K-Swiss Battered but Beautiful

Shoemaker K-Swiss (Nasdaq: KSWS  ) has taken it on the chin over the past year. Its shares have fallen nearly 50% after its multiyear turnaround plan took a breather, grinding growth to a halt. On Tuesday, the pain continued after K-Swiss reported fourth-quarter earnings per share of $0.02, down considerably from $0.30 in the prior year. Investors didn't hide their dismay, sending shares down more than 9%.

Most of K-Swiss' earnings declines owed to lagging domestic sales, which slid a painful 34.6% in the fourth quarter. International sales came through with a less grimace-inducing performance, increasing 6.1%. Domestic future orders -- what customers signal they expect to buy in the coming year -- plunged nearly 40%, giving investors plenty of data to mull over as they frantically sell their shares.

One-hit wonder?
The partial source of K-Swiss' woes over the past several years has been its "all eggs in one basket" approach. Roughly 62% of its total sales come from one shoe design -- a classic style that has remained virtually unchanged for decades. With much larger rivals like Nike (NYSE: NKE  ) , Reebok, and Adidas (OTC BB: ADDDY.PK) churning out numerous new models every year, K-Swiss just hasn't had the oomph to keep up with the big boys.

Depending so heavily on one shoe style is risky business in an industry as fashion-conscious and fast-shifting as footwear. Look no further than the infamous rise and fall of Heelys (Nasdaq: HLYS  ) in the past year. As consumers' love for the all-white classic shoe waned, K-Swiss was left without attractive alternatives, leaving shareholders wondering what lies ahead.

K-Swiss' future growth prospects are almost certainly unspectacular. The company probably won't be a runaway growth story like Crocs (Nasdaq: CROX  ) , Skechers (NYSE: SKX  ) , or Steve Madden (Nasdaq: SHOO  ) . That dismal forecast is certainly reflected in K-Swiss' share price, now trading at just 11 times last year's earnings. But is it really time to throw in the towel?

Down, but not out
Those who focus on earnings growth alone may be overlooking a gold mine on K-Swiss' balance sheet. Regardless of plummeting sales, management has amassed a huge cash stockpile while remaining completely debt-free. K-Swiss currently holds more than $290 million in cash; at $8.22 per share, that represents more than half its current share price.

How much of that cash stash will K-Swiss need to rebuild the brand and get sales back on track, and how much will be used for share repurchases and dividends? Reinvigorating marketing and creating new styles should consume a decent portion of the hoard, but management hasn't been shy in reminding investors about its plans for big buybacks once the market finally leaves its shares for dead. If K-Swiss follows through, investors who've seen their investment crumble in recent years could finally rewarded handsomely.

Buying its way back to success
Suppose that rebuilding the company gobbles up one-third of the cash. That would still leave around $200 million to buy back shares -- 13.1 million shares, or about 37% of current shares outstanding, at the latest prices. How would that affect shares' performance?

Averaging the past five years of earnings, let's say earnings come in at $64 million. That undoubtedly won't happen this year, but it's not a far-fetched proposition by 2009, if the brand and its marketing get their act together. All those share repurchases would help launch earnings beyond $3 per share, making the current $15 share price look like an absolute steal.

K-Swiss certainly faces hard times ahead. Management hasn't downplayed the challenges its future presents, giving bleak earnings guidance for 2008. While there's likely more ugly news to come in the year ahead, patient investors with nerves of steel could be rewarded once management applies the full value of its frugal spending habits and Fort Knox balance sheet.

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