BARRY (R G) CORP DFZ
May 22, 2012 - 11:34am EST by
bentley883
2012 2013
Price: 13.25 EPS $0.98 $1.31
Shares Out. (in M): 11 P/E 13.5x 10.1x
Market Cap (in $M): 134 P/FCF 7.1x 6.4x
Net Debt (in $M): 0 EBIT 22 26
TEV ($): 121 TEV/EBIT 5.6x 4.6x

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  • Small Cap
  • Apparel
  • Highly Cash Generative
  • Low multiple
  • Acquisition
 

Description

Investment Thesis: R.G. Barry (DFZ) is a mis-priced small cap stock in the footwear/apparel sector. I believe a significant transformation in the Company’s business model and growth prospects associated with two recent acquisitions, which has notably increased DFZ’s intrinsic value, has gone unrecognized by investors. By redeploying its excess capital effectively, DFZ’s business model has transitioned to one with higher margins/EPS, improved ROIC, increased cash flow and accelerating growth. This shift in the Company’s business has the additional benefits of reducing DFZ’s seasonality and customer concentration profile. Some of these benefits have already begun to materialize in the Company’s quarterly results while others will follow in future quarters. As this transition is fully recognized, I believe investors will reward the shares with a higher valuation. The stock is attractive relative to the Company’s underlying EPS and FCF generating capabilities of about $1.50 per share and ~$20 million respectively in calendar 2013. Selling at roughly 8.5x calendar 2013 EPS and 3.8x on an EV/EBITDA basis with a FCF/EV yield of 16.5%, the shares are attractive on an absolute basis. Additionally my valuation analysis shows that each of the Company’s businesses (footwear and accessories) are valued at a significant discount on their individual earnings compared with other public companies in each respective sector. Thus, investors are getting two business for the price of one. I believe the recent underperformance of the shares during the last two months (which follows a history of underperformance in the stock during the Company’s seasonally weak selling season), presents a buying opportunity and note that the shares are selling significantly below intrinsic value of ~$18 per share.

Key statistics:

Symbol

DFZ

FYE

June

Date

5/18/12

Price

$12.80

52-week range

$8.15-$14.21

Avg. Volume

22,255

Div./Yield

$0.32 / 2.5%

MC

$134.1M

EV

$121.3M

Net Cash /Shr.

$12.7 / $1.13

FY 12E Sales

$17.1M

FY 13E Sales

$18.2M

FY 12E EPS

$1.31

FY 13E EPS

$1.42

Expanding From a Position of Strength: DFZ’s core footwear/slipper business has a number of attractive attributes that should be appealing to investors. The company is the leadingUS manufacturer of slippers, with a market share of roughly 30% (vs. its nearest competitor, who has less than half of DFZ’s share). Within its core consumer base, the Dearfoam’s brand is well regarded for quality and value as a result of its broad distribution and 65 year history. As evident from sales trends during the last few years, the product has recession resistant characteristics. The Company discontinued manufacturing its slippers in 2004 and transitioned to more of a flexible, variable cost centric model, outsourcing its products from various manufacturers, principally inChina. This business generates a healthy 15%-20% ROIC and strong FCF. Given the Company’s market share and the dynamics of the market, growth prospects approximate mid-single digit levels, with new opportunities centered on expansion into new North American countries.

Two Transformational Acquisitions: Following a patient and extensive search, DFZ acquired two companies during Q1 of calendar 2011. On January 27th, the Company purchased Foot Petals Inc., a privately held developer and marketer of premium insoles and comfort solutions for footwear problems for $14 million in cash. On March 31st, DFZ acquired Baggallini, a privately-held manufacturer of women’s handbags and travel accessories for $34.6 million. Detailed information on both companies can be found in DFZ’s 10K/Q filings and on the Company’s web site at: http://www.rgbarry.com. I believe the combination of these two acquisitions has significantly transformed the Company and increased its investment appeal. 

While management has not provided pro-forma financial details on either business, the footnotes of the Q3 FY 2011 10Q and the FY 2010 10K filing provides enough information for investors to broadly gauge the size, returns and financial impact of these two acquisitions. Using the data for Q3 and Q4 of FY 2011 (which does not take into account seasonality) “back-of-the-matchbook” pro-forma estimates for each of these two acquisitions is illustrated in the table below. Both companies have excellent high margin business models that will have a significant positive impact on DFZ’s overall profitability and financial returns.

Estimated Pro-forma Data

Comparing the Foot Petals & Baggallini Acquisitions vs. Footwear

 

 

FY 2011

FY 2011

vs. Footwear**

 

Foot Petals*

Baggallini*

FY 2011

FY 2010

Revenues

13.228

20.224

118.844

123.787

Gross Profit

8.335

11.276

41.776

51.359

  Gross Margin %

63.0%

55.8%

35.2%

41.5%

 

 

 

 

 

Operating Income***

4.564

5.156

11.935

14.736

Operating Profit %

34.5%

25.5%

10.0%

11.9%

 

 

 

 

 

OE&I Exp./Inc.

0

0

0.158

0.241

 

 

 

 

 

Pretax Income

4.564

5.156

12.093

14.977

Taxes

1.670

1.887

4.426

5.582

  Tax Rate %

36.6%

36.6%

36.6%

36.6%

Net Income

2.894

3.269

7.667

9.395

 

 

 

 

 

Shs. Out. (mil.)

11.227

11.227

11.227

11.036

EPS Impact

$0.26

$0.29

$0.68

$0.85

 

 

 

 

 

Notes:

 

 

 

 

* = Annualizing data from the FY 2011 Q3 10Q and 10K documents.

