Nine West's Stumble
Alexandria, VA (Aug. 27, 1998) -- On a day when the S&P 500 fell more than 3.5%, when Russia's market fell 9% (after a 14% drop on Wednesday, following a 79% drop since January 1st), when parliamentary opposition in Moscow called more loudly for Boris Yeltsin's resignation, well, we plan to keep our heads down and continue doing the work of evaluating individual businesses.
Yesterday's Cash-King report was filled up with philosophy trickling down out of an ivory tower. A reflection here, a square root there, a smattering of symbols, and some broad theory about measuring the financial accomplishments (and shortcomings) of public companies. A few more days like that one, and I'll wipe out our entire readership.
So as to hold your attention (and mine) for another day, I'll actually apply yesterday's string of theoreticals to a popular consumer franchise, Nine West Group, the designer and retailer of women's leather shoes, purses, and bags. You've probably seen this company, or one of its labels, in malls across the country. Nine West sells its merchandise under multiple brands, like Amalfi, Enzo Angiolini (I always hear good things about this one), 9 & Co., and Pappagallo. Nine West also has licensing agreements to sell shoes and handbags under the popular Calvin Klein and Evan Picone trademarks.
We're talking about a classic Peter Lynch company here, with bustling storefronts across the country and a known brand that draws repeat-purchasing customers. That's just what we look for when we hunt down Cash-Kings -- a good name, healthy demand, and the habitual purchase of convenience merchandise. As for the stock, Nine West has been public since early 1993, and its share price ran from $20 in February, 1993 to $58 by October 1996.
Those boots are made for walkin'.
But let's take a look at the development of its business over the three-year period beginning February 1996 and ending February 1998. February marks the close of Nine West's fiscal year each year. Is Nine West the sort of company we'd invest in? At first blush, it certainly seems so -- national name brands and consumer love. A 15-minute walking tour of their financial statements will confirm or deny that. We'll be using yesterday's seven Cash-King criteria for commercial direction: 1) rising sales, 2) rising gross margins, 3) rising net margins, 4) a rising ratio of cash-to-debt, 5) a falling Flow Ratio, 6) share buybacks, and 7) a believable plan for global expansion.
#1. Rising Sales
First, we check to see if more people are marching into more Nine West stores with greater frequency than ever before, as we study the company's growth in revenues. I clarified yesterday that, in ideal Cash-King situations, sales grow at annual rate of 15% or more. And that's exactly what we have here:
(in billions) 1996 1997 1998 $1.26 $1.60 $1.87
From the close of fiscal 1996 to the close of 1997, Nine West posted sales growth of 27%. And from 1997 to 1998, revenues kept running higher, up another 17%. Ideal.
#2. Rising Gross Margins
One step below sales, the company has battled to maintain pricing power, while holding down the manufacturing costs of doing business. Here's a look at its gross margins over the past three years:
1996 1997 1998 39.9% 43.1% 42.9%
From 1996 to 1997, Nine West pushed gross margins 8% higher, to 43.1%. The following year, margins fell slightly. Our rankings label "Ideal" any rise in gross margins in excess of 5%. On the flip side, when gross margins fall, we rank it "Bad News." Nine West had a taste of both ends of the spectrum between 1996-1998, so let's note gross margins as a neutral for the company over this period.
#3. Rising Net Margins
Rising net margins signal a company that's becoming ever more profitable with each passing quarter. In Nine West's case, net margins have been on the rise for the past two years -- meaning that the company turned more profit on a pair of leather pumps in 1998 than they did in 1997. They earned greater reward from the same amount of work -- a sound approach to business. Here are the company's net margins over the three years:
1996 1997 1998 neg.* 3.9%* 4.2%
* excludes one-time gains
A company earns an "Ideal" ranking if they increase net margins by more than 5%, year to year. In Nine West's case, margins ran out of the red to 3.9% in 1997, then increased 7.7% in 1998. Delightful, delicious, delectable, delirious -- ideal.
