When it comes to DSW Inc. (NYSE:DSW), there’s a clear split on whether DSW stock is a buy. DSW has faced choppy trading for about two years now, and even the analysts are divided. Street target prices range from $19 to $26, with the average just 2% higher than the $21.79 closing price on Tuesday.
There is a bull case here. As Luke Lango argued last week, DSW stock looks cheap and has catalysts coming in fiscal 2018 (ending January 2019).
Strong loyalty from rewards members, new amenities in-store, and growing online penetration all suggest positive comparable store sales next year. And at 11x the EPS DSW analysts are projecting for next year, backing out net cash, DSW stock is priced for basically zero growth.
But I argued immediately after earnings that the 11% gain in DSW stock was far too much. And after further review, I still think that’s the case. DSW itself isn’t projecting any earnings growth next year, except for benefits from tax reform. The footwear niche probably has more protection from e-commerce than other parts of retail, but competition still is coming, including from suppliers.
More broadly, I like DSW’s plans going forward. But from here, they still look most likely to only keep the company swimming in place. And that’s not enough to take on the risk of owning any retailer these days.
The Bull Case for DSW Stock
As CEO Roger Rawlins detailed on the Q4 conference call, DSW had a strong 2017. Rawlins opened his portion of the call by pointing out that the company grew earnings for the first time in four years.
Total revenue set an all-time high. Comps improved throughout the year. Revenue growth came despite weakness at acquired e-commerce eBuys and the bankruptcy of Gordmans Stores, for whom DSW had supplied inventory for its shoe selections. Gordmans now is owned by Stage Stores Inc (NYSE:SSI).
And DSW is looking to a strong 2018 as well. Rawlins said DSW was adding inventory to support growth in the kids’ category. Seasonal business should improve. Marketing spend will increase. And, as Lango pointed out, new stores with shoe repair and nail salons are coming, following a successful pilot program.
The CEO said DSW was planning to take market share in fiscal 2018, with revenue expected to rise 2-4% excluding the impact of an extra week in FY17 and the loss of revenue from eBuys.
That all sounds good and sounds like progress. But looking closer, I’m far from convinced there’s that much to get excited about.
The biggest reason for concern is that as good as FY18 sounds from a qualitative standpoint, DSW’s own guidance isn’t that impressive. Excluding the impact of the extra week last year, EPS is guided to rise between 4% and 14%. Tax reform alone should have added roughly 15% to earnings, based on the differing effective tax rates.
DSW is investing some of the savings in marketing and increased labor expense. But there’s another benefit to earnings this year: the exit from eBuys. eBuys was posting operating losses, per the most recent 10-Q. Simply exiting that business should provide another benefit to profitability next year, though DSW hasn’t broken out those losses on a non-GAAP basis.
Even comparable-store sales guidance in the “low single digit” range isn’t all that impressive. Traditionally, retailers need 2-3% comps simply to leverage operating expenses. Positive comps seem good in the context of the retail environment. But barely positive same-store sales usually lead to minimal earnings growth, at best.
All told, it’s too early to project some sort of acceleration in DSW’s business. And longer-term concerns persist.
Valuation and Competition for DSW
~11x earnings does seem cheap, but on a peer basis, DSW stock isn’t necessarily inexpensive. Shoe Carnival, Inc. (NASDAQ:SCVL) trades at a similar multiple, with a similar growth profile. Many other brick-and-mortar retailers are in the same ballpark.
There is some help in the near term from a competitive standpoint, notably from the bankruptcy of Payless ShoeSource. But Amazon.com, Inc. (NASDAQ:AMZN) unit Zappos appears to be growing. Athletic shoe makers like Nike Inc (NYSE:NKE) and Under Armour Inc (NYSE:UAA, NYSE:UA) are looking to expand their direct offerings.
DSW has relatively small athletic exposure, but other suppliers like VF Corp (NYSE:VFC) brand Vans have their own branded online sites. And with comp growth still low, it doesn’t take much in the way of share erosion to turn same-store sales negative.
From here, there’s just not enough to see DSW stock as a compelling play. A 4.6% dividend yield does help its cause. Also I see many better short plays in retail, though DSW does have ~15% of its float sold short at the moment. There’s just not enough to get excited about yet. That’s how DSW analysts see it, too, and until that changes, DSW stock is unlikely to make a big move.
As of this writing, Vince Martin has no positions in any securities mentioned.