President Obama recently outlined his plan to withdraw American military forces from Afghanistan. Rocky Brands (Nasdaq:RCKY) is a small Ohio boot manufacturer that's been directly affected by the action overseas. Three years ago, based on Special Operations input, it created the S2V combat boot specifically designed to take a pounding on the battlefield. According to soldier feedback, they're performing beyond expectations and it is this success that makes its stock worth a closer look.

TUTORIAL: Budgeting Basics

First Quarter
Rocky's had a tough go in recent years. Its $542,000 net profit in Q1 was the first time the company has seen a first quarter profit in three years. A combination of lower interest expenses and higher gross and operating margins contributed to the good news. Despite revenues declining by 6.7% year-over-year to $52.3 million, the business it did garner was from products with higher gross margins, which increased by 340 basis points to 36.8% in the quarter. Its operating margin was up by 67 basis points to 2.0%. It might not seem like much, but its trailing twelve-month operating margin is higher than it's been since 2006. Good things are starting to happen.

Capital Structure
For a company that's been plagued by high debt and the interest expense that goes with it, 2010 was a watershed year. In May 2010, RCKY did a secondary offering for 1.8 million of its shares at $8.40 each. The $14.1 million in net proceeds would all go to partially paying down its $40 million, five-year term loan at 11.25%. At the same time it prepaid another $15 million and finally, in October, it secured a $70 million credit facility through PNC Bank (NYSE:PNC) at a much more favorable rate of interest (LIBOR plus 1.5%) completely replacing its loan with GMAC Commercial Finance. Its recapitalization reduced outstanding long-term debt for Q1 2011 by 41% to $27.8 million from $46.8 million in the same quarter a year earlier. As a result, its interest expense in the first quarter dropped by 87%, a far more reasonable financial arrangement.

Rocky Brands and Peers

Rocky Brands (Nasdaq:RCKY) 4.92
Timberland (NYSE:TBL) 12.35
Wolverine World Wide (NYSE:WWW) 11.20
Lacrosse Footwear (Nasdaq:BOOT) 8.71
Weyco Group (Nasdaq:WEYS) 13.29

Value Trap
Rocky Brands is the classic value trap conundrum. Is it cheap for a reason or are investors simply ignoring the good things that are happening in the business? I believe it's the latter. VF (NYSE:VFC) announced in mid-June that it was buying Timberland for $2.2 billion, a 43% premium to the New Hampshire company's closing price prior to the deal announcement. VF believes Timberland's enterprise value is worth 12.4 times EBITDA. If you take out the 43% premium, the multiple drops to 8.2 times. Even discounting the acquisition, Rocky Brands is cheap compared to its bigger rivals.

Not convinced? Consider these two Ben Graham numbers. The first is net current asset value per share. That's current assets less total liabilities and Graham looked for companies trading at less than two-thirds NCAV. That's not easy to find these days. Rocky's market cap is 1.7 times NCAV while Timberland's is 4.4.

Finally, there's something called the "Graham Number" which looks for stocks trading at less than a price-to-book of 1.5 and price-to-earnings of 15. The two ratios multiplied together should be less than 22.5. By taking the square root of 22.5 multiplied by earnings per share and book value per share, you get an estimate of fair value. In Rocky's case, its fair value is $19.72, providing 68.3% potential upside. Timberland's fair current fair value is $22.26, providing none. While there's always the possibility it's a value trap, I'm doubtful.

The Bottom Line
Rocky Brands has a history of peaks and valleys. As we sit here today, it's climbing up the mountain, not down. (For related reading, also take a look at Analyzing Retail Stocks.)

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