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DSW's Lackluster Fourth Quarter Disappoints Investors

Leo Sun, The Motley Fool

Shares of DSW (NYSE: DSW) recently tumbled after the footwear and athletic apparel retailer posted mixed fourth-quarter numbers. DSW's revenue rose 16% annually to $843.4 million, matching analysts' expectations. Its comparable store sales rose 5.4%.

But on the bottom line, DSW posted an adjusted loss of $5.4 million, or $0.07 per share, compared to a profit of $30.8 million, or $0.38 per share, a year earlier. Analysts had anticipated a profit of five cents per share.

A young woman shops for shoes at a shoe store.

Image source: Getty Images.

The decline was caused by a wind-down of its exited businesses, including the e-commerce site EBuys and Town Shoes banner, and its acquisition of shoe designer and distributor Camuto Group last year. In fiscal 2019 DSW expects its sales to grow by the low double digits, and for its adjusted EPS to rise 8% to 14%.

At $22, DSW trades at less than 12 times this year's earnings, and pays a forward dividend yield of nearly 4%. That low valuation and high yield look tempting, but is DSW a worthy investment?

The key facts

DSW was once stuck in a rut as competition from diversified retailers, the saturation of the North American footwear market, and major footwear brands launching their own e-commerce platforms and stores throttled its sales growth. DSW tried to grow its business with acquisitions, but many of its new subsidiaries struggled with similar issues.

Over the past two years DSW streamlined its business by abandoning struggling subsidiaries like EBuys, Town Shoes in Canada, and the footwear chain Gordmans. It then focused on renovating its namesake stores, increasing its selection of shoes (including children's footwear with DSW Kids), expanding its e-commerce platform and loyalty program, and testing out on-site shoe repair and nail salon services.

Those improvements enabled DSW to post accelerating comps growth in the first half of 2018 as its gross margins expanded. However, its comps growth decelerated over the past two quarters, and its gross margin contracted significantly during the fourth quarter.

Metric

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Comps growth

1.3%

2.2%

9.7%

7.3%

5.4%

Gross margin

26.8%

28.9%

32.1%

32.6%

24.4%

Operating margin

4.7%

5.4%

3.1%

6.4%

(3%)

Source: DSW quarterly reports.

DSW's gross margin of 24.4% missed the consensus forecast of 25.2%, and its negative operating margin missed the average estimate of 0.7%, mainly due to higher marketing investments, higher incentive compensation, and its aforementioned acquisitions and divestments.

A major near-term weight on DSW's bottom line is its joint $375 million purchase of Camuto with ABG (Authentic Brands Group). The integration of Camuto's production, sourcing, infrastructure, and licensed brands could cause headaches just as DSW's core business stabilizes.

DSW doesn't expect the Camuto acquisition to significantly boost its gross margin or earnings until fiscal 2020. But over the long term, DSW believes Camuto will help it generate $1 billion (nearly 30% of its estimated 2020 sales) in higher-margin revenue as it sells more exclusive brands. Those brands, DSW believes, will bring more customers back to its brick-and-mortar stores.

Two women try on sneakers at a shoe store.

Image source: Getty Images.

Still a best in breed player

DSW also changed its name from Designer Shoe Warehouse to Designer Brands Inc. to showcase the fact that it owns three core businesses: DSW, Camuto, and the Canadian retailer The Shoe Company. That change also highlights DSW's evolution from a brick-and-mortar footwear retailer into a first-party footwear maker.

Designer Brands' sales growth could decelerate in 2019, and its margins could contract as it integrates Camuto and boosts its marketing spend, but it arguably remains a "best in breed" play in the footwear sector. Here's how its growth estimates and forward valuations compare to those of industry peers like Foot Locker (NYSE: FL) and Caleres (NYSE: CAL) , the parent company of Famous Footwear:

Company

Sales growth

EPS growth

P/E (FY 2019)

Designer Brands

16%

11%

12

Foot Locker

4%

10%

12

Caleres

6%

9%

10

Estimated growth for fiscal 2019. Source: Yahoo Finance, March 20.

Designer Brands is clearly the cheapest relative to its growth potential. Moreover, Designer Brands' 3.9% yield is significantly higher than Foot Locker's 2.5% yield and Caleres' 1% yield.

Still a solid company

Designer Brands' fourth-quarter report was disappointing, but the 13% post-earnings drop was an overreaction. The company probably won't report accelerating sales growth with expanding margins in the next few quarters, but its full-year guidance looks solid, its stock is cheap, its dividend is generous, and it's wisely evolving to stay relevant in a market filled with direct-to-consumer competitors.

Investors shouldn't expect this stock to rally anytime soon, but its low valuation and high yield still make it a decent lower-risk play for income investors.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool recommends DSW. The Motley Fool has a disclosure policy .