Description

Introduction

• WWW has been written up a few times over the years on this forum. We believe that at the stock’s current valuation, the company presents an interesting risk-reward profile at this time.
• WWW manufactures branded footwear with good consumer awareness that is primarily purpose-built (i.e. outdoors, work) and not so fashion driven. Some of their top brands are Merrell (~29% of sales), Saucony (~19%), Sperry Top-Sider (~11%), Wolverine (~9%), and Sweaty Betty (~8%). While reputation varies by brand, WWW’s brands are generally known for being highly functional.
• Despite some earnings volatility and periodic M&A over the years; the company has a demonstrated history of generating substantial cash flow, something we expect will continue into next year.
• Recent reports and checks suggest WWW is on the path to working through its excess inventory by year-end and is showing progress on migrating away from its historically wholesale-heavy channel approach while increasing its DTC sales in its most popular brands.
• Shares look to present an attractive opportunity should the company reach a normalized margin profile as the company enters the second half of 2023 due to the sell-through of end-of-life inventory, cost savings, and operational efficiencies.

Background

• In November 2022, WWW reported $0.48 in earnings per share alongside revenue of $691.4M, missing analyst estimates by $0.07 and $18.34M, respectively. Gross margins declined by 320 basis points from the prior year’s quarter due to higher freight and inventory costs. Inventory also increased immensely to $880.9M, up 113.8% versus what management labeled “unusually low levels last year.” Due to the earnings results and the inventory build, the stock plummeted by nearly 34%.
• On 1/11/23, WWW announced at the ICR conference its 2023 plans to reduce its overbuild in inventories and a strategy to increase profits moving forward. The company also reported a preliminary Q4 sales forecast of $665M, beating street estimates at $658.8M, which was much better than initially feared by the investor base. Inventories were also projected to decrease by $75M sequentially to $805M showing positive signs that the company had the inventory issue under control. In reaction to the news, the stock would run up roughly 33% as shareholders received confirmation that the inventory work-down could be accomplished and that the company had a concrete plan to de-lever the balance sheet.
• On 2/8/23 WWW announced that the firm had entered into a transaction to sell off the company’s Keds brand to Designer Brands (DBI) to help simplify the business and continue the focus on the company’s core growth brands. In addition, the Company announced that it intends to grant an exclusive license to DBI for Hush Puppies footwear in the United States and Canada, where DSW has been the exclusive retail partner for Hush Puppies since last year.
• On 2/22/23, WWW reported its full results for the 4^th quarter and full year of 2022. In addition to the top and bottom-line results, management provided its 2023 outlook. The outlook was positively received, as the stock increased ~6.5% following the release. The outlook reflected that WWW had excellent visibility for cost savings and operational efficiencies due to inventory normalization, supply chain cost savings, and profit improvement initiatives that the company had spelled out.

Current Opportunity

• We are contemplating a muted revenue and eps growth in 2023 but an expansion to normalized adjusted operating margins towards the back half of the year. Due to work down in inventories and lower supply chain input costs, the company should benefit in the second half of the year and into 2024. The company should be able to take advantage of this, along with the sale of its Keds division, generating as much as $250 million in free cash flow in 2023. With a normalized margin profile and its well-positioned hiking, running, athletic apparel, and industrial work category brands, WWW is set to take advantage of industry growth for the longer term.
• The company recently offered up growth pillars that call for:
  • A DTC focus and making digital marketing a priority
  • New product launches in all its leading brand categories
  • Accelerated international growth, especially within China
• WWW is attractive because of its established distribution network and its reach to over 170 countries worldwide. Due to the value proposition WWW’s brands offer its end customers, its diverse and broad consumer base should give the company a competitive advantage to exploit secular growth trends within the industrial work, casual footwear, and athletic apparel segments. The company expects to see $150 million in annual “profit improvements,” with at least $65 million expected to be achieved in 2023.
• Over the last few quarters, the company has increased its DTC sales within the Merrell brand due to the digital marketing strategy implemented by CEO Brendan Hoffman and his team. WWW is now starting to implement and leverage those same strategies within the rest of the portfolio of its businesses. The increases in DTC sales should result over the long term in higher adjusted operating margins of close to 12% as the company’s working environment normalizes.

