Fairness demands that I open this article on Brown Shoe (NYSE:BWS) with an admission and an apology – I was wrong about the company's decision to name Diane Sullivan CEO back in May of 2011. While I had thought the company numerous operational missteps during her tenure as COO boded poorly for her future as CEO, the fact is that her strategy of weeding out underperformance at Famous Footwear and selling off unpromising wholesale brands has led to some meaningful operational improvements. There are still challenges for the company to address, but I can no longer cite questions about management as a credible source of concern.

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Strong Margins Offset Weaker Sales
Not unlike a lot of retail companies, Brown Shoe saw disappointing revenue this quarter due in part to weather. Revenue fell almost 2% as reported, though adjusting for divested brands bumps that up to just the tinniest sliver of year-on-year growth.

Sales at Famous Footwear were up less than 2%, with same-store sales growth of just over 1%. As a sign of the impact weather may have had on the quarter, April comps were up better than 14% as the weather finally turned more favorable. Wholesale sales were down 3% on an adjusted basis, while specialty sales declined more than 2%.

Margins were surprisingly strong. Gross margin improved more than a point and a half from last year, and were more than two points ahead of sell-side estimates. Every unit reported better gross margin, with Famous up slightly (30bp; and the company leader at 45%), specialty up 130bp, and wholesale up 310bp. Operating performance wasn't bad either. Operating income rose 8% on an adjusted basis, with 40bp of operating margin expansion and SG&A expenses only slightly ahead of expectation.

SEE: Understanding The Income Statement

Fixing Famous Faring Fine
Brown Shoe's efforts to turnaround and improve Famous Footwear continue to pay dividends, particularly the emphasis on closing underperforming stores and improving merchandising decisions. While the 1.1% reported same-store sales growth for the fiscal first quarter wasn't great, it was certainly better than the 0.8% decline at Shoe Carnival (Nasdaq:SCVL) and the 2.4% decline at DSW (NYSE:DSW).

Looking ahead, there's still more that management can do. I would be surprised if there are still a large number of stores left to close or relocate, but I don't expect management to let up on the surveillance and bad stores will be closed as needed. At the same time, management is looking to tie in rents with same-store sales performance, and that could be a good move for margins.

None of this is to say there aren't challenges. Just because management wants to tie rents to store performance doesn't mean lessors will go along with it (though the weak environment for retail real estate gives management some leverage). I'm also cautious about the plans to install a new inventory allocation system – the company's installation of an SAP system was a multi-year mess, and the company can not afford a similar mistake. Last and not least, there are always store merchandise challenges to deal with – Famous doesn't have the same access to top-selling athletic brands as Dick's (NYSE:DKS), Foot Locker (NYSE:FL), or Finish Line (Nasdaq:FINL), and that deprives it of some of the best growth in the footwear sector today.

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Are The Divestitures Done?
With the recently announced sale of the Avia and Nevados brands for $74 million, Brown Shoe has all but unwound the ill-fated ASG deal and gotten rid of most of its second-tier/unpromising wholesale brands. The company paid $145 million (plus an unspecified amount of debt) back in the day, and has since sold off parts and pieces for a total of $129 million. The company has chosen to keep the Ryka brand, though, so all in all it's hard to complain about the ASG deal on a net basis.

As is the case with the Famous store closures, I expect further divestitures to be fewer and far between; if a brand slips, it may be sold, but I don't think there's a lot left to sell today. At the same time, perhaps it's time to turn a sharper eye toward the Specialty (Naturalizer) business – a loss-making business with fairly unimpressive recent growth trends.

The Bottom Line
While I do believe Brown Shoe's turnaround strategy has been successful, and the company may have further improvements in store (whether through better merchandising, margins, or fixing Naturalizer), the stock is up strongly from the bottom – over $20 a share now versus the nearly $2 low of 2009 and the sub-$7 lows of 2011. Given that shoe retailing (and wholesaling) is still a fundamentally low-margin/low cash flow generating business, I would caution investors not to get carried away with the story or the stock.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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