Collective Brands (NYSE:PSS) had a lot of the characteristics of a potential winner. The company has a strong market position in its niche, a low valuation and realistic levers to pull for long-term growth. All that the stock needed was a solid quarter to get investors confident again ... and voila, the company did just that with its third quarter earnings report.
An Okay Quarter And Low ExpectationsOf course, a "solid quarter" is a relative concept. Collective Brands' third quarter results were not all that strong in and of themselves, but they were a fair bit better than analysts were expecting. Total sales rose almost 2%, while comparable store sales were down 2.7%. That is admittedly not strong, but still better than some Wall Street expectations.
Within those numbers, the domestic Payless business was clearly soft; revenue was down 5% on a 4.6% decrease in comps. Payless international was stronger, though, as sales were up 8%.
Profitability was where Collective Brands really outperformed. Gross margin increased about a full point, due in part to declines in like-for-like product costs. SG&A expenses were higher (and outpaced revenue growth), but the company nevertheless managed healthy operating income growth and handily surpassed the consensus earnings estimate.
Good News All Around?Collective Brands is not unusual right at this moment in the shoe industry. Brown Shoe (NYSE:BWS) shares popped on a double-digit increase in sales, and others including Shoe Carnival (Nasdaq:SCVL) and Foot Locker (NYSE:FL) have been strong since they reached collective lows in September.
Beyond this cyclical uptick (Better economy? Back to school spending?), Collective has some credible reasons for optimism. The company has been re-routing manufacturing outside of China, expanding its international sales efforts, and supporting the faster-growing "Performance + Lifestyle Group."
Better still, the company seems to have a solid and valuable niche. Nike (NYSE:NKE) can charge practically whatever it wants and people will pay it; that is not Collective Brands' business and they have no delusions about that. Instead of competing with Nike, this company aims to produce shoes with better quality and styling than what is on offer at Target (NYSE:TGT) or Wal-Mart (NYSE:WMT) and keep hold of that market.
The Bottom LineCollective Brands is among the world's largest shoe retailers, but has never been particularly adept at producing good returns on its capital. It is not unusual among shoe companies in that respect - single-digit ROICs are rather more the norm. Nevertheless, Collective Brands seems to be on a path toward improvement and perhaps even double-digit earnings growth for a stretch of years.
It is hard to say whether there are enough tricks in the bag for Collective Brands to produce sustainably interesting returns on capital, though the company's market share and cash flow do suggest the company deserves a lower cost of capital than CAPM would imply. This company looks relatively cheap on its fundamentals and, even with the strong move after earnings, patient shareholders might find this one to be worth a look.
By Stephen Simpson
Stephen Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
