A Small Miss Means Little For The Long Term At Wolverine

By Stephen D. Simpson, CFA | July 11, 2012 AAA

Starting around September of this year, the next couple of years at Wolverine (NYSE:WWW) could be very interesting. The billion dollar-plus acquisition of Collective Brands' (NYSE:PSS) Performance and Lifestyle Group holds the promise of transforming the company from a high-return/low-growth cash-farmer into a company that produces both robust returns and solid growth. Against that backdrop, a two-cent miss in quarterly earnings just doesn't seem like a big deal and this looks like a stock that could still be an attractive buy today.

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Second Quarter Results Frame the Need for the PLG Deal
Wolverine's fiscal second quarter results weren't poor, but they do highlight some of the challenges that may have inspired the aggressive acquisition move.

Revenue rose less than 1% this quarter, with the large Outdoor Group seeing nearly 3% growth, while Heritage dropped more than 3% and Lifestyle fell about half a point.

While the company had a slight miss on revenue, it had a more substantial miss on gross margin. Due in part to closeouts, gross margin fell 160 basis points. While Wolverine management didn't do anything unexpected on the SG&A line, the slightly higher spending here, coupled with the lower gross margin, drove a 17% drop in operating income and that two-cent miss in EPS.

SEE: The Most Important Metrics For Earnings Season

PLG Is an Opportunity to Change
There's nothing wrong with the business Wolverine already has; the company produces good returns on capital and solid free cash flow, while also boasting a very solid international business. That said, there's also nothing wrong with injecting some growth into the model.

The PLG deal is going to give Wolverine multiple opportunities to drive improved performance. The star brand of the deal, Sperry, is quite strong and could be an even bigger threat to the likes of Nike's (NYSE:NKE) Converse with Wolverine's better international distribution. Likewise, Saucony's presence in athletic and specialty stores brings new sales channels to Wolverine, and PLG's much greater exposure to department stores like Kohl's (NYSE:KSS) could also open this channel wider for Wolverine's other brands.

SEE: Free Cash Flow Yield: The Best Fundamental Indicator

It's probably not fair to compare this deal to VF's (NYSE:VFC) acquisition of Timberland, but I do believe it could do a lot of good for Wolverine. At the same time, the large amount of debt that Wolverine is taking on makes good execution critical. Clearly not all acquisitions go as planned (as companies like Brown Shoe (NYSE:BWS) have learned), and any missteps or disappointments in terms of synergies are going to result in swift punishment from the market.

The Bottom Line
Given the reputation and last performance of Wolverine's management, I'm surprised that these shares trade where they do - I would have thought that the market would have already dialed in a lot of incremental value for the PLG deal. Then again, some of this could be due to the weak conditions in the European market (a major market for Wolverine) and the risk of further cost inflation in China.

SEE: 5 Other Countries Affected By A Troubled Europe

All in all, I like the PLG deal and I'm not really bothered by this quarterly miss. There's some risk that management is maintaining expectations that are too high for the rest of the year, and investors should be a little careful about building a full position ahead of the next earnings report. That said, when considering the long-term potential of the soon-to-be larger Wolverine, it's hard not to like these shares today.

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

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