Ryan Fuhrmann, CFA
February 23, 2007
Shares of footwear designer and marketer K-Swiss (Nasdaq: KSWS) fell as much as 13% yesterday after releasing weak 2006 earnings and a sharp drop in expected earnings. There could be more shoes to drop as conditions look grim, but K-Swiss does have a couple of investment merits worth trying on for size.
Before we look at what attracts investors to K-Swiss, recent developments highlight the risks of investing in a small-cap company with only one main product. The stock has had a nice run, having more than doubled from under $10 in late 2002, as its Classic sneaker proved popular. But Classic accounts for nearly 70% of total sales and is suddenly being shunned here at home. As a result, management expects domestic sales to fall as much as 30% in 2007 and lead to a big decline in earnings.
K-Swiss has diversified into higher-performance tennis and basketball footwear in recent years, and international sales are doing well, but until Classic sales stabilize in the U.S. the company will continue to suffer. When that will happen is anyone’s guess; it doesn’t even look like management knows, as its projected earnings range for 2007 is pretty wide.
However, K-Swiss should be able to withstand a downturn. It doesn’t have any debt and generates substantial free cash flow. In similar fashion to footwear giant Nike (NYSE: NKE), all of K-Swiss’s shoe manufacturing is outsourced to low-cost regions such as China and Taiwan. And as far as I have found, the company does not operate its own retail stores, avoiding the subsequent costs of owning and leasing retail selling space.
And although I just ripped on K-Swiss for relying too much on one product, the Classic sneaker is one of the more durable footwear brands. Its design is largely unchanged from when it was first introduced in the 1960s, and it does appear to be gaining recognition overseas. Classic is suffering right now, but sales trends should eventually recover. In fact, I would pick Classic any day over faddish footwear brands such as Crocs (Nasdaq: CROX) or Decker Outdoor‘s (Nasdaq: DECK) UGG boots.
Before the recent turn of events, K-Swiss even had an impressive five-year streak of double-digit sales, earnings, and cash flow growth. The shares will likely be dead money in a market mostly interested in operating trends over the next 12-18 months, but if the share price falls any further, long-term minded Fools may want to consider placing the stock in their shopping carts.
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Fool contributor Ryan Fuhrmann is long shares of Nike but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.