** = Footwear (slippers) segment from FY 2011& 2010 10K documents.

*** = Operating profit in FY 11 in footwear division excludes $3.5 million in special charges.

Increased Earnings Power: The major benefit of the acquisitions of Foot Petals and Baggallini (the Accessories Division) is that both companies will significantly increase DFZ’s financial returns, earnings power and cash flow generating capabilities. The operating margin for the new accessories division is roughly in the mid 20% range. Thus, the profitability of DFZ new accessories business is ~2x-3x that of the 9%-12% historic margins in DFZ’s traditional footwear/slippers division. Immediately following the merger DFZ made additional investments in both companies, (especially Baggallini) to better position the companies for future growth. These investments center on expanding both brands’ growth opportunities through increased distribution and the broadening the product line. These actions have depressed operating margins in the accessories division during the last few quarters and have hidden the accessories division’s true earnings potential. As these investments begin to moderate over the next few quarters, greater margin expansion should become apparent. In addition, with the accessories division now viewed as the Company’s primary growth vehicle, management has been actively restructuring or eliminating some low margin business in its footwear division. While this has negatively impacted recent sales, this should help maximize footwear profitability and cash flow beginning in the second half of calendar 2012. The overall margin leverage coupled with the more rapid growth opportunities inherent in these accessories businesses (roughly mid-teens versus low-single digits in the footwear division), should translate into a meaningful increase in earnings and cash flow in the future.

On the Company’s recent conference call management stated that in the fiscal year ended June of this year about 30% of earnings will come from these acquired companies and projects this figure will rise to 35%-40% next fiscal year. My forecasts show that in calendar 2013 the accessories division will account for close to 40% of DFZ’s overall earnings. Given the earnings leverage associated with this business, I estimate that DFZ’s will have earnings power of approximately $1.50 per share in calendar 2013, which will translate into FCF of roughly $20 million. By my estimates ROIC for the Company will rise to roughly 20% (and exceed 30%, excluding goodwill and intangibles) during this time. Given the higher returns and growth prospects in this business, this higher quality earnings stream should command a premium valuation relative to that which the lower margin/growth slipper business has traditionally been accorded.

Additional Benefits Should Help The Stock Valuation: I believe there are a number of additional benefits of the Foot Petals and Baggallini acquisitions that should increase the valuation of the stock and improve investment psychology. These benefits include:

  • Reduced Seasonality: Historically DFZ’s earnings and cash flow are quite lumpy due to the seasonal retail purchasing patterns in the footwear business. The December quarter (Q2) had been the Company’s largest revenue quarter, accounting for about 40%-45% of full-year sales, followed by the September quarter (Q1), which comprised roughly 23%-28% of yearly sales. Thus, the first half of the fiscal year had accounted for about 65%-70% of sales, while the second half accounts for only 30%-35%. The impact of this seasonality has even been more pronounced relative to profitability. The Company has made all of its profits in the first half of the year, while profitability in the second half of the fiscal year had been breakeven to a modest loss.

 

This seasonality has translated into heightened volatility in the share price, especially during the first half of the calendar year. As illustrated in the following table, during the last few years the share price has recorded periods of both absolute and relative underperformance during the first half of the year. I believe this volatility is directly correlated to the seasonality in the Company’s business. Historically, investors who have taken advantage of this period of relative share weakness have been rewarded later in the year. I believe the current weakness in the share price presents another opportunity for patient value investors to purchase the stock.

DFZ Historic 1H Share Underperformance

 

 

 

 

 

 

 

 

 

2012

2011

2010

2009

2008

2007

2006

DFZ

-16.2%

-16.4%

-6.1%

-16.8%

-13.5%

-10.5%

-19.0%

S&P 500

2.0%

1.7%

3.3%

-12.9%

-8.1%

0.4%

2.7%

Relative Performance

-18.2%

-18.1%

-9.4%

-3.9%

-5.5%

-10.9%

-21.7%

Foot Petals and Baggallini exhibit only modest seasonal patterns in their businesses, therefore, the overall seasonality in the Company’s business will be moderated. The combination of less seasonality in these businesses and their significantly higher margins should eliminate DFZ’s first half operating losses. DFZ’s recently reported Q2 (March) results highlight the reduced seasonality in the Company’s financial results. In what has historically been a seasonally weak quarter for the legacy footwear business, marked by breakeven to a moderate loss in the period, DFZ’s March quarter results showed profitability. Reducing the volatility in the Company’s earnings should translate into a less volatile stock and a higher valuation.

  • Customer Concentration Issue Moderated: One of the factors which may have contributed to DFZ’s low valuation is the customer concentration issue associated with Walmart. It is important to note that this relationship is not new and has been in place for ~30 years. Highlighting the depth of the relationship, Wal-Mart allows DFZ access to its IT systems to manage the retailer’s inventory and be a fulfillment agent. Given DFZ’s expanding retail presence, the percent of revenues generated from Walmart has been declining in recent years (38%, 35% and 32% in FY 2009, 2010 and 2011 respectively), prior to the recent acquisitions. Foot Petals and Baggallini currently reduce Wal-Mart sales to about 26%-27% of overall revenues and are projected to be roughly 24% in 24 months. Moreover, the impact on profitability is even more pronounced given the combination of the significantly higher margins and more rapid growth in the accessories division along with the favorable pricing Wal-Mart likely receives. My estimate is that by the end of fiscal 2014, Wal-Mart will account for no more than 15% of profits. While still meaningful (and a good customer for DFZ to have), this lower customer concentration should translate into a higher valuation for DFZ’s share price.

