The market seems to like the Q4 report from DSW Inc. (NYSE:DSW). DSW stock has gained over 10% on Tuesday, and it sits not terribly far from a 52-week high reached in November.
But I’m skeptical the report is quite as good as the market seems to think. Q4 results appear ahead of expectations; however, FY18 (ending January 2019) guidance looks modestly disappointing, particularly given benefits from tax reform.
From a broader standpoint, DSW still seems to have the same challenges facing most retailers. The long-term growth profile doesn’t look all that strong. At 11x the midpoint of FY18 guidance plus its $3.72-per-share in net cash, DSW is cheap. But it’s likely cheap for good reason, as recent results show.
Q4 Earnings
The numbers from DSW admittedly look solid. For Q4, revenue increased 6.7% year-over-year, including a 1.3% same-store sales increase. That figure was modestly below expectations (by about a point of growth), but roughly in line. Adjusted earnings-per-share rose 90% year-over-year and beat consensus by 11 cents. Backing out a 6-cent-benefit to FY17 EPS from a 53rd week in the fiscal year (and a 14th week in the quarter), non-GAAP EPS still rose 60%.
That’s solid profit growth for any company, obviously, and standout results in the current retail space. But at the moment, the issue is that Q4 looks like an outlier. For the full-year, EPS rose to $1.52 from $1.46 a year before. Excluding the benefit of the 53rd week, then, profit was basically flat and margins contracted from the year before.
Similarly, FY18 guidance doesn’t look all that impressive. Excluding the impact of the lost week this year, and the exit of e-commerce business Ebuys, revenue is guided up 2-4%, with comparable sales in the “low single digit” range. That sounds good in the context of retail at the moment, but “low single digit” still implies sales growth that will lag increases in rent and labor.
Indeed, adjusted EPS is guided to $1.52-$1.67, which (again backing out the extra week in FY17) suggests an increase of 4-14% year-over-year. But a lower tax rate — guided to 29% this year versus 39% historically — on its own should increase net income about 16%. Pre-tax income, then, is guided to decline, which suggests another year of margin contraction.
Relative to other retailers, the numbers don’t look that bad. Comps are stable and earnings declines are minimal. Better-known companies like Bed Bath & Beyond Inc. (NASDAQ:BBBY) and even Dick’s Sporting Goods Inc (NYSE:DKS), who also reported Tuesday, are seeing more pressure on both the top and bottom lines. But the numbers still don’t look quite good enough to get excited about DSW at the current valuation.
DSW Stock Doesn’t Look Cheap Enough
The fact remains that DSW has been a stagnant business for some time. As the company itself pointed out in the Q4 release, FY17 was the first year where sales and earnings increased since fiscal 2013. Online competition from Amazon.com, Inc. (NASDAQ:AMZN) unit Zappos, plus DTC efforts from Nike Inc (NYSE:NKE) and adidas AG (ADR) (OTCMKTS:ADDYY) will provide continuing pressure. And the spend by DSW to match those omnichannel efforts should continue to pressure margins.
Q4 results look OK. FY18 guidance isn’t bad, but even at 11x EPS plus cash, “OK” and “not bad” don’t look quite good enough.
That’s a multiple that implies basically stable profits, and that’s what DSW is delivering, for now. Looking forward, with more top- and bottom-line pressure coming, flat earnings seem possibly a best-case scenario.
A 4.6% dividend yield, thanks to a 25% hike announced Tuesday, helps the case. It’s possible DSW could get toward a 13-14x EPS multiple, and a price around $25. But that’s still ~15% upside and maybe 20% total return in what looks like an optimistic scenario, where multiples move toward the high-end of the multi-year range. That’s not enough upside to take the risks relative to footwear and retail more broadly. As such, I’d fade the post-earnings gains in DSW stock.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
