Weyco Group: Cheap For Good Reasons

Weyco Group: Cheap For Good Reasons

Florsheim shoes

Source

For the past two years, shares in the Weyco Group (WEYS) have been under severe pressure. The stock reached an all-time high of $40 per share by mid-2018, and since then it has traded in a downward channel.

Currently, Weyco is trading at cheap valuations. For example, the company is trading at a P/E of 10.3x, P/B of 0.9x, EV/EBITDA of 5.6x, and an EV/Sales of 0.6x. The fact that the company is trading below its book value, indicates the belief from the market that Weyco would not generate returns above its cost of capital.

While shares appear to be trading at cheap multiples, we believe Weyco is being fairly valued by the market, based on their business fundamentals. The company has very unpredictable trends within its operating segments and is having trouble in their international operations. Because the company generates most of its revenues from its wholesale segment (80% of sales), the impact of the COVID-19 pandemic can have permanent repercussions. Their exposure to mid-tier department stores and a prolonged recession would disrupt their business model.

We also believe Weyco has zero competitive advantages as the company sources their inventories from third-party suppliers, therefore preventing them from gaining economies of scale in production, and zero pricing power. The footwear market is highly competitive and there is little in product differentiation if the company does not have brand equity. Their low returns on invested capital (10-year median return of 8.6%) can act as evidence of a lack of competitive advantages. Working in favor of the company is a strong balance sheet with a zero net debt position.

We believe Weyco is a stock that is trading at cheap multiples for a reason. Unless management starts fixing its international operations, which is currently losing money, investors should not hope for a quick turnaround. Making matters worse is COVID-19 which is far from over. At this point, we would rather wait on the sidelines than hope for a turnaround.

The Big Picture

Source: Company filings

Weyco is a designer and marketer of footwear, mostly tailored to the men’s fashion market. The company manages 4 banner brands in Florsheim, Nunn Bush, Stacy Adams, and BOGS. Their shoe style ranges from formal to casual, to weather-related such as boots. The company sources all of its inventory from India and China and operates under three segments: North American wholesale segment, North American retail segment, and its “Other” segment which includes both wholesale and retail but in markets such as Europe, Australia, Asia, and South Africa.

Top line growth has been sloppy, reaching its highest point in 2015. The company enjoyed strong demand from 2010 to 2015 when revenues went from $229.2M to $320M. However, by 2016 the retail landscape became more competitive with the accelerated rise of e-commerce. Since 2016, revenues at Weyco have been very volatile, with up and down years, but still not surpassing the $320M benchmark set in 2015. Overall, revenues have been compounding at an annual growth rate of 3% from the 2010 to 2019 period.

However, management has done an excellent job of keeping costs under control, especially since demand has been choppy. For example, we like how COGS has been kept within a very tight range of 60.6% to 62.3% as a percent of total sales. That has allowed gross profit margins to average around 39.1%.

Below the gross profit line, “fixed” expenses such as G&A and marketing costs have also been under control with investments in marketing increasing, offset by lower G&A costs as a percent of sales. We believe that to be a good trade-off, as a company like Weyco needs a constant reinvestment in marketing to build brand awareness within their market. Selling and marketing expenses as a percent of sales have increased from 6% in 2010 to 9.6% in 2019. In dollar terms, the company now spends approximately $30M in marketing costs, compared to just $14M in 2010. A higher marketing budget is, in our view, the only way for the company to keep its banner brands relevant in a continuously changing consumer taste.

The good cost control measures by management have allowed the company to sustain steady margins, even when revenues have been volatile. Operating income margins have averaged around 8.8%.

Florsheim is the growth driver for now

Source: Company filings

Out of Weyco’s 4 banner brands, the only one showing some momentum behind is Florsheim. It is also the only brand in its portfolio that hasn’t seen declining revenue growth.

Just by looking at Weyco’s brand performance, investors should get a quick idea about the competitive nature of the footwear industry. Brands can quickly be affected by changing consumer tastes, such as in the case of Weyco’s Nunn Bush brand. That brand has lost almost a third of sales in a 9-year period. We can also see volatility in brands such as BOGS, which had a strong growth period between 2011 and 2015, followed by two tough years, and is now regaining some ground.

Weyco’s International business is the weakest link

Source: Company filings

While Weyco’s North American region (the U.S and Canada) is showing some resilience to a tough retail market, the same thing cannot be said about their international sales. Every region outside North America is facing severe challenges as seen by the declining revenue trends. For the last two years, Weyco’s “other” segment is losing money:

Source: Company filings

As a percent of sales, Weyco’s “other” segment represents a decent chunk, accounting for 12% of total sales. A turnaround in their international segment should be highly accretive to shareholders.

The Bottom line

Source: tikr.com

There is no doubt about Weyco’s cheap valuation. At a recent 0.64x EV/Sales multiple, the company is trading below their 10-year average sales multiple of 1x. Currently, there are zero analysts following the company.

For us, we believe the cheap valuation is appropriate, given the lack of growth. The strength of one brand cannot pull the weight of the whole company forward, and there is also the heavy lifting needed to bring their international sales to the point of breaking even.

At this point, we don’t see a compelling investment case. Yes, shares are trading for cheap, but with so much volatility in their results and the current economic uncertainty, we’d rather watch from the sidelines.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seeking Alpha

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