 

  • A Modest Acceleration in Overall Growth: Historically some investors have not found the shares appealing due to the Company’s low growth profile. Given DFZ’s large share of the slipper market and existing relationships with most of the relevant retailers in theUS, growth opportunities have been modest. The focus for growth in the footwear business is leveraging its retail partnerships to expand internationally intoMexico andCanada. Given this expansion and modest price increases, management believes growth in the footwear division should approximate mid-single digits (I have modeled low single-digit growth to be conservative). Following a period of eliminating some low margin business in FY 2011, which negatively impacted footwear sales, growth should resume in the second half of calendar 2012. The recent acquisitions of Foot Petals and Baggallini (and potential future acquisitions) add a new growth dimension to the DFZ investment story. Management targets growth for its accessories business in the low-to-mid teens. This growth is likely to come from leveraging DFZ’s retail relationships and increasing distribution (i.e. door count) for both Foot Petals and Baggallini among independent and full price big box retailers (i.e. Dillard’s and Nordstrom’s). The Baggallini product line is being broadened from basic lines to include more fashionable products while price points are being increased on the upper end. With the addition of Foot Petals and Baggallini, DFZ’s total revenues should show a modest acceleration and grow in the 6%-7% range during the next 24 months. Possible future acquisitions could accelerate growth even further. While, not likely to be categorized as a traditional growth company, this should help address one of the issues that has restrained the stock’s valuation.

 

  • An Indication That Management is a Good Allocator of Capital: I believe these two acquisitions show that management is a smart allocator of capital. Despite criticism from some investors, management was patient in waiting for the right opportunity and appears to have selected wisely. With a forecast of ~40% of earnings in calendar 2013 coming from the two acquisitions (or roughly $7 million), this translates into an impressive after tax return of 14.5% on the $48.5 million cost of both acquisitions. That is important given that an important management goal is to redeploy the excess capital in its business for future potential acquisitions. Similar to Foot Petals and Baggallini, management is targeting acquisitions of strong existing bolt-on type businesses/franchises (as opposed to turn-around stories) which it can purchase at a reasonable price, and will accelerate the Company’s growth and financial returns. The discipline management has demonstrated and potential returns in both Foot Petals and Baggallini, should give investors greater confidence in management’s ability to execute on its plan and increase shareholder value.

 An Attractive Valuation, Selling Significantly Below Intrinsic Value: I believe the shares of DFZ are attractively price on both an absolute and relative basis. Currently, the shares are valued at a P/E of roughly 8.5x my forecast for earnings power of $1.50 per share and are selling at an EV/EBITDA multiple of only 3.8x. From a FCF perspective, the FCF/EV yield of my $20 million forecast is 16.5%. As illustrated in the following table, DFZ is also attractively priced on a relative basis when compared with both public footwear related and handbag accessories companies.

Comparative Analysis

Valuations Of Public Footwear Companies

 

 

 

 

 

 

 

 

 

 

 

 

ttm

ttm

Sales Growth

Company

Stock

Price

P/S (ttm)

EV/EBITDA

Op. Margin

2012

2013

Addias AG

ADDYY.PK

$38.92

0.91

9.65

8.0%

13.4%

NA

Croc's

CROX

$16.76

1.45

7.59

13.7%

19.0%

13.0%

Decker's Outdoor

DECK

$52.72

1.46

6.09

18.9%

13.3%

12.5%

K-Swiss

KSWS

$3.08

0.42

-1.86

-20.8%

-11.0%

11.0%

Nike

NKE

$106.99

2.10

13.53

13.0%

15.7%

9.6%

Rocky Brands

RCKY

$12.59

0.39

4.78

7.6%

5.3%

5.5%

Sketchers

SKX

$17.89

0.60

-9.17

-7.2%

-9.0%

9.2%

Wolverine World Wide

WWW

$42.39

1.48

11.78

11.3%

7.1%

7.5%

  Average (x-negatives)

 

1.10

8.90

12.1%

12.3%

9.8%

 

 

 

 

 

 

 

 

R.G. Barry

DFZ

$12.80

0.93

5.02

14.4%

7.0%

7.0%

R.G. Barry (Footwear only*)

$12.80

1.19

6.48

9%-12%

 

4%-5%

 

 

 

 

 

 

 

 

 

 

Cal. EPS

P/E

PE/Growth

Company

Stock

2012

2013

2012

2013

2012

2013

Addias AG

ADDYY.PK

$2.11

NA

18.4

NA

1.38

NA

Croc's

CROX

$1.49

$1.73

11.2

9.7

0.59

0.75

Decker's Outdoor

DECK

$4.53

$5.47

11.6

9.6

0.88

0.77

K-Swiss

KSWS

($0.51)

$0.14

-6.0

22.0

0.55

2.00

Nike

NKE

$5.43

$6.30

19.7

17.0

1.25

1.77

Rocky Brands

RCKY

$1.73

$1.93

7.3

6.5

1.37

1.19

Sketchers

SKX

$0.08

$0.68

NM

26.3

NM

2.86

Wolverine World Wide

WWW

$2.73

$2.98

15.5

14.2

2.19

1.90

  Average (x-negatives)

 

 

14.0

15.1

 

1.60

 

 

 

 

 

 

 

 

R.G. Barry

DFZ

$1.40

$1.50

9.1

8.5

1.31

1.22

 

 

 

$0.90

 

14.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comparative Analysis

Valuations Of Public Handbag Accessories Companies

 

 

 

 

 

 

 

 

 

 

 

 

ttm

ttm

Sales Growth

Company

Stock

Price

P/S (ttm)

EV/EBITDA

Op. Margin

2012

2013

Coach

COH

$67.23

4.13

11.68

31.7%

15.7%

13.4%

Fossil Holdings

FOSL

$71.84

1.70

8.86

17.7%

15.0%

12.8%

Guess

GES

$25.75

0.87

3.78

15.5%

2.4%

8.1%

Michael Kors

KORS

$40.14

6.76

30.83

18.6%

NA

30.8%

Vera Bradley

VRA

$23.31

2.05

9.02

20.9%

18.1%

14.7%

  Average (x-negatives)

