Brown Shoe Needs More Execution, Less Excuses

By Stephen D. Simpson, CFA | August 30, 2011 AAA

I have been a fan of shoe retailer Brown Shoe (NYSE:BWS) for some time, having profitably owned it many years ago, but perhaps it's time to reevaluate that position. While many retailers are struggling in a difficult consumer spending environment, there are more worrisome issues between the lines. Brown Shoe is making mistakes that it should not be making and offering up fairly thin excuses in place of execution. Brown Shoe's problems are not unsolvable and the valuation is compelling, but shareholders have every right to demand more from this management team.

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Another Poor Performance
This fiscal second quarter marks the company's third consecutive major miss with respect to analyst expectations. Revenue rose more than 7% in the quarter, but still came in slightly shy of the average analyst guess. The company's largest segment, Famous Footwear, saw sales drop almost 1%, while the wholesale business was up more than 24% and the small specialty segment rose about 1%.

There's a little more going on than that, though. For starters, the acquisition of American Sporting Goods was pretty much solely responsible for the company's growth this quarter, so the organic performance is less impressive. On a more positive note, same-store sales at Famous Footwear were up 0.2%.

Here, though, is one example of what I consider to be the company's disappointing doublespeak. Management pointed out that Famous Footwear sales would have been up more than 3% if the decline in toning shoe sales was excluded. Okay, that's worthwhile information and a sign that the "core" business is better than it looks. On the flip side, why didn't management spot this trend sooner and position accordingly? Even acknowledging that toning declines haven't hurt Brown Shoe as much as rival Skechers (NYSE:SKX), couldn't they see this was a fad? (For more, see Investing In Fads.)
Profit Problems Point to Another Complaint

Brown Shoe missed by a bit on the top line, but quite a bit more on the bottom line, and the disappointment here is arguably worse. Gross margin dropped three full points, some of it because of the higher percentage of wholesale revenue and some of it because of that toning shoe inventory.

More troubling is the big drop in operating income (down over 90% to just under $1 million). Operating expenses did not rise all that much, but the company continues to report problems with the integration/implementation of its SAP (NYSE:SAP) IT platform. It's not hard to find examples of other companies that have struggled with SAP, but the company announced this move about three years ago and it is far past time for this to be working properly.

More Execution, Fewer Excuses
Why am I being so hard on Brown Shoe management? The fact is, these are tough operating times for most companies in the shoe category - Skechers, Shoe Carnival (Nasdaq:SCVL) and Collective Brands (NYSE:PSS) are all have their issues, and outperformers like Nike (NYSE:NKE) are quite rare. When times are tough, management teams must be at their best and must minimize leakages like inventory mistakes and IT integration foibles.

What's more, I was quite perturbed by a comment in the press release. Management stated that the company was going to extend its buyback policy by another 2.5 million shares and was "displaying the confidence the company has in its business".

How is the board's decision to spend shareholder money on stock an expression of confidence?

Insiders hold less than 3% of Brown Shoe shares. There have been a couple of small insider buys lately, but if the board members really wants to show their confidence in the company, why not pony up their own personal cash and buy shares?

The Bottom Line
There's an old saying on Wall Street that companies struggle in threes - in other words, once a company stumbles, there's usually three bad quarters before returning to a better path. This is the third bad quarter for Brown Shoe, but it may be too soon to declare an all-clear. Aside from K-Swiss (Nasdaq:KSWS) (and Nike), it's hard to find a shoe business that has a lot of momentum now and the erosion of consumer confidence in the United States likely points to more struggles before things start to recover.

Brown Shoe's performance is disappointing and management's characterization of that performance is even more so. Still, this is a major shoe retailer trading at pretty distressed valuations. Shareholders probably can't have as much confidence in management as would be preferred, but this is very much a stock worth watching and considering as a turnaround play. There's a fair price for every asset and Brown Shoe shares may well be trading below that now.

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