DSW Inc. is Fashionable Again, But Will the Good Times Last?

DSW (NYSE: DSW  ) is proving to investors that it can be fashionable once again. Shares of the discount shoe chain surged more than 9% yesterday to close around $30.99 a share, marking the stock's biggest gain in nearly two years. The move came after the company released better than expected earnings results for its fiscal second quarter. However, after a turbulent past year in which the stock fell more than 26%, some analysts wonder whether the rally can continue. Let's look at what's working for DSW lately and whether it can go higher from here.

Source: DSW.

Beating the odds
First, a look at how the shoe retailer performed in its latest quarter. For the period ended Aug. 2, DSW generated a profit of $0.38 per share, a penny higher than the company's earnings per share of $0.37 a year ago. This was also significantly better than the $0.32 per share Wall Street expected DSW to deliver in the second quarter.

Revenue climbed 4.5% to $587 million, handily beating analysts' estimate for sales of $565 million in the quarter. Additionally, the company created shareholder value by repurchasing roughly 2 million shares for $55 million. DSW still holds $43 million of its authorized $100 million in share buybacks.

Source: DSW.

One key thing DSW did right in the quarter was to gain better control of its inventories. In the previous quarter, the company posted negative 3.7% comparable-store sales growth, related, in part, to management's failure to address inventory problems, according to research from Barron's. Things have changed. In the second quarter, DSW achieved same-store sales growth of 0.08%, and its inventories decreased by 3.3% on a cost per square foot basis.

DSW CEO Mike MacDonald said in the earnings press release, "The actions we took to balance inventories created margin pressure but inventories at the end of the quarter were current and below the prior year on a cost per square foot basis." Keeping inventory levels in check should lift sales in the quarters ahead and help the company avoid widespread product markdowns.

Expanding into new markets
The retailer opened two DSW stores in Toronto, Canada, this month as part of its international expansion plans. In tandem with this growth, DSW also recently acquired a 49.2% stake in Town Shoes, one of Canada's largest shoe retailers.

In an attempt to broaden its customer base in the Great White North, DSW also launched an e-commerce site dedicated to Canadian customers. This gives shoppers there the chance to buy DSW merchandise anytime online. DSW now has 410 stores in 42 states, the District of Columbia, and Puerto Rico, along with the two locations in Canada.

This means there is plenty of room for the company to expand in the future. Importantly, at the end of the second quarter DSW boasted a strong balance sheet with roughly $465 million in cash and investments and zero long-term debt. This gives management ample cash to invest in further expansion in the U.S. and abroad.

Shares of DSW are today still trading nearly 35% below the stock's 52-week high. I believe this creates an opportunity for patient investors to get into this name while the turnaround story is in its infancy. DSW's management proved in the latest quarter that it is capable of stricter inventory controls, while also demonstrating its agenda to reward investors with share buybacks. Therefore, I believe the stock could go higher as the company builds on this momentum going forward.

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