 

3.10

12.83

20.9%

12.8%

13.3%

 

 

 

 

 

 

 

 

R.G. Barry

DFZ

$1.50

0.93

5.02

14.4%

7.0%

7.0%

 

 

 

 

 

 

 

 

 

 

Cal. EPS

P/E

PE/Growth

Company

Stock

2012

2013

2012

2013

2012

2013

Coach

COH

$3.88

$4.64

17.3

14.5

1.10

1.08

Fossil Holdings

FOSL

$5.36

$6.24

13.4

11.5

0.89

0.90

Guess

GES

$2.62

$3.03

9.8

8.5

4.10

1.05

Michael Kors

KORS

$0.89

$1.11

45.1

36.2

NA

1.17

Vera Bradley

VRA

$1.70

$2.02

13.7

11.5

0.76

0.79

  Average (x-negatives)

 

 

19.9

16.4

 

1.00

 

 

 

 

 

 

 

 

R.G. Barry

DFZ

$1.40

$1.50

9.1

8.5

1.31

1.22

 

 

 

 

 

 

 

 

Notes: DFZ's footwear only data from sectional reporting in 10Q & 10K's and my estimates.

 

                 

I believe that DFZ’s valuation reflects the fact that most investors have not recognized that ~ 40% of the Company’s earnings will be coming from its faster growing, higher margin/return new accessories business. It appears that the valuation accorded DFZ’s current overall business is more consistent with comparable footwear companies. In segmenting the earnings attributable from each division, one could make the case that little value is being accorded the higher margin accessories business. As illustrated in the table, investors have clearly valued the public handbag accessories-related companies at a significant premium relative to the footwear-related companies as a result of their higher growth and returns. This disparity highlights the investment opportunity in the stock tied to properly valuing the earnings stream of each of DFZ’s businesses at more appropriate levels.

I believe that the best way to gauge the intrinsic value of the Company’s stock is to properly value the earnings stream of both of its major businesses. My analysis shows that in calendar 2013, DFZ’s accessories business will contribute roughly 40% of profits, or $0.90 per share, while 60% of earnings, or $0.60, will come from the Company’s traditional footwear/slippers business. To be conservative, I value each division at a discount to their peer group average. Thus, valuing the footwear business at a multiple of 10x and the accessories business at a multiple of 15x leads to a stock price of $18 per share. This represents appreciation potential of about 40%, or about a 30% discount to intrinsic value. Also, a dividend yield of roughly 2.5% provides current income to investors.

Catalyst

  • An accleration in overall sales, earnings and FCF growth.
  • Expanding margins.
  • Less seasonality.
  • Greater buy-side coverage.
    sort by   Expand   New

    Description

    Investment Thesis: R.G. Barry (DFZ) is a mis-priced small cap stock in the footwear/apparel sector. I believe a significant transformation in the Company’s business model and growth prospects associated with two recent acquisitions, which has notably increased DFZ’s intrinsic value, has gone unrecognized by investors. By redeploying its excess capital effectively, DFZ’s business model has transitioned to one with higher margins/EPS, improved ROIC, increased cash flow and accelerating growth. This shift in the Company’s business has the additional benefits of reducing DFZ’s seasonality and customer concentration profile. Some of these benefits have already begun to materialize in the Company’s quarterly results while others will follow in future quarters. As this transition is fully recognized, I believe investors will reward the shares with a higher valuation. The stock is attractive relative to the Company’s underlying EPS and FCF generating capabilities of about $1.50 per share and ~$20 million respectively in calendar 2013. Selling at roughly 8.5x calendar 2013 EPS and 3.8x on an EV/EBITDA basis with a FCF/EV yield of 16.5%, the shares are attractive on an absolute basis. Additionally my valuation analysis shows that each of the Company’s businesses (footwear and accessories) are valued at a significant discount on their individual earnings compared with other public companies in each respective sector. Thus, investors are getting two business for the price of one. I believe the recent underperformance of the shares during the last two months (which follows a history of underperformance in the stock during the Company’s seasonally weak selling season), presents a buying opportunity and note that the shares are selling significantly below intrinsic value of ~$18 per share.

    Key statistics:

    Symbol

    DFZ

    FYE

    June

    Date

    5/18/12

    Price

    $12.80

    52-week range

    $8.15-$14.21

    Avg. Volume

    22,255

    Div./Yield

    $0.32 / 2.5%

    MC

    $134.1M

    EV

    $121.3M

    Net Cash /Shr.

    $12.7 / $1.13

    FY 12E Sales

    $17.1M

    FY 13E Sales

    $18.2M

    FY 12E EPS

    $1.31

    FY 13E EPS

    $1.42

    Expanding From a Position of Strength: DFZ’s core footwear/slipper business has a number of attractive attributes that should be appealing to investors. The company is the leadingUS manufacturer of slippers, with a market share of roughly 30% (vs. its nearest competitor, who has less than half of DFZ’s share). Within its core consumer base, the Dearfoam’s brand is well regarded for quality and value as a result of its broad distribution and 65 year history. As evident from sales trends during the last few years, the product has recession resistant characteristics. The Company discontinued manufacturing its slippers in 2004 and transitioned to more of a flexible, variable cost centric model, outsourcing its products from various manufacturers, principally inChina. This business generates a healthy 15%-20% ROIC and strong FCF. Given the Company’s market share and the dynamics of the market, growth prospects approximate mid-single digit levels, with new opportunities centered on expansion into new North American countries.

