August wasn't a good month for footwear manufacturer K-Swiss (Nasdaq:KSWS). Its stock lost half its value and now trades near an all-time low of $4.85. Five years ago, it was trading near $40. Most of the decline came between 2007 and 2009. This year's rough ride in the markets finished it off. No analyst in his right mind would touch its stock. But I'm going to suggest three reasons why K-Swiss is a speculative buy right now.
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Financial Health
Despite a precipitous decline in its share price caused by four consecutive years with an operating loss, K-Swiss is still very much alive. Its current Z-Score is 3.3, which means it has a low probability of bankruptcy. Furthermore, its total debt is $11.8 million, just 6% of shareholder equity. When comparing K-Swiss to similarly sized peers (see below), it's clear that its cash position is much stronger than any of its competitors is. The question remains for how long. Prior to its four-year losing streak, it had $291 million in cash on the balance sheet. In 2007, it could go almost eight quarters without revenue compared to less than two today. Skechers, which has the next-best level of cash-to-total-debt, actually fares worse, able to survive 1.3 quarters compared to 1.6 for K-Swiss. It has the balance sheet to survive but not with another four years of losses.

K-Swiss and Peers

Company Cash/Total Debt
K-Swiss (Nasdaq:KSWS) 5.3
Rocky Brands (Nasdaq:RCKY) 0.1
RG Barry (Nasdaq:DFZ) 0.9
Weyco Group (Nasdaq:WEYS) 0.4
Skechers (NYSE:SKX) 1.8

Margins
This is the key to its future. Its second quarter gross margin was 34.3%, 310 basis points lower year over year. For the entire 2011, it expects a gross margin of 37.5%, 170 basis points worse than in 2010. Margins are currently heading in the wrong direction. Its most profitable year in the past decade was 2005, when its operating profit was $107 million with a gross margin of 46.7%. Every year when its gross margin is below 40%, it has lost money. Steve Scruggs, portfolio manager for the Queens Road Small Cap Value fund (QRSVX), believes K-Swiss is moving in the right direction with a good marketing plan and should be able to get its gross margins back into the mid-40s soon enough. If so, this stock won't be under $10 for very long.

Revenue Growth
This is where the picture turns positive. Second quarter revenues grew 40% year-over-year to $65.5 million. Future orders are up 39.2% to $89.9 million with 2011 revenues expected around 25% higher at $271 million. It's still a long way off the $509 million it recorded in 2005, but at least it's in the right direction. Revenue growth at this point, while nice to have, is not nearly as important as higher gross margins. However, what is nice to see is the growth of its Palladium brand, which it acquired for $15.5 million in two parts in 2008 and 2009. Its diversification beyond athletic footwear will ultimately pay dividends. K-Swiss just needs to hang in there long enough to see it through.

The Bottom Line
K-Swiss is a speculative buy. There's no denying it. If you can't afford to lose your entire investment, you shouldn't be buying. Furthermore, a lot has to happen in the next few quarters for its turnaround to continue, including margins over 40%. However, if you have some fun money, the upside potential is tremendous. (For additional reading, take a look at Investing In Fads.)

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