The spirit of the Olympics has been on full display in recent days, and in light of this world-class, worldwide competition, it's a good time to check on an equally tough sport -- the battle for your athletic feet.
Recently released 2005 data from research firm NPD Group shows that, once again, footwear sales growth continues to outpace apparel. With 9% revenue growth at NPD, an analyst characterized the year by saying, "Footwear is on fire." And where there's fire, we may just find an investment or two to heat up your portfolio. The number of companies in this sector seems to be shrinking, with buyout offers becoming standard practice -- Adidas' purchase of Reebok being just one example -- but there are still enough companies left for us to examine.
In this investigation of the industry, we will focus on three enterprises, representing large to small capitalizations in Nike (NYSE: NKE ) , Timberland (NYSE: TBL ) , and Stride Rite (NYSE: SRR ) , respectively, to see what each offers as potential investments.
The reigning running champ
In the University of Oregon's track and classroom are found the seeds that grew into the Nike behemoth. Track coach Bill Bowerman and accounting student Phil Knight made a small partnership, amounting to about $1,000, in order to import a Japanese-made running shoe. Fast-forward more than 40 years later, and Nike's pinkie-toe-sized beginnings have ballooned into an empire with a market capitalization of $22 billion and annual sales of more than $14 billion.
Like an athlete preparing for the Olympics, Nike continues to push its abilities to higher levels of performance. For example, from 2001 to 2005, sales, gross margins, the cash-to-long-term-debt ratio, and the return on equity have all steadily strengthened for the company. What this tells us is that Nike not only knows a thing or two about selling shoes but also that management knows how to run a business. As investors, we are looking to invest in well-run companies, and Nike is meeting that challenge.
In the most recent quarter, footwear sales led the charge with high double-digit growth in the U.S. and the Americas. In the Asia-Pacific region, however, sales improved only marginally. But that means there's an opportunity for growth, and management suggested in its quarterly conference that Nike will begin employing a more aggressive strategy in China and India. CEO Bill Perez put it bluntly: "We want to own those markets."
To tackle that objective, Nike plans to use a more cohesive global strategy to better connect the brand to the consumer by removing gaps in its distribution model and making greater use of both its Nike stores and the Internet. Something tells me that the enterprise that brought us His Airness, Michael Jordan, and the new young king, Lebron James, to the world of footwear will indeed conquer these emerging markets.
Hiking up distribution
In the NPD report, Timberland was mentioned as a company that stands to benefit from the recent trends toward the "SUV of footwear" -- a term that points to boots and hiking styles. A look at Timberland's fourth-quarter results however, doesn't exactly paint a picture of an athlete in his or her prime. Revenues for the quarter increased by a paltry 2.3% compared with the year ago period. Against industry trends, ironically, it was Timberland's apparel and accessories units that offered the greatest growth -- they increased 5.4% year over year.
Time will tell whether the company's recent SmartWool acquisition will help kick-start sales. For 2005, SmartWool's annual sales are estimated to be in the $42 million range -- a nice boost to Timberland net revenues for 2006. I helped out SmartWool's top line by purchasing several pairs of its socks for hiking. This is a line that Timberland, given its more expansive distribution model, should be able to integrate into its existing structure and build upon.
In the meantime, Timberland's cash position and cash generation are two positives worth mentioning. It currently has $213.2 million in cash and no debt. This kind of balance sheet gives it plenty of flexibility to aggressively expand its operations either organically or through additional acquisitions.
Additionally, the company is doing a decent job in bringing in the free cash flow (FCF). Despite inventory write-offs in 2005, which dropped its FCF slightly from 2004 levels, it still produced $156.3 million in FCF. What's more, with a market cap of $2.3 billion, Timberland trades at roughly 13 times FCF. In light of management's mid-single-digit growth estimate for 2006, as well as upside potential that may come as Timberland builds out the SmartWool brand through its distribution model, this is a reasonable multiple.
A baby shoe worth looking into
With a market cap of $522 million, Stride Rite is by far the smallest of these three footwear companies. But don't take it for a chump. The scrappy company has been a champ of an investment over the past three years, with a compound annual growth rate over that period of 21% -- almost 7 percentage points more than the S&P 500's performance.
Why has it done so well? It seems the market keeps underestimating Stride Rite's potential. For example, using the consensus estimate of $0.93 per share for the year, it's trading at roughly 16 times this year's earnings. It is also being valued at approximately 16 times the trailing 12 months of FCF. Analysts, on the other hand, are expecting the company to achieve strong double-digit revenue growth (25.6%) and earnings-per-share growth (41%) this fiscal year.
A major reason that growth is expected to jump this year is a result of Stride Rite's recent acquisition of Saucony, which, along with its Hind brand, should help Stride Rite make solid advances in the athletic footwear and apparel market. Saucony, for instance, will soon be launching a new line of retro footwear. Set to hit stores in fiscal 2007, Saucony Originals are a technical running shoe modeled after an early-1980s version.
If redoing the old styles works for apparel retailers such as Guess? (NYSE: GES ) and Abercrombie (NYSE: ANF ) -- with their flared pants, which are hot all over again -- it should work for a shoe manufacturer. Should the company continue to improve its growth rate organically with product innovation and through smart acquisitions, Stride Rite could indeed be considered an interesting small-cap play.
Time to lace 'em up?
Nike, Timberland, and Stride Rite are all trading at approximately 16 times this year's projected earnings, even though each has different growth expectations for the year. But whether it's dynamite operational performance in Nike, a reasonable enterprise value-to-FCF multiple in Timberland, or a solid estimated double-digit growth in Stride Rite, all three carry a reasonable value at today's prices. Both Nike and Stride Rite add an extra incentive to investors with comparable dividend yields. Finally, Nike stands out above the other three with its exceptional consistent performance on margins, balance sheet, and returns on equity.
All three are worthy candidates for additional research, but there is a reason why the Swoosh is the most recognizable symbol in athletic apparel and footwear -- the company is a champion.
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Fool contributor Jeremy MacNealy does not own shares of any companies mentioned.