    Two Transformational Acquisitions: Following a patient and extensive search, DFZ acquired two companies during Q1 of calendar 2011. On January 27th, the Company purchased Foot Petals Inc., a privately held developer and marketer of premium insoles and comfort solutions for footwear problems for $14 million in cash. On March 31st, DFZ acquired Baggallini, a privately-held manufacturer of women’s handbags and travel accessories for $34.6 million. Detailed information on both companies can be found in DFZ’s 10K/Q filings and on the Company’s web site at: http://www.rgbarry.com. I believe the combination of these two acquisitions has significantly transformed the Company and increased its investment appeal. 

    While management has not provided pro-forma financial details on either business, the footnotes of the Q3 FY 2011 10Q and the FY 2010 10K filing provides enough information for investors to broadly gauge the size, returns and financial impact of these two acquisitions. Using the data for Q3 and Q4 of FY 2011 (which does not take into account seasonality) “back-of-the-matchbook” pro-forma estimates for each of these two acquisitions is illustrated in the table below. Both companies have excellent high margin business models that will have a significant positive impact on DFZ’s overall profitability and financial returns.

    Estimated Pro-forma Data

    Comparing the Foot Petals & Baggallini Acquisitions vs. Footwear

     

     

    FY 2011

    FY 2011

    vs. Footwear**

     

    Foot Petals*

    Baggallini*

    FY 2011

    FY 2010

    Revenues

    13.228

    20.224

    118.844

    123.787

    Gross Profit

    8.335

    11.276

    41.776

    51.359

      Gross Margin %

    63.0%

    55.8%

    35.2%

    41.5%

     

     

     

     

     

    Operating Income***

    4.564

    5.156

    11.935

    14.736

    Operating Profit %

    34.5%

    25.5%

    10.0%

    11.9%

     

     

     

     

     

    OE&I Exp./Inc.

    0

    0

    0.158

    0.241

     

     

     

     

     

    Pretax Income

    4.564

    5.156

    12.093

    14.977

    Taxes

    1.670

    1.887

    4.426

    5.582

      Tax Rate %

    36.6%

    36.6%

    36.6%

    36.6%

    Net Income

    2.894

    3.269

    7.667

    9.395

     

     

     

     

     

    Shs. Out. (mil.)

    11.227

    11.227

    11.227

    11.036

    EPS Impact

    $0.26

    $0.29

    $0.68

    $0.85

     

     

     

     

     

    Notes:

     

     

     

     

    * = Annualizing data from the FY 2011 Q3 10Q and 10K documents.

    ** = Footwear (slippers) segment from FY 2011& 2010 10K documents.

    *** = Operating profit in FY 11 in footwear division excludes $3.5 million in special charges.

    Increased Earnings Power: The major benefit of the acquisitions of Foot Petals and Baggallini (the Accessories Division) is that both companies will significantly increase DFZ’s financial returns, earnings power and cash flow generating capabilities. The operating margin for the new accessories division is roughly in the mid 20% range. Thus, the profitability of DFZ new accessories business is ~2x-3x that of the 9%-12% historic margins in DFZ’s traditional footwear/slippers division. Immediately following the merger DFZ made additional investments in both companies, (especially Baggallini) to better position the companies for future growth. These investments center on expanding both brands’ growth opportunities through increased distribution and the broadening the product line. These actions have depressed operating margins in the accessories division during the last few quarters and have hidden the accessories division’s true earnings potential. As these investments begin to moderate over the next few quarters, greater margin expansion should become apparent. In addition, with the accessories division now viewed as the Company’s primary growth vehicle, management has been actively restructuring or eliminating some low margin business in its footwear division. While this has negatively impacted recent sales, this should help maximize footwear profitability and cash flow beginning in the second half of calendar 2012. The overall margin leverage coupled with the more rapid growth opportunities inherent in these accessories businesses (roughly mid-teens versus low-single digits in the footwear division), should translate into a meaningful increase in earnings and cash flow in the future.

    On the Company’s recent conference call management stated that in the fiscal year ended June of this year about 30% of earnings will come from these acquired companies and projects this figure will rise to 35%-40% next fiscal year. My forecasts show that in calendar 2013 the accessories division will account for close to 40% of DFZ’s overall earnings. Given the earnings leverage associated with this business, I estimate that DFZ’s will have earnings power of approximately $1.50 per share in calendar 2013, which will translate into FCF of roughly $20 million. By my estimates ROIC for the Company will rise to roughly 20% (and exceed 30%, excluding goodwill and intangibles) during this time. Given the higher returns and growth prospects in this business, this higher quality earnings stream should command a premium valuation relative to that which the lower margin/growth slipper business has traditionally been accorded.

    Additional Benefits Should Help The Stock Valuation: I believe there are a number of additional benefits of the Foot Petals and Baggallini acquisitions that should increase the valuation of the stock and improve investment psychology. These benefits include:

     

    This seasonality has translated into heightened volatility in the share price, especially during the first half of the calendar year. As illustrated in the following table, during the last few years the share price has recorded periods of both absolute and relative underperformance during the first half of the year. I believe this volatility is directly correlated to the seasonality in the Company’s business. Historically, investors who have taken advantage of this period of relative share weakness have been rewarded later in the year. I believe the current weakness in the share price presents another opportunity for patient value investors to purchase the stock.

