2023-05-26 10:17:54 ET
Summary
- GCO has been in the crosshairs with shareholder activists to drive profitability and run lean since 2018.
- While it weathered the initial storm as well as COVID pandemic, it appears relatively weaker amidst the post-pandemic reset.
- Earnings shocker came in with GCO reporting EPS of ($1.6) and CY23 EPS guidance more than halved to $2.25.
- Liquidity constraints remain as cash reserves are depleted amidst a weak operating environment. We initiate it at Sell with target price of $13.5 (6x P/E).
Background
Genesco (GCO) is a footwear focused retailer operating through its 1,400+ stores providing branded footwear, apparel and accessories. It has wide range of brands including Journeys, Little Burgundy and Johnston & Murphy in the US and Canada and Schuh in the UK. It also licenses various brands such as Levi's, Dockers, G.H. Bass and others for footwear. It looked to undergo transformational changes with the sale of Lids Sports Group, closing non-profitable stores (it has closed 100 stores in past 5 years) and cutting costs to bring the path back to profitability. It has been in the crosshairs with activist group and weak operational performance has led to its significant underperformance vs its peers with the company eroding 70% of investor wealth in the last decade.
Disastrous Earnings and Guidance
GCO reported comparable sales declining by 8% YoY for the quarter driven by a record decline of 14% in Journey's comp sales (which contributes more than 56% of the revenues), partially offset by improvement of 13% and 18% in Schuh and Johnston & Murphy Group. This decline comes even as Journey's lapped a 16% decline in Q1 2022 highlighting continued weakness in its core business. Management cited a 'bumpy post pandemic reset' as a result of persistent inflationary headwinds, lower tax refunds and competitive discounting, particularly in athletic footwear, disrupting normal seasonal demand and shopping patterns at Journeys. Gross margins declined 100 bps driven by increased markdowns in Journey's business, largely offsetting the improvement in freight and logistics costs. SG&A expenses deleveraged by a mammoth 550 bps YoY as a result of increase in compensation expense, selling salaries and occupancy expense along with a sales decline. Adjusted EPS came in at ($1.59) vs $0.44 YoY driven by weak operating margins. Inventory increased by 17% YoY in Schuh and Johnston & Murphy business while Journey's inventory remained flat which would further put pressure on gross margins for the year.
Topping a disastrous earning, the guidance for the year further jolted the company's position. Management expects Q2 to be continually weaker with sales decrease in similar lines as Q1 while gross margins would decrease by 40-50 bps as a result of increased markdowns at Journey's to clear the inventory. It expects earnings per share loss of $1.25 at mid-point for Q2. Management further noted that revenue will decline 4-5% for the year compared to previous expectation of 0-2% growth, three months back. Adjusted earnings per share is expected to be in the range of $2.0 - $2.5, more than halving its previous expectations of $5.5.
As we were in the first quarter, we saw a pretty dramatic drop-off in store traffic and comps after we completed a successful holiday season. We believe that the trend would improve in March, for a couple of reasons. One is that we got further away from boots. and we talked about the consumer trading down in boots, and also just really holding back on overall purchases. And we thought that the switch into spring and a reason to reward robe and to buy spring fashion would also bring the consumer in. But we frankly didn't see the improvement in store traffic. The consumer just seems to be sitting on the sidelines.
- Mimi Vaughn, President and CEO, Genesco
It now expects to close 100 underperforming Journey's stores which would lead to a cost saving to the tune of $40 mn for the year. From liquidity side, GCO exited with cash balance of just $32 mn compared to $48 mn in previous quarter which could lead to liquidity constraints amidst a declining operational performance. Total Debt almost tripled at $112 mn compared to $44 mn in the previous quarter as management replenished inventory levels and financed losses. All in, the stock nosedived by over a third reflecting the weakness.
Valuation
We believe the company could face liquidity challenges as the operating performance weakens and the debt burden continues to increase to replenish inventory and finance losses. Along with that, being a full price retailer, the company would continue to face market share losses to other e-commerce/ off-price and brand's own stores as consumers continually prefer value. We initiate this at Sell with target price of $13.5 (at 6x P/E) implying a further downside of over 30%.
Upside risks to rating include 1) improvement in Journey's segment driven by new product assortment driving store traffic 2) Schuh and J&M continue to outperform rest of the brands and drive growth and 3) softer sales decline would offset SG&A deleverage leading to an uplift in the EPS
SA's quant rating also reflect GCO as Strong Sell.
Conclusion
GCO is in a very tricky position. Being a full price retailer, it is already facing structural challenges from its competitors which are driving value and consumers increasingly shifting towards that. Along with that, we believe management's optimism on H2 may not materialise as it laps tougher comps (comps grew 3% in Q3 and 5% in Q4) along with better earnings. It also has reported higher inventory which could dampen the gross margins further due to increased markdown at Journeys. And, the liquidity position appears weak as the management is staring at dwindling cash reserves and rising debt in a weak operating environment. We rate this as Sell.
For further details see:
Genesco: Earnings Shocker, Initiate At Sell