DFZ has been written up twice before on VIC. The company again has a compelling valuation and now has another catalyst that should start showing up in results.
Briefly, RG Barry is a leading US designer/marketer of footwear accessories (slippers, sandals, slipper socks, hosiery, etc…). They have a 35% market share of the US slipper market. Their principal brand is Dearfoams (from which the DFZ ticker symbol is derived). Barry also supplies some retailers under their own private labels.
A few years ago DFZ was in bad shape financially. The company brought in a turnaround expert (who is still on the Board and owns 3% of the company), moved its manufacturing to Asia, and dropped marginal products and customers. The prior two VIC write-ups go into much more detail. DFZ now has a healthy balance sheet and promising new products.
DFZ is a bargain even before considering any catalysts. There is $2.40 per share of net cash (including short term investments). Market Cap is $81million and Enterprise Value is $56 million. EV/EBITDA=4, P/E= 9.6, EV/E=6.5 (using estimates for FY just ended). Free Cash Flow approximates Earnings. Management guidance is that pretax earnings for the Fiscal Year ending last month will be 10% higher than the prior year. The June quarter is typically a loss, although it wouldn’t shock me to see it move into the black this year. Only one analyst publishes earnings estimates. Those are $0.78 (up from $0.70 three months ago) and $0.84 (unchanged) for FY08 and FY09 respectively. I think that the FY09 earnings have a good chance of being stronger because of the catalyst described below. They have another 1-2 years before they start paying cash taxes, although their reported earnings assume a normal tax rate. There are 10.7 million diluted shares outstanding
Barry has been slowly rolling out new products, primarily Terrasoles (with an eco/green theme) in over 500 retail stores and Superga (an Italian brand) in over 230 stores. Superga is higher end and sold in chains like Nordstrom’s, Barney’s and Lord and Taylor’s. The two brands are expected to grow by over 25% and 30% respectively next year (admittedly from a small base). DFZ has recently won several design awards.
Many investors have criticized management for not sending their spare cash back to shareholders, but management sees their cash balance as being an important asset. While they are open to acquisitions the CEO believes that “I’d hate to be a company that’s leveraged right now in the economic times we have”. I sleep better at nights as an investor knowing that management has a respectful attitude towards cash on the balance sheet.
As you’d expect from a company in this space, Wal-Mart is an important customer. For the prior fiscal year (ending June 2007), Wal-Mart accounted for 33% of their revenues. JC Penny was their second largest customer at 11%. A few months ago, DFZ was made the exclusive supplier of replenishment slippers to Wal-Mart.
Combine the information from the above paragraph and from this extract from their May earnings call:
Heather Boksen [analyst]: Got it. And one question about the Wal-Mart business, I don’t know if you can answer it or not but I figure I’ll throw it out there. The Wal-Mart business before it went exclusive to you, about how much of that business did you have?
Greg Tunney [CEO]: About two thirds of it is what it represented for us in their total store count. We really didn’t have the northeastern sector of what they were doing. That part of it, which is a big part of their volume as you can imagine, we didn’t have that part of the business so we picked up about another third of their total business in that category.
Heather Boksen: So that Wal-Mart business could be going up 50% now that you’re exclusive? Are those numbers right?
Greg Tunney: Well right now we can – that business is a replenishment business and as we start to monitor that, our concern is will that replenishment business continue to be as robust as it has been? Right now we’re definitely seeing some downticks of that just with the slowdown at retail. So I think Heather, it’d be a little premature that we think that’s a 50% increase.
I think we’ve really got to see how the retail environment’s going to reward us on the replenishment business because a lot of that business is really a business that’s dictated on traffic in the stores and how robust that traffic is, and we really benefit from that when that happens.
Everything else being the same, you’d expect DFZ revenues to increase by 16% just from this (150% * 33%). As management points out in the last part of the extract, that’s probably overly optimistic. On the other hand, you’d also expect earnings to increase by more than revenues under these circumstances.
So, what you have is a company with good consumer recognition, strong market share, a solid balance sheet, and nice profitability selling at a dirt-cheap price. In addition, there’s good reason to believe that the results for the new Fiscal Year will show even more improvement than the current consensus. The company is small enough that it can be a easily bought by another company. However, it is too small for some potential acquirers.
There are of course some risks.
a) He who lives by Walmart can die by Walmart. However, this can be said of almost any consumer goods manufacturer. Even a behemoth like Proctor and Gamble cannot afford to upset Walmart.
b) Increased petroleum prices affect the cost of the materials used in their products. It also increases their freight costs. They probably have a bit more exposure to the former than some of their competitors. The latter would affect most manufacturers whose factories are in Asia (basically the whole industry). The company is working to reduce the petroleum content in their designs.
c) Their new products might fail.
d) Poor use of their cash (BTW, their $15 million of ST investments are claimed to be highly liquid within seven days. As of the May 10Q, there was no indication that this liquidity had changed but that is a risk).
e) Regarding a recession, you can evaluate the impact in one of two ways: Either (1) reduced spending will hurt them, or (2) consumers will get less expensive gifts etc… and this will help providers of relatively inexpensive products.
Sole supplier status to Walmart is reflected in earnings.