    DFZ Historic 1H Share Underperformance

     

     

     

     

     

     

     

     

     

    2012

    2011

    2010

    2009

    2008

    2007

    2006

    DFZ

    -16.2%

    -16.4%

    -6.1%

    -16.8%

    -13.5%

    -10.5%

    -19.0%

    S&P 500

    2.0%

    1.7%

    3.3%

    -12.9%

    -8.1%

    0.4%

    2.7%

    Relative Performance

    -18.2%

    -18.1%

    -9.4%

    -3.9%

    -5.5%

    -10.9%

    -21.7%

    Foot Petals and Baggallini exhibit only modest seasonal patterns in their businesses, therefore, the overall seasonality in the Company’s business will be moderated. The combination of less seasonality in these businesses and their significantly higher margins should eliminate DFZ’s first half operating losses. DFZ’s recently reported Q2 (March) results highlight the reduced seasonality in the Company’s financial results. In what has historically been a seasonally weak quarter for the legacy footwear business, marked by breakeven to a moderate loss in the period, DFZ’s March quarter results showed profitability. Reducing the volatility in the Company’s earnings should translate into a less volatile stock and a higher valuation.

     

     

     An Attractive Valuation, Selling Significantly Below Intrinsic Value: I believe the shares of DFZ are attractively price on both an absolute and relative basis. Currently, the shares are valued at a P/E of roughly 8.5x my forecast for earnings power of $1.50 per share and are selling at an EV/EBITDA multiple of only 3.8x. From a FCF perspective, the FCF/EV yield of my $20 million forecast is 16.5%. As illustrated in the following table, DFZ is also attractively priced on a relative basis when compared with both public footwear related and handbag accessories companies.

    Comparative Analysis

    Valuations Of Public Footwear Companies

     

     

     

     

     

     

     

     

     

     

     

     

    ttm

    ttm

    Sales Growth

    Company

    Stock

    Price

    P/S (ttm)

    EV/EBITDA

    Op. Margin

    2012

    2013

    Addias AG

    ADDYY.PK

    $38.92

    0.91

    9.65

    8.0%

    13.4%

    NA

    Croc's

    CROX

    $16.76

    1.45

    7.59

    13.7%

    19.0%

    13.0%

    Decker's Outdoor

    DECK

    $52.72

    1.46

    6.09

    18.9%

    13.3%

    12.5%

    K-Swiss

    KSWS

    $3.08

    0.42

    -1.86

    -20.8%

    -11.0%

    11.0%

    Nike

    NKE

    $106.99

    2.10

    13.53

    13.0%

    15.7%

    9.6%

    Rocky Brands

    RCKY

    $12.59

    0.39

    4.78

    7.6%

    5.3%

    5.5%

    Sketchers

    SKX

    $17.89

    0.60

    -9.17

    -7.2%

    -9.0%

    9.2%

    Wolverine World Wide

    WWW

    $42.39

    1.48

    11.78

    11.3%

    7.1%

    7.5%

      Average (x-negatives)

     

    1.10

    8.90

    12.1%

    12.3%

    9.8%

     

     

     

     

     

     

     

     

    R.G. Barry

    DFZ

    $12.80

    0.93

    5.02

    14.4%

    7.0%

    7.0%

    R.G. Barry (Footwear only*)

    $12.80

    1.19

    6.48

    9%-12%

     

    4%-5%

     

     

     

     

     

     

     

     

     

     

    Cal. EPS

    P/E

    PE/Growth

    Company

    Stock

    2012

    2013

    2012

    2013

    2012

    2013

    Addias AG

    ADDYY.PK

    $2.11

    NA

    18.4

    NA

    1.38

    NA

    Croc's

    CROX

    $1.49

    $1.73

    11.2

    9.7

    0.59

    0.75

    Decker's Outdoor

    DECK

    $4.53

    $5.47

    11.6

    9.6

    0.88

    0.77

    K-Swiss

    KSWS

    ($0.51)

    $0.14

    -6.0

    22.0

    0.55

    2.00

    Nike

    NKE

    $5.43

    $6.30

    19.7

    17.0

    1.25

    1.77

    Rocky Brands

    RCKY

    $1.73

    $1.93

    7.3

    6.5

    1.37

    1.19

    Sketchers

    SKX

    $0.08

    $0.68

    NM

    26.3

    NM

    2.86

    Wolverine World Wide

    WWW

    $2.73

    $2.98

    15.5

    14.2

    2.19

    1.90

      Average (x-negatives)

     

     

    14.0

    15.1

     

    1.60

     

     

     

     

     

     

     

     

    R.G. Barry

    DFZ

    $1.40

    $1.50

    9.1

    8.5

    1.31

    1.22

     

     

     

    $0.90

     

    14.2

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Comparative Analysis

    Valuations Of Public Handbag Accessories Companies

     

     

     

     

     

     

     

     

     

     

     

     

    ttm

    ttm

    Sales Growth

    Company

    Stock

    Price

    P/S (ttm)

    EV/EBITDA

    Op. Margin

    2012

    2013

    Coach

    COH

    $67.23

    4.13

    11.68

    31.7%

    15.7%

    13.4%

    Fossil Holdings

    FOSL

    $71.84

    1.70

    8.86

    17.7%

    15.0%

    12.8%

    Guess

    GES

    $25.75

    0.87

    3.78

    15.5%

    2.4%

    8.1%

    Michael Kors

    KORS

    $40.14

    6.76

    30.83

    18.6%

    NA

    30.8%

    Vera Bradley

    VRA

    $23.31

    2.05

    9.02

    20.9%

    18.1%

    14.7%

      Average (x-negatives)

     

    3.10

    12.83

    20.9%

    12.8%

    13.3%

     

     

     

     

     

     

     

     

    R.G. Barry

    DFZ

    $1.50

    0.93

    5.02

    14.4%

    7.0%

    7.0%

     

     

     

     

     

     

     

     

     

     

    Cal. EPS

    P/E

    PE/Growth

    Company

    Stock

    2012

    2013

    2012

    2013

    2012

    2013

    Coach

    COH

    $3.88

    $4.64

    17.3

    14.5

    1.10

    1.08

    Fossil Holdings

    FOSL

    $5.36

    $6.24

    13.4

    11.5

    0.89

    0.90

    Guess

    GES

    $2.62

    $3.03

    9.8

    8.5

    4.10

    1.05

    Michael Kors

    KORS

    $0.89

    $1.11

    45.1

    36.2

    NA

    1.17

    Vera Bradley

    VRA

    $1.70

    $2.02

    13.7

    11.5

    0.76

    0.79

      Average (x-negatives)

     

     

    19.9

    16.4

     

    1.00

     

     

     

     

     

     

     

     

    R.G. Barry

    DFZ

    $1.40

    $1.50

    9.1

    8.5

    1.31

    1.22

     

     

     

     

     

     

     

     

    Notes: DFZ's footwear only data from sectional reporting in 10Q & 10K's and my estimates.

