If you look at the broad market these days, I think you’ll find an unwarranted sense of optimism across most sectors. The economic recovery has elements that are encouraging, but I don’t see the kinds of data that fully convince me that