After running in multiple organized events in 2023 (two half marathons, 1 quarter marathon trail run, a 10-kilometer race and a 5-kilometer race, plus lots and lots of training miles over the last 12-months, but who’s counting?) I started 2024 with a night-time trail run the first weekend in January. I won’t go into the grizzly details, but instead of getting a finisher’s medal, I got a dislocated finger and trip the emergency room from slipping on a muddy descent; it is the first “DNF” (for “did not finish”) status I’ve ever had on a race. My sister (who is also my running coach) indicated that I would have reduced my risk of falling had I worn actual trail running shoes rather than the beat-up old pair of running shoes I had opted to use. So now I am going to be in the market for a new pair of shoes in early 2024, but I may give up on trail running. Among the options I am likely to look at will be the Saucony brand, one of the handful of well-established footwear brands run by Wolverine World Wide (NYSE:WWW), though I plan on trying out many options before I decide.
Likewise, I may initiate a long position in the shares of Wolverine World Wide in 2024, having successfully traded them short-term in 2023, especially as the shares have declined since I last wrote on the company in May, while some others in the footwear space have out-performed.
On January 8th 2023, the shares rallied strongly as the company reaffirmed its guidance for fully revenues for 2023 and gave reassuring guidance on inventory and net debt. I began my writing process many days before this development, but I will address the valuation below with this development in mind. I was very cautious on the shares in May of last year, finding the macro environment trends unfavorable at the time with regards to consumer spending on footwear, along with Wolverine World Wide’s specific operational challenges. While overall consumer spending has held up well, clearly Wolverine shares have not seen any particular benefit, but at current levels, it is worth taking a fresh look for an investment thesis.
Great Products, Troubled Results
In addition to the Saucony brand of running shoes, Wolverine World Wide is behind some other well-known footwear names, although it has been trimming its focus recently, including selling its Saucony joint-venture for the China market to XTep (EXTPY), a deal that was well covered by Seeking Alpha contributor Bamboo Works. The other well recognized would include Merrell hiking shoes, Hush Puppies casual women’s shoes, and Sweaty Betty active wear since late 2021 (the company also owns Stride-Rite children’s shoes but licensed out the rights since 2017). There are multiple other brands and categories as well, such as work and safety boots. These are distributed to consumers through both retail partners as well as company-owned channels. The business model here is not unique, of course, and is a pretty standard approach in retail.
The recent results have shown some of the strain of coming out the pandemic with lumpy sales and working capital hiccups in inventory and de-stocking, none of which are unique either, and Wolverine is not alone in dealing with a challenging retail environment.
Looking back to the quarterly sales and inventory levels from before Covid-19 through the most recent quarter tells the tale – sales plummeted in 2020 in the middle of the pandemic, then fairly quickly climbed back. At a slight lag, inventory got bloated at the same time that sales have been in a steady downtrend since mid-2022. Inventory management is clearly improving since the peak, but remains elevated relative to 2020 levels.
Wolverine follows a calendar year reporting for its fiscal reporting, so the most recent results are Q3 of 2023 (through 9/30/23), with Q4 obviously having just wrapped up. Looking under the hood at Q3 results, revenue was $527.7 million, about a 25% decrease in sales relative to Q3 in 2022. Gross margins held steady at ~40%, but operating expenses were impacted by a couple of one-time items, including an impairment charge taken of $40.2 million and gain on asset sales of $57.7 million, neither of which hit the books in the prior year quarter. The ultimate result of the much lower sales and one-time items was net income of $8.6 million in the quarter, versus $39.0 million in Q3 of 2022.
Sales are broken out by channel (wholesale and direct to consumer) and segment (active, work, lifestyle, and other). Sales are pretty well dominated by the wholesale active category, which is primarily the Saucony and Merrell brands sold by retail partners. For Q3, $225.2 million in sales were located here, accounting for 42% of all sales (and on a year to date basis, was 46% of all sales through the first three quarters). When including the active group sales that were direct to consumer, the total is $328.6 million, or 62% of the quarter’s sales, so this is clearly the workhorse of the company.
It is no particular surprise then that management is electing to focus efforts on growing the active group segment and divest or find other options for the other segments. As it stands, management’s outlook going into the final quarter of the year was for about a 13% drop in total annual revenue at $2.2 billion, with EPS for the year between $0.35 and $0.40. The broad outline of expected full year 2023 results for revenue was just reaffirmed ahead of the big ICR Conference this week.
In terms of the balance sheet and cash flow statement, there was $160.4 million in cash on hand at 9/30/23, with $272.0 million in receivables, versus $197.2 million in payables, $10 million in current portion debt, and revolving credit balance of $370.0 million. The long-term debt stands at $716.3 million, and has been slowly coming down in recent quarters. Through the first three quarters, cash generated from operations has been pretty minimal, $7.0 million, with most cash coming from the sale of assets worth $136 million. The company pays out an annual dividend of $0.40 per share, coming to nearly $8.2 million per quarter and not fully supported by internal cash generation thus far in 2023 (realizing that Q4 is missing from the picture here, and is often peak sales for clothing retail).
As mentioned at the outset, on 1/8/24, the shares climbed sharply, from ~$7.70 to ~$9.00, and have essentially held those gains a day later, trading hands as I write for about $8.90. The change was presumably driven by the reaffirmation around guidance provided, not just on sales for the year, but especially on inventory and net debt levels at year end to be $460 million and $750 million respectively, both solid improvements. The inventory guidance would be a ~$100 million improvement over the end of Q3, and while not quite back to pre-Covid level, clearly an 18% reduction to more normalized working capital does represent pretty drastic improvement.
However, the change does all of a sudden make it a measurably less attractive value entry point. For example, instead of having a P/E on an estimated EPS of $0.40 of ~19x when the shares were $7.70 (already modestly ahead of the sector median of 16x), now you’re looking at 22.5x, definitively richer than that sector median. Future earnings are a better benchmark, and as the retail environment settles into a better overall balance matching supply to demand again, the expectation is that earnings will climb, with the 2024 EPS estimate of $0.87 imputing a P/E of 10.3x, more representative of what you might expect to find in mature, slower growing sector in retail. In other words, I do not expect the market to value to value it at or above the 16x earnings multiple, although its historical average over the last five years has been in line with that.
Even after recent rally, the valuation is not stretched, and there appears to remain potential for further gains if management proves its ability to continue to deliver on trimming down the stable of brands, reign in the working capital use, and bring in earnings in 2024 close to expectations. Even after gaining almost 20% in the last two trading sessions, I believe there is conservatively an additional 15% to 20% total return in the next 12 months, premised on $0.85 in earnings per share and a 12x P/E multiple, plus the dividend.
For income seeking investors, the yield dropped from 5.2% to 4.4%, about equal to the coupon on 2-year US Treasuries right now but with all the downside the risks of equities. Nevertheless, compared to some other well-known footwear options that pay no dividend, it might be considered a viable option for income. At $0.40 per year would be around 46% payout ratio on estimated 2024 earnings.
The operating improvements evidenced in inventory and the reaffirmation of revenue guidance have removed a chunk of the pessimism in the market around Wolverine World Wide, without pushing it into over-bought territory. The valuation looks fair based on the expectations and guidance, and the choice to really focus on the active segment that really drive the sales appears promising. While I liked it even more at $8.00, I am still comfortable with rating it as a “buy”, while keeping a cautious eye on those same consumer spending trends for signs of weakness that kept me on the sidelines last May.