     

                     

    I believe that DFZ’s valuation reflects the fact that most investors have not recognized that ~ 40% of the Company’s earnings will be coming from its faster growing, higher margin/return new accessories business. It appears that the valuation accorded DFZ’s current overall business is more consistent with comparable footwear companies. In segmenting the earnings attributable from each division, one could make the case that little value is being accorded the higher margin accessories business. As illustrated in the table, investors have clearly valued the public handbag accessories-related companies at a significant premium relative to the footwear-related companies as a result of their higher growth and returns. This disparity highlights the investment opportunity in the stock tied to properly valuing the earnings stream of each of DFZ’s businesses at more appropriate levels.

    I believe that the best way to gauge the intrinsic value of the Company’s stock is to properly value the earnings stream of both of its major businesses. My analysis shows that in calendar 2013, DFZ’s accessories business will contribute roughly 40% of profits, or $0.90 per share, while 60% of earnings, or $0.60, will come from the Company’s traditional footwear/slippers business. To be conservative, I value each division at a discount to their peer group average. Thus, valuing the footwear business at a multiple of 10x and the accessories business at a multiple of 15x leads to a stock price of $18 per share. This represents appreciation potential of about 40%, or about a 30% discount to intrinsic value. Also, a dividend yield of roughly 2.5% provides current income to investors.

    Catalyst

    Messages


    SubjectRE: Acqs
    Entry05/22/2012 05:31 PM
    Memberbentley883

    Abra

    Thanks for your question. I would note the following points:

    -- The footnotes in the 10Q filing for Q3 (March) FY 2011 and 10K filing for FY 2011 (June) provide the basis for the data I presented in my pro-forma data table and gave us the initial indication of the impact of each business on DFZ’s financials.

    -- Additionally, Foot Petals is already in DFZ’s financial results for a little over four quarters and Baggallini for almost four quarters. The segment breakout in the 10K&Q filings provide a breakout for both gross and operating margins for the new accessories division. This provides the basis for my comments that the operating margin in the new accessories business is ~ mid-20%, which compares with DFZ’s pre-acquisition operating margins of ~9%-12%.

    -- As noted in the report, operating margins in the accessories business over the last couple of quarters have been depressed by investments management has been making in the businesses (especially Baggallini) for new growth opportunities. I suspect that these margins will trend up over the next 12-18 months as some of these investments abate and they begin to pay dividends in the form of higher revenues.

    -- Despite the impact of some of these investments, we have already begun to see the favorable impact of these higher margin businesses in DFZ’s reported results. For example, historically Q3 (March) earnings tend to be roughly breakeven due to seasonal factors in the Company’s legacy footwear business. Recently reported Q3 FY 2012 results showed the Company reporting a nice profit due to the profit contribution from the new accessories businesses.

    I hope that is helpful.


    Subjectforgive my ignorance - pension
    Entry05/25/2012 02:16 PM
    MemberSpocksBrainX
    forgive me I wrote this up before and have lost touch with it - do they still have that frozen pension issue and/or how did they resolve/deal with it?   I was always worried profits would get sucked up by that.
     
     

    SubjectRE: Questions/Answers
    Entry06/01/2012 12:04 PM
    Memberbentley883

    Paul/Ppyy

    Thanks for your interest and questions and sorry for the delay in responding. I will try to answer your questions in the points below.

    -- Regarding the purchase price of Baggallini and Foot Petals, you need to look at them separately. The two founders of Baggallini (former flight attendants), who for the most part were no longer involved in the Company and had hired a professional management team to run the business, decided it was time to cash out and sell. The owners had been taking out all of the cash flow from the business and were under investing in its future. The management team (who are still at the Company) was frustrated as they did not have the capital to grow the business. During the sale process DFZ was not the highest bidder, with a PE firm offering a higher price. However, DFZ won because of its cash offer (due to its balance sheet strength) and the belief that DFZ was more of a strategic buyer (as opposed to a PE firm flipping to another buyer in a few years) who could better assist in building the brand (aided by its retail relationships) and growing the business. Immediately following the acquisition, DFZ’s management began providing capital to Baggallini and making investments to re-launch the brand and fund growth.

    Regarding Foot Petals, the Company’s founder, Tina Aldatz, was going through a divorce and had been running out capital. Tina, being more of a creative person, as opposed to a manager, was looking to remain involved and get access to capital. During those days banks were not exactly tripping over themselves to give out credit. DZF management had discussions with her for about two years before the acquisition was finalized. Tina was attracted to partner with DFZ because of the combination of access to capital, DFZ’s broad relationships with retailers and that she could remain on the creative team. She has an active role on the design team today, with one of DFZ’s senior marketing executives managing the operations.

    I would agree that both acquisitions are nicely accretive. Acquisitions like this don’t come along often and their timing is more of a coincidence than any accelerated plan. Despite investor criticism, management was patient and kept its power dry waiting for the right deals. I suspect that any future acquisitions will be similar in size, nature and financial impact. I believe management is not looking at a big game-changer deal or any fixer-upper and most importantly is willing to wait for the right deal to come along. I suspect any deal will mostly be funded from the Company’s healthy and rapidly growing cash flow.

