Monday, March 06, 2006

Stride Rite

One of my readers suggested that I have a look at Stride Rite Corp. (SRR)

Stride Rite Corporation markets the leading brand of high quality children's shoes in the United States. Other well-known brand names, including Keds, Sperry Top-Sider, Tommy Hilfiger, Saucony, Grasshoppers, Munchkin, Spot-bilt and Hind. Apparel products are marketed by the Company under the Saucony and Hind brand names. Saucony, a leading “technical footwear” brand, was acquired in the fourth quarter of last year.

It appears that the company is still suffering some weakness in a few of its core brands such as Keds, where sales in the fourth quarter were down over 20%. Keds appears to be getting repositioned and transformed as a higher-end brand, but the company is quite early in the process. Similarly, the company’s wholesale “Children’s Group” appears to be in need of turnaround with sales in the fourth quarter down 17%.

The good news: The company is sprucing itself up with acquisitions and with determined cost control. The Saucony acquisition remains fresh, and it appears that much of the inventory build-up (inventories were up 32% with Saucony and up only 3% without)and slowing asset turnover that the company exhibited in the most recent quarter is a function of Saucony inventory, especially more fashion oriented footwear. To be fair, we will not see a fresh Saucony line until later this year.

Sperry Top-Sider is doing well against very tough comparisons and the company appears to be doing very well in its 271 retail stores. In fact, the company anticipates adding some 30 stores this year, an 11% expansion.

Children’s footwear sales at its retail stores appear to be quite strong. Saucony’s running shoes are doing well (and are my personal favorite!) Sperry Top-Sider remains strong.

Financials….most recently, they appear disappointing with losses on the operating line and consequent losses in EBIT. I suspect a function of integration costs and repositioning of Keds. Return on invested capital on a normalized basis is about 7.5% down from a more normal range of 8.40-10.40% of the last five years.

Cash flow from operations has always exceeded net income, so the quality of earnings has been high. Depreciation has generally exceeded capex in the last five years as well. Consequently, lots of free cash flow historically until this year.

The company generated $141 million in free cash flow between 2000 to year end 2004. The company has also bought back stock effectively with fully diluted shares currently at 37.2 million versus a share base of 43 million in 2000.

The company appears to be involved with a large potentially activist shareholder who is getting representation (one seat) on its board.

Using somewhat conservative estimates for operating margins and growth, and reflecting some increased spending for the store expansion, I would value this business near $15, essentially, the company is fairly valued. However, should the company be able to restore its working capital turnover to more normal levels from its current peak, the company could easily be valued in the low $20’s.

Some debt was added to finance the Saucony acquisition, but interest coverage remains comfortable, in my opinion.

In my view, the business has some near-term challenges to overcome: the integration of Saucony, the repositioning of Keds, and the turnaround of kids wholesale. The company does have some wonderful and leading brands. The brands own valuable shelf-space in department stores, specialty stores such as West Marine, and shoe retailers. The company faces the pressure of an influential outside shareholder who has demanded (and gotten) one seat. Returns on capital have been somewhat uninspiring and could use improvement. Fully priced, as is in my opinion, but some relatively easy fixes could enhance shareholder value to the low $20's.

Neither I, my family, nor my clients have a current position in Stride Rite.


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