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DSW Falls on Comparable-Sales Decline, Pessimistic Guidance

By Dan Caplinger - May 24, 2016 at 10:02AM

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The shoe retailer sees tough times ahead.


Image source: DSW.

Throughout the current earnings season, companies that rely on consumers to shop at their store locations have faced significant challenges. Shoe and accessories retailer DSW (DBI -2.45%) has had to deal with a tepid retail environment, and coming into Tuesday's fiscal first-quarter financial report, DSW investors expected the company to suffer earnings declines from year-ago levels despite producing some top-line growth. DSW shocked investors by failing to meet those expectations, and the outlook it gave for the remainder of the year raised new concerns among long-term shareholders.

Let's look more closely at the latest from DSW and what it says about the shoe retailer's future.

DSW breaks a heel

DSW's fiscal first-quarter results painted an ugly picture of the company's current situation. Revenue was up 4% to $681 million, falling short of the nearly $700 million in sales most investors were looking to see from the company. Net income plunged 37%, and even after allowing for some one-time acquisition costs, adjusted earnings of $0.40 per share were a nickel per share less than the consensus forecast among investors.

Taking a closer look at DSW's fundamentals, perhaps the most disappointing number came on the comparable-store sales front. Comps were down 1.6% from year-ago levels, which represented a massive slowdown from last year's 5.1% gain. Moreover, much of the rise in overall revenue came from the acquisition of Ebuys, which added more than $15 million to the top line. Without that boost, sales would have been up less than 2%.

DSW faced pressure on its margin figures. Higher markdowns helped bring adjusted gross margin down by 2.5 percentage points, along with the fact that the new Ebuys unit produces a lower margin than DSW's traditional business. Increased spending on marketing, investments in technology, and overall corporate expenses had a negative impact on operating income, and a higher tax rate this year also weighed on DSW's ability to maintain profits. Outstanding inventory levels also rose sharply, and even excluding the inventory obtained in the Ebuys acquisition, growth of 4.7% showed some of DSW's struggles to get merchandise out the door.

On a segment basis, DSW's divisions both faced difficult conditions. Comps at the larger DSW retail segment were down 1.4%, but the Affiliated Business Group suffered a larger 3.4% decline in comps.

CEO Roger Rawlins didn't pull punches in warning investors about the tough conditions DSW is facing right now. "We have reduced our sales and earnings guidance to reflect the current trend of our business in a challenging retail environment," the CEO said. "This is the prudent action to take so that inventory, expenses, and capital investments are aligned to maximize profitability and positioned to expand earnings as our trend improves."

Why the future looks bleak for DSW

However, the troubling thing about DSW's performance is that many of the company's efforts haven't panned out as well as hoped. In Rawlins' words, "We have invested heavily in technology, stores, marketing, and support services, [and] these investments have driven sales, but we haven't grown our bottom line." In response, DSW will look more closely at its cost structure to try to find ways to boost productivity and increase net income.

The extent of the decline in DSW's guidance was shocking. The retailer now expects revenue for the full fiscal year to grow between 6% and 7%, down from an 8% to 10% range given three months ago. Initial expectations had included calls for a 1% to 2% increase in comparable-store sales, but DSW now believes investors should prepare for a 1% to 2% decline in comps for the year. Gross margin could fall by 1 to 1.5 percentage points, and adjusted earnings in a range of $1.32 to $1.42 per share would be a decrease of more than $0.20 per share compared to DSW's previous guidance.

In response, DSW shares posted sharp declines, falling more than 11% in the opening minutes of the trading day following the announcement. Until and unless the retail environment starts to improve, DSW investors will have to be ready for even greater pressure on the shoe retailer's results throughout the remainder of the year and potentially beyond.

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