This is part of The Motley Fool's annual Stocks for Mom special.
Trading at $19.70 as of 5/4/04
52-week high: $28.45
52-week low: $14.13
For Mother's Day, I offer you a beaten-down tennis shoe company.
Though not as famous as fellow athletic shoemakers Nike
The stock first hit my radar after passing my Modified Foolish 8 screen, which concentrates on quality small caps with consistently solid returns on equity (ROE). Then, it made it onto Tom Gardner's Watch List in Hidden Gems -- a watch list that has performed extremely well, returning 26% (vs. the S&P 500's 9%) since its inception a year ago.
Last week, however, K-Swiss management reported record earnings that also included downward guidance for the upcoming second quarter. Investors pounded the stock, driving it down some 20%.
I see two reasons for the severe reaction. First, a Wall Street Journal article the day before the earnings release noted that while K-Swiss benefited from a surge in the popularity of classic "white on white" sneakers, that popularity may be leveling off. Second, the backlog of orders from Foot Locker
The end result is that, after reporting a 31% rise in first-quarter sales, management is now predicting just a 2% bump in the second quarter.
Having looked at the financials and listened to the earnings conference call, I think the market has overreacted. K-Swiss has been profitable, cash-rich, and debt-free for years. Management has demonstrated its ability to efficiently allocate capital with an ROE figure that has risen to around 30%. Aside from Foot Locker, sales to all customers are up sharply, as are overseas shipments.
The problem with Foot Locker can't be overlooked, but as K-Swiss President Steven Nichols pointed out on the call, "They own more of our shoes than they did two years ago. We've grown significantly as a percentage of their business. I think we're going to have ups and downs from quarter to quarter." Indeed, Foot Locker has accounted for anywhere from 13% to 35% of sales. At the moment, the pendulum is at 15% -- very near the historical low.
With the recent meltdown, K-Swiss is trading at just 13 times revised 2004 earnings. I can't speak to the short-term direction of the stock price, but with so much bad news already priced in, I think there are a couple of factors that give plenty of room for upside: fast-growing (non-Foot Locker) U.S. and international sales and an eventual pickup again in Foot Locker orders.
The risk is certainly there that the Foot Locker pendulum will take far too long to swing back, but even if that happens, a return to 10% to 15% growth rates seems entirely feasible. If so, that earnings multiple of 13, coupled with effective management, makes this one worth a closer look.
Rex Moore is part of Tom Gardner's team on Motley Fool Hidden Gems (take a free trial). He owns no companies mentioned in this article.
A Stock for Mom represents the opinion of one Fool and should in no way be taken as the opinion of either The Motley Fool, Inc. or the company in question, or as representative of anyone or anything other than that specific Fool's thoughts. The Fool has a disclosure policy.