Before cruising over to the balance sheet, let's celebrate together the company's strong income-statement performance over the past few years. Sales have taken off to $1.87 billion, gross margins are holding steady, and net margins are on the rise. Nine West has put the peanut butter in the chocolate and the chocolate in the peanut butter -- rewarding shareholders with both growing sales and sales that have grown more profitable.
By halftime, this one has the look and feel of a Cash-King business. But before we fumble with our keyboard and punch up our online broker to buy, let's glance over the balance sheet.
#4. Cash Outgrowing Debt
Uh-oh, somebody threw a red flag in the air, or elbowed us so hard in the stomach that we're gasping for air, or deflated the air from our bicycle tires overnight.
Nine West's debt situation falls into the "Bad News" category in each of the last few years. First off, the company is well below our cash-to-debt target of 1.5. In 1996, cash was a mere 0.044x long-term debt -- the actual figures being $471 million in debt and just $21 million in cash.
Worse still, and most important in our coverage of business direction, the ratio has fallen consistently over the past twenty-four months. At the close of 1998, Nine West had $687 million in debt and $24 million in cash. Here's how it breaks down over each of the past three years.
1996 1997 1998 .044x .042x .034x
#5. Lowering Flow Ratio
Was that the sound of a stadium full of fans raucously booing? Or did someone just crash their Big Wheel into a stone wall? Or did that old brick building halfway out of town finally collapse? Or am I just having a really, really bad nightmare?
The Flow Ratio -- in my opinion the single most important Cash-King criteria -- measures the strength of a company's position in its markets. It tracks how efficiently the company turns product into cash while delaying payments to suppliers. A strong Flow Ratio relies on keeping inventories and accounts receivable in check, while forcing accounts payable (unpaid bills) higher. If the logic of that is lost on you, please read our Flow Ratio Explanation.
We spend our time as investors looking for companies with a Flow Ratio below 1.25, and we strongly favor companies that have a stable Flowie, ideally driving it lower.
A shoe strap just broke.
Nine West's Flow Ratio is not only too high, but it's been dramatically on the rise over the past few years. Between 1996 and 1998, the company has seen its inventories rise from $397 million to $544 million, while its current liabilities have fallen from $294 million to $209 million. Ooof! A double dip of disaster.
Here's how that's played out in the Flow Ratio:
1996 1997 1998 1.94 3.03 3.17
This simply indicates that, over the past few years, Nine West has been losing what little authority it had in its markets. The rise in inventory is likely the result of Nine West tying its outlets to very aggressive sales targets, without rewarding them for keeping unsold inventory under wraps. In other words, the home office is encouraging stores to buy as much merchandise as possible, sell like mad, and then stack the storeroom with what can't be sold. Those stacks have been growing higher.
This is a very bad long-term model in retailing. And, now weakening financially from its binge, Nine West has to pay its shoe, bag, and sunglasses suppliers in a very timely fashion (falling accounts payable).
#6. Share Buybacks
Given that the company has $687 million in debt today, and $24 million in cash, you're right to expect that Nine West hasn't been on a stock shopping spree. Here are the figures on the total number of shares outstanding, fully diluted:
in millions) 1996 1997 1998 35.7 38.9 39.4
From 1996 to 1997, shares rose 8.9% (bad news), then from 1997 to 1998, they rose 1.3% (neutral). I'll rank Nine West neutral on tending to its shares outstanding.
7. Expanding Possibilities
We've found a series of bitter disappointments on the balance sheet, after celebrating the apparently healthy rise in sales, earnings, and net margins. Can you see how the one can counteract the other? Over the past few years, Nine West has been so focused on growth that the always important management of that growth has weebled and wobbled, and just about fallen down.
Inventories are out of control, which is again symptomatic of a retailer that has tied incentives to sales growth but not product management. Long-term debt is rising markedly, and suppliers are demanding more upfront payments. At the same time, accounts receivable have climbed at a rate of 29% per year since 1996; Nine West has been forced to relax its hold on distributors, accepting their payments for merchandise later and later.
