Wolverine Surpassing Its Marks, But Not Cheap

By Stephen D. Simpson, CFA | July 09, 2013 AAA

It's not just well-run athletic shoe companies like Nike (NYSE:NKE) or Adidas (Nasdaq:ADDYY) that can reward shareholders. The shares of companies that fall more into the “lifestyle footwear” category like Brown Shoe (NYSE:BWS) and Wolverine (NYSE:WWW) have also done quite well over the past year, with the later clearly benefiting from the huge scale-up provided by the PLG acquisition. While I'll admit that underestimating Wolverine could be dangerous as it continues to surpass sell-side estimates, it's hard for me to see the value argument for these shares right now.

Another Strong Quarter As The PLG Integration Continues
Wolverine announced that revenue rose 88% as reported this quarter, or 5.5% on a pro-forma basis – good for a slight beat relative to Street estimates. By segment, the Lifestyle category (which includes Sperry and Stride Rite) delivered 20% pro-forma revenue growth, while Performance (Merrell and Saucony, among other brands) was down 5% and Heritage (Wolverine and Caterpillar) was down about 1%.

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Wolverine also did quite well with margins and profits. Reported gross margin improved over three points from the year-ago period – so much higher than the sell-side average estimate (up about 10bp) that I have to assume there were some differences tied to accounting for transaction/integration costs. Then again, operating income was up 62% as reported and pro-forma operating margin was about a point higher than the average sell-side guess, so it's possible that Wolverine is just doing that much better with integration, synergy generation, and overall performance.

Is Underperformance In Performance A Reason To Worry?
It looks like the Performance group came in about 10% below its target for the second quarter. Normally, I wouldn't make too much of it, and it doesn't look the market is terribly concerned about it, but I'd definitely keep a close eye on this business. The launch of the Merrell M-Connect was supposed to be going very well and Saucony is the #3 running shoe (behind Berkshire Hathaway-owned (NYSE:BRK.A) Brooks and ASICS), so the underperformance surprised me.

The Story Remains The Same – Take PLG Worldwide
Not much has changed regarding the growth opportunities at Wolverine, and the biggest opportunity still appears to be taking the brands acquired in the PLG deal (Saucony, Sperry, Stride Rite and Keds) and moving them from roughly 10% in OUS sales to 20% or 25%. Wolverine has long enjoyed pretty solid international distribution, so this should be a “when, not if” evolution, and one that should help the company maintain strong mid-to-high single digit revenue growth.

What's less talked about, though, is the potential for ongoing brand expansion. The large debt load taken on to do the PLG deal probably limits near-term brand acquisitions, but I wonder if the company could do more on an organic basis – it's been about 10 years since Wolverine added a brand to the stable (SoftStyle) from within the company. Then again, acquisitions have worked well for VF Corp (NYSE:VFC), so maybe it's not something that Wolverine really needs to worry about for the long term.

The Bottom Line
I'm willing to assume that Wolverine can continue to grow revenue at a long-term rate of roughly 6%, with a return to high single-digit free cash flow margins lifting free cash flow growth into the low teens. Unfortunately, even though I like this business, those growth numbers don't generate a fair value that makes this an appealing stock. Due to the large amount of debt on the balance sheet, fair value looks to be around $50, and that suggests that the market has overshot the mark with these shares, even as the company continues to exceed sell-side expectations.

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