• WWW’s balance sheet ended the quarter with $1.0 billion in net debt and a reported leverage ratio of 2.7x. The sale of the Keds brand, which assists management in streamlining the business into more robust segments, should result in reducing the net debt level to a target rate of $750 million and an approximate leverage level of 2x by this time next year.

Projected Returns

• We believe that given the focus that Hoffman has put into the company on WWW’s core brand strength and with normalization to margins returning to its historical averages, the company should be able to obtain a three-year top-line growth CAGR of 3.9% and achieve a 10.2% adjusted EBITDA margin in 2025, a margin level above the recently depressed results from 2022, but still below the +12% levels achieved pre-pandemic. The top-line sales projections take into account that WWW will see a recovery in sales volumes that reflected pre-pandemic growth along with the company's price increases taken over the past few years. We believe the margins profile will reflect better DTC sales and lower input costs, such as shipping and labor, as seen during the reopening pandemic. Our base case relying on these assumptions implies that roughly $3 billion in sales will translate to an EPS of $1.82 for 2025. At a multiple of 13x, our base case has a price target of $23.66.
• Our bear case target assumes that the current three-year top-line revenue growth CAGR will be around 1.9% and assumes an adjusted EBITDA margin of roughly 7.8%. Results like this would be expected if inventory issues experienced in 2022 persisted for much longer than anticipated and input prices such as labor and shipping costs were to reflate upwards. On roughly $2.8 billion in sales and $0.99 in EPS for 2025, we assume a 9.0x P/E multiple and a price target of $8.91.
• Our bull case assumes that top-line revenues will grow at a 3-year CAGR of 5%, which equates to just over $3.1 billion in total sales and $2.00 in EPS in 2025. This scenario factors in a higher percentage of DTC sales and assumes the company will achieve EBITDA margins of 12%, consistent with pre-pandemic levels. Our price target in this given backdrop is $30.00, which assumes an EPS multiple of 15x on 2025 estimates.

 Additional Investment Considerations

• Before Wolverine, Brendan Hoffman was CEO of the publicly traded Vince Holding Corp., The Bon-Ton Stores Inc., Lord & Taylor, and Neiman Marcus Direct, where he grew neimanmarcus.com and launched bergdorfgoodman.com in the early days of online e-commerce retail. Hoffman has seen fast and furious change online. Instagram wasn’t founded until two years after he left Neiman Marcus, but the evolution was supercharged all the more during the pandemic. The e-commerce and DTC sales initiatives are a priority for the company. Of note, Hoffman’s total payout of his annual performance bonus can be adjusted by up to 30% based on the e-commerce revenue multiplier.
• Former senior executives have stated that management usually takes a conservative approach to make new investments and is aware of Wall Street’s expectations each quarter. However, management will not hesitate to invest in a new vertical through M&A if the right opportunity presents itself.
• Historically, WWW has had an excellent reputation for designing, producing, and distributing new footwear designs within its existing portfolio of brands.
• WWW’s primarily focuses on casual and fitness footwear and does not skew towards the higher end of fashion trends.

Risks

• Increased interest rates – with a net debt/EBITDA of 4.2x, interest rate increases could hurt bottom-line results.
• Inflation – increased shipping, raw materials, and labor could affect margins.
• Consumer slowdown risk – a consumer slowdown could force the company to implement more discounting.
• Fashion risk – changes in fashion trends could hurt overall sales.
• Timing – even though there are encouraging signs that the inventory issues have been solved, there could be another quarter or two to work through these issues fully.

Catalyst

• Reduction of debt
• Reduction of inventory to normalized levels.
• Increased sales percentage share of DTC