Fools, these aren't the conditions for continued expansion throughout the nation, spreading gradually across the globe. Yes, many of our friends are familiar and happy with Nine West products. But no, the company is not well-positioned today to do anything more than push sales and earnings on fumes in the short-term. It'll take a meaningful restructuring, a write-off of inventory, and a more sophisticated store incentive plan that rewards product management as much as product sales. And Nine West will have to slow its expansion, as it commits itself to paying down debt.
Not surprisingly, Nine West shares have been hammered over the past year. In fact, take a look at this three-year chart of its performance (Nine West stock price monthly for 3 years). By the close of fiscal 1997 in February, the public markets were still generally pleased with the company's performance. The stock was trading above $50 per share. But at that time, the balance sheet showed the classic signs of business erosion, with the Flow Ratio touching above 3.00. Since then, the popular shoemaker has been on a grim descent to $19 per share, off more than 60%, where it sits today.
The game isn't over; the company can be righted. The question is: Will management pull back the reigns and focus on efficiency? I have a feeling that if they consulted with you tomorrow morning, they'd stand a much better chance of doing just that. In the meantime, given the inventory levels, if you're a Nine West shopper, be sure to negotiate on price.
Tomorrow, I'm going to run Pfizer through this rigorous review. Until then...
Stock Change Bid AXP -6 15/16 90.25 CHV -1 75.50 CSCO -4 1/2 99.13 KO -4 7/16 74.75 GPS -1 3/8 59.00 EK -1 15/16 84.44 XON -1 1/16 69.25 GM -3 1/8 60.75 INTC -3 1/4 79.75 MSFT -3 9/16 109.00 PFE -4 1/8 103.88 SGP -4 13/16 97.06 TROW -1 11/16 33.63
Day Month Year History C-K -3.89% -4.43% 10.45% 10.45% S&P 500 -3.79% -6.92% 3.69% 3.69% Nasdaq -4.62% -9.93% 1.20% 1.20% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 109.00 39.26% 2/3/98 22 Pfizer 82.30 103.88 26.22% 5/1/98 37 Gap Inc. 51.09 59.00 15.48% 6/23/98 23 Cisco Syst 86.35 99.13 14.80% 2/27/98 27 Coca-Cola 69.11 74.75 8.17% 8/21/98 22 Schering P 95.99 97.06 1.12% 2/6/98 56 T. Rowe Pr 33.67 33.63 -0.14% 2/13/98 22 Intel 84.67 79.75 -5.82% 5/26/98 18 AmExpress 104.07 90.25 -13.28% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 84.44 33.71% 3/12/98 20 Exxon 64.34 69.25 7.64% 3/12/98 15 Chevron 83.34 75.50 -9.41% 3/12/98 17 General Mo 72.41 60.75 -16.10% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 2616.00 $737.55 2/3/98 22 Pfizer 1810.58 2285.25 $474.67 6/23/98 23 Cisco Syst 1985.95 2279.88 $293.93 5/1/98 37 Gap Inc. 1890.33 2183.00 $292.67 2/27/98 27 Coca-Cola 1865.89 2018.25 $152.36 8/21/98 22 Schering P 2111.7 2135.38 $23.68 2/6/98 56 T. Rowe Pr 1885.70 1883.00 -$2.70 2/13/98 22 Intel 1862.83 1754.50 -$108.33 5/26/98 18 AmExpress 1873.20 1624.50 -$248.70 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1688.75 $425.80 3/12/98 20 Exxon 1286.70 1385.00 $98.30 3/12/98 15 Chevron 1250.14 1132.50 -$117.64 3/12/98 17 General Mo 1230.89 1032.75 -$198.14 CASH $48.07 TOTAL $24066.82 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio for future investment. This will be reflected
in the numbers as soon as possible.
*The year for the S&P and Nasdaq will be as of 02/03/98