    -- Sorry, I do not have any particular insights on any friendly takeover offer DFZ’s management received in the past.

    -- As for the related party transactions mentioned, the co-founder and the mother of the Chairman separated herself from DFZ’s in 2005 and all monies for her product designs and patent rights have finished. As for the agreement to repurchase the Chairman’s stock after his death, I would view this as a put option on the shares, given the lack of liquidity associated with the stock.

    -- Regarding your question on expanding the Dearfoam’s slipper and Baggallini product line, I will have to answer them separately. Keep in mind that DFZ’s management has always experimented with different strategies/programs (i.e. licensing, TerraSoles, etc.) to grow sales. Thus, a trial in trying to sell a premium Foot Petal labeled (as opposed to a Dearfoam label) slipper in one of the major retailers (an idea proposed by Tina Aldatz) is consistent with the Company’s history. This will not require a great deal of capital or inventory. So if unsuccessful, the trial should not carry any real major financial risk. However, if successful it could open up a new opportunity for a separate branded high-end slipper line. As for DFZ’s plan to expand Baggallini’s price point into the $100-$180 range, our research, including discussions with some retail buyers, suggests that there is a dearth of good product in this price category. DFZ’s management has stated that it has done a fair amount of focus group testing to support the move. Now that Baggallini has adequate capital it has begun to design specialty products for this market segment to test the waters. Management plans for a slow roll out in a limited number of stores at a few retailers. The opportunity is to increase ASP’s and sell multiple products to its traditional customers who favor the brand.

    -- As for status of DFZ’s international expansion, the Company has completed its first phase with the selection of six major international distributors inCanada,AsiaandEurope(it will handleMexicodirectly). The plan is to gain traction with placement in selected retailers during FY 2013. If the initial launch is successful, DFZ will expand to additional retailers. Consistent with management’s overall conservative approach, the Company expects a slow transition over the next few years.

    -- Sorry, I do not have any insight on Pacifica Capital’s plans.

    -- Your pension question required me to do a little research. As you probably know, DFZ had a defined benefit plan that was discontinued (i.e. frozen) in 2004. Thus, with no additions to plan membership the obligation will not expand. DFZ has been funding the plan above the minimum requirements in an attempt to close the gap between its obligations and the value of the assets in the plan, and had been successful in reducing this liability gap. However, the downturn in the equity market during late 2008 negatively impacted its progress. As you probably know relative minor +/- adjustments do not impact the P&L and flow through the Company’s shareholders equity in the OCI category. Post 2008, DFZ decided to begin shifting its asset base from equity to fixed income assets to reduce the risk of any further setbacks. From a mix of 90%/10% equities/fixed income in 2009, the mix has shifted to roughly 30%/70% respectively, with a goal of 20%/80% in the future. As a result of DFZ funding its assets, the gap has been reduced from about $12.1M in 2009 to $3.5M at the end of FY 2011. Management’s goal is to eliminate that gap in the future.

    Hope these comments are helpful.


    Subjectthx!
    Entry06/01/2012 02:06 PM
    MemberSpocksBrainX
    thanks for the detailed response!

    SubjectInvestment Thesis On Track
    Entry09/12/2012 05:01 PM
    Memberbentley883

    DFZ’s recently reported Q4 (June) FY 12 results illustrates that my investment thesis on the stock is unfolding as expected. Most notable, and consistent with what I discussed in my original write-up, is that this was only the second time in last 30 years that the Company was profitable in the June quarter. While this performance was aided by the ongoing improvements to enhance profitability within the footwear division, the secular shift in DFZ’s business model was due to the impact of the recent acquisitions of Foot Petals and Baggalini (which form the new accessories division). As discussed in the report, the combination of the higher margins and less seasonality in these businesses has transitioned the Company’s financial model to one with higher returns and less seasonality. In Q4 DFZ’s accessories business accounted for about 35% of revenues, but contributed roughly 52% of operating income. I continue to believe that investors have not fully recognized the impact of these acquisitions on transforming the Company’s business model and increasing DFZ’s intrinsic value. Thus, I believe there is still meaningful upside in the stock.

    The following are other noteworthy points from the Q4 report and 10K:

    -- Q4 marks four consecutive quarters of y/y improvement in operating margins (and dollars) in the footwear business. This highlights the success that management has had in eliminating lower margin business and offsetting the loss of revenues to grow and positively impact earnings and cash flow.

    -- While the Company’s footwear operating margins are prone to wide quarterly swings tied to the seasonality in the business, the margins in the accessories business have been more stable in the low 20% range. In addition, the margins/returns in the accessories business are somewhat depressed, reflecting on-going investments to enhance its Foot Petals and Bagallini brands and grow distribution.

    -- DFZ’s full year FY 12 operating margin of 15% shows that management is ahead of plan reaching this goal and compares with a pre-acquisition range of 9%-12%.

    -- Management indicated that they are comfortable with their previous guidance calling for a mid-teens growth rate in the new accessories business and expects it to accelerate from that level through this year. I believe this reflects such factors as the early success they are seeing (i.e. retail sell-through) in expanding the upper end of the Baggallini product line and increasing the distribution for these products.

    -- Management indicated that they believe that a stock repurchase program could add shareholder value (which I agree with) and will be investigating this option.

    -- Given the increase in multiples/valuation that management is seeing in potential acquisitions above the $30 million in sales level coupled with management’s strong unwillingness to overpay, DFZ has scaled back the size of companies they are looking at acquiring to the $10-$30 million range. Given a bias for smaller more manageable acquisitions I view this news favorably.

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