July 24, 2012 - 1:59pm EST by
2012 2013
Price: 13.80 EPS $1.62 $0.00
Shares Out. (in M): 8 P/E 8.5x 0.0x
Market Cap (in $M): 104 P/FCF 0.0x 0.0x
Net Debt (in $M): 19 EBIT 18 0
TEV ($): 123 TEV/EBIT 6.7x 0.0x

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Rocky Brands (RCKY) is undervalued at these levels and should trade near $20 (instead of its current $13.80 price).  In recent years RCKY management has done an admirable job cutting costs and cleaning up the balance sheet, and earnings have grown as a result.  Trading at less than 9x trailing earnings, RCKY is cheap both on an absolute basis and relative to peers, and insiders were recently buyers of the stock. 

The biggest “catch” here is that liquidity isn’t great.  RCKY’s market cap is only $100 million, and year-to-date in 2012, trading volume in RCKY has averaged a mere $180 thousand per day.  But for smaller funds and personal accounts, I think RCKY is an excellent value at its current price.


Company and Industry Description:
Rocky Brands is a footwear company focused on the work and outdoor markets.  The niche of the footwear industry that RCKY competes in is a fragmented one.  Competitors include Wolverine (ticker WWW), Red Wing Shoes (private), Lacrosse Footwear (ticker BOOT), and Berkshire Hathaway’s Justin Brands and HH Brown subsidiaries, among others.   The retail channel for work and outdoor footwear is fragmented as well.   I don’t have up-to-date industry-wide data here, but in RCKY’s case, 20% of its footwear is sold direct to the consumer through its own retail channel, another 17% is sold through independent boot retailers, and only 17% is sold through national sporting chains and mass merchants (the rest is sold through a large variety of channels including uniform stores and the like).  The key takeaway here is that large national chains are not the main distribution channel for this niche of the footwear industry (although I’m sure they will increase share over time).  Although the work and outdoor footwear industry is not a high growth one, it’s still a decent niche to be in as fashion risk is relatively low and the power of the retail channel is relatively low as well. 

RCKY’s brands include Rocky, Georgia Boot, Durango, Lehigh and Mossy Oak.  Retail prices for RCKY’s boots range from $30 to $375.  About 80% of their revenue is from the wholesale sale of boots through more than 10K retail locations, and the other 20% is from their retail segment, where they sell shoes direct to consumers over the internet, in their company-owned store in Nelsonville, OH, and through a fleet of mobile trucks that visit worksites.  They also occasionally sell boots to the U.S. Military, although that has been less than 1% of their business over the last twelve months.  RCKY owns manufacturing facilities in the Dominican Republic and Puerto Rico, and they also source some products from 3rd party manufacturers (primarily in China).

RCKY was founded in 1932 in Nelsonville, Ohio, and for many decades was a small, rather nondescript shoe company (or smaller and more nondescript than it is today).  In the late 1970s/early 1980s, however, the Company focused more on the work boot market and grew as a result.  RCKY went public in 1993 at $12 per share, and then in early 2005, the Company doubled in size when it spent nearly $100 million buying competitor EJ Footwear.  After a successful first year of EJ Footwear ownership, the company stumbled and saw revenue declines.  A large U.S. Military order ($28 million of revenue in 2005) ran out, and the Company saw modest declines in its wholesale revenues.  Moreover, the EJ Footwear acquisition had increased RCKY’s fixed cost base, so operating leverage worked against them.  The Company exacerbated its problems by increasing the size of its mobile truck fleet (which had been acquired with the EJ Footwear acquisition) only to later realize, upon installing point-of-sale equipment in the trucks and performing profitability analysis, that most of the mobile trucks weren’t actually profitable.  The subsequent recession in 2008 and 2009 did them no favors either.  In 2005, RCKY generated $296 million in sales, $28 million in operating income, and $2.33 in EPS.  By 2009, RCKY generated just $229 million in sales, $9 million in operating income, and $0.29 in EPS (excluding a restructuring charge, net of tax).  Subsequently however, as I’ll discuss below, profitability has greatly improved.


RCKY management has done an excellent job at cutting costs
As I mentioned above, a drop-off in military orders, the recession, and the adverse effects of operating leverage combined to hammer RCKY’s profitability in the years after its EJ Footwear acquisition.  In recent years RCKY management has worked to cut its fixed cost base, largely by reducing its retail footprint (cutting the number of mobile retail trucks from nearly 100 to the “low 20s” and closing nearly all of their “mini-stores”) and channeling more orders to its website.  In 2007, SG&A topped out at $96 million (35% of sales), whereas in the LTM period ended 3/31/12, SG&A was $68 million (28% of sales). 

In addition to cutting fixed operating costs, RCKY has also worked to clean up the balance sheet.  Long-term debt of $110 million as of the end of 2006 has been reduced to $22 million of cheap (LIBOR+150) debt as of 3/31/12.  As a result, interest expense has come down from $12 million in 2007 to less than $1 million in the LTM period.  Additionally, RCKY also used $5 million of cash to fully fund and terminate their pension plan in 4Q11.  Note that LTM GAAP EPS for RCKY is $1.13 but that the pension termination charge (net of tax) had a $0.49 negative impact on EPS, so adjusted LTM EPS is $1.62.  Perhaps this is one of the reasons RCKY is cheap, as the pension termination charge may prevent it from screening as well as it should.

The significant reductions in fixed operating expenses as well as interest expense have greatly improved RCKY’s profitability despite some revenue declines:

                                                      2005       2006       2007       2008       2009       2010       2011       LTM
Revenue ($ millions):                     $296       $263       $275       $259       $229       $253       $240       $241
Adj. Operating Profit*:                  $28.1      $19.7      $11.6      $14.7       $9.5       $17.1      $18.1      $18.3
Adj. EPS*:                                     $2.33      $0.95      $0.08      $0.75      $0.29      $1.14      $1.60      $1.62 

*Adj. operating profit excludes restructuring charges ($0.7 million pretax in 2009), intangible asset impairment charges ($0.8 million pretax in 2006, $24.9 million pretax in 2007, and $4.9 million pretax in 2008), and a pension termination charge ($5.3 million pretax in 2011).  Adj. EPS also excludes these items (net of the tax effect in all cases).


Overall weakness in the RCKY’s topline is much less worrisome than it looks
Of course, the worrisome thing about looking at the table above is that revenue is still well below pre-recession levels and actually declined from 2010 to 2011.  If we break out sales by channel, however, the pattern is not as concerning: 

                                                     2005       2006       2007       2008       2009       2010       2011       LTM
Wholesale:                                   $210       $203       $203       $187       $174       $188       $193       $195
Retail:                                             $58         $59         $71         $66         $50         $47         $45        $44
Military:                                           $28         $1           $2           $6           $5           $17         $2           $2

The overall weakness in RCKY’s topline has been driven primarily by an absence of military orders (which are lumpy) and a decline in their retail segment, which has been an intentional part of RCKY’s strategy to lower fixed costs in recent years.  If one just focuses on RCKY’s core wholesale channel, we see decent, if unspectacular, growth since the recession.  And while wholesale sales are not yet back pre-recession levels, I wouldn’t consider this an indictment of RCKY’s competitive position given that RCKY’s customer base (blue collar workers, including a lot of construction workers) was hit  hard in the recession and is recovering more slowly than other customer groups.

RCKY management has not provided any specific guidance for 2012, but sales in the wholesale channel were up 6.5% in 1Q12 (2.0% for the entire company) and management noted that “based on the fall order book we expect our sales momentum to carry through the remainder of the year.”  And when asked about the retail segment on the conference call, RCKY management had this to say: “We are remaking it, retiring an old business model.  It was very labor-intensive and very capital-intensive.   And we’re getting this inflection now in the sales….we’ve been remaking it since 2008.  We’ve had declining sales, but improving operating margins.  And in the back half of this year, we’re now forecasting sales to actually – the sales trend, downtrend – to reverse.  So the business can be much larger than it is today.”


RCKY is cheap on just about any metric
RCKY’s two closest publicly-traded comps are Wolverine World Wide (ticker WWW) and Lacrosse Footwear (ticker BOOT).  Below I’ve compared RCKY to these two comps across a number of valuation metrics:

                                                          RCKY                      WWW                   BOOT (pre-acquisition)
Share Price (7/23/12):                    $13.66                     $42.89                   $10.98
Market Cap:                                       $102                      $2085                        $71        
Enterprise Value:                               $122                      $1957                        $80
LTM Sales:                                          $241                      $1404                      $139
LTM Adj. Operating Profit:                    $18                        $152                          $8
LTM Adj. EBITDA                                   $24                        $168                        $11
LTM Adj. EPS                                      $1.62                      $2.40                      $0.64
Tangible BV/share:                          $11.60                    $11.74                      $8.07
EV/Sales:                                             0.5x                        1.4x                        0.6x
EV/EBIT:                                               6.6x                      12.9x                      10.5x
EV/EBITDA:                                           5.1x                      11.6x                       7.0x
P/E:                                                      8.4x                      17.9x                     17.2x
P/TB:                                                     1.2x                       3.3x                       1.4x

I’m not saying that RCKY should trade in-line with WWW, as RCKY deserves some size and liquidity discount, but I think the current discount is too large.  At the very least, RCKY should trade in-line with competitor BOOT, which is even smaller.

As for BOOT, on July 5th it announced that it was being acquired by ABC-Mrt, a Japanese footwear retailer for $20 per share ($139 million in total including net debt).  For the table above, I’ve used BOOT’s last closing price before the acquisition announcement, but if we use the acquisition price, then BOOT was bought for 1x sales, 18x EBIT, 12x EBITDA, 31x EPS, and 2.5x tangible book.

The BOOT transaction demonstrates the upside potential if RCKY were ever to be sold (and I think it would make an attractive acquisition target given its small size).  Note however that RCKY instituted a poison pill in July of 2009 and recently renewed its poison pill clause, so an acquisition of RCKY won’t happen unless management wants it to.


Insiders recently bought shares
In March of this year, RCKY’s CFO bought 2500 shares in the open market $12.54 and the CEO bought 2000 shares at $12.68.  These are modest amounts of course, but not insignificant.  The $31K the CFO spent on shares represents ~10% of his base salary, and the $25K the COO spent represents ~6% of his base salary.


And RCKY insiders have been shrewd traders of their stock in the past
I went back and looked at all of the Form 4s for RCKY insiders since 2003, and RCKY insiders have definitely been savvy at both buying and selling shares in the past.  From November of 2003 through June of 2006 (periods when the stock price was almost exclusively above $20), RCKY insiders sold approximately 164K shares at an average price of $26.94. 

In July of 2006 however, the Company preannounced disappointing 2Q06 results and the stock fell from above $20 per share to below $11, and shortly thereafter RCKY insiders became buyers, scooping up 10K shares in August and September of 2006 below $12.  Since then, RCKY insiders have been mostly buyers of their own stock, with especially heavy buying taking place in the spring of 2008 and the spring of 2009.  Overall, since the stock fell by more than 50% in July of 2006, RCKY insiders have bought approximately 113K shares at prices ranging from $2.75 to the most recent purchase at $12.68.  The only insider sales since then were 14K shares sold by two directors in March of 2011 at prices ranging from $13.93 to $15.81.  Note also that since 2006, RCKY insiders have exercised 90K options without selling any of newly exercised shares.



  • Capital allocation: Since the EJ Footwear acquisition, RCKY has allocated their cash flow ($76 million of cumulative cash flow from operations less capex from 2006 through 1Q12) exclusively to debt paydown.  I believe this has been the right decision for them, but now that they only have $22 million of very cheap (LIBOR + 150) debt remaining, management’s capital allocation strategy become less obvious.  In the most recent 10-K, management writes “We presently intend to retain our earnings to finance the growth and development of our business and do not anticipate paying any cash dividends in the foreseeable future….Presently, our credit facility restricts the payment of dividends on our common stock.”  When I spoke with the CFO, he indicated the share buybacks were toward the bottom of their list of priorities because of the already small float but that there has been more talk about dividends in recent board meetings, although there had been no decisions made there.  Hopefully RCKY does not overpay for a bad acquisition.
  • ERP implementation: During 2011, RCKY began planning for the implementation of a new ERP system.  The system went live in their wholesale business at the end of April, and they plan on bringing the retail business onto the new system later this year.  As with any such implementation, there are always potential business interruption risks.
  • Macroeconomic weakness:  As a business that sells to mostly blue collar workers, RCKY is not immune to macroeconomic weakness.  I think there is upside to RCKY’s topline from a boost in construction activity (less than 600K homes were completed last year, and I’d argue the normalized run rate is something north of 1 million), but the recent U.S. macroeconomic data hasn’t been encouraging.


  • Release of continued strong earnings figures
            -Note that RCKY is releasing 2Q12 results after the close today.
            -RCKY’s LTM GAAP EPS is likely to improve significantly when 4Q12 results are announced, as 4Q11 included a $0.49 pension termination charge.  Perhaps the stock will screen better when this charge no longer shows up in LTM figures.
  • Potential initiation of a dividend
  • Potential buyout from strategic acquirer
            -Not highly likely but certainly possible
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