Alpha ( 8 companies).

SHOO performs poorly in our view. It is comparable in profitability but lags behind in growth, which is our main concern. This implies the company's weakness is fundamental to its operations, as others have managed to grow despite the competition from fast fashion. Profitability is biased by Deckers' ( DECK ) and Crocs' ( CROX ) fantastic margins.

Valuation

SHOO is currently trading at 9x LTM EBITDA and 8x NTM EBITDA. This is a discount to its historical average.

Our view is that SHOO appears attractively priced. Compared to its historical average position, we see the following positives:

• Margin erosion, due to short-term factors, has only brought it in line with historical levels. This implies a normalized level will be higher.
• Despite the increased competition, the business remains strong and has scope to increase sales.
• The P/E discount implies a substantial decline in profitability which has not occurred.

The problem is that SHOO is facing near-term headwinds that could contribute to negative price action initially. Importantly, there is no near-term reason for positive price action, as investors are already expecting a Q2 bounce back following the Q1 issues.

Key risks with our thesis

The risks to our current thesis are:

• Given the issue with wholesale, we believe the margin deterioration and revenue decline was extreme in Q1, pricing a softer result in Q2. If this quarter is equally poor, we believe this could lead to concerns around the performance in FY24, also.
• Skechers is currently suing SHOO for one of its designs. This is not unheard of in the fashion industry and we do not expect a materially negative impact from this currently.

Final thoughts

SHOO is a financially attractive business. Despite its soft revenue growth, it has great cash flows and good margins. The business model is fundamentally strong but requires constant innovation, which its track record implies will continue. We believe the stock is oversold in recent months due to fears about where its financials will land, implying upside.

Our view is that investors should consider the results in Q2 before making an investment decision, although should note the company is already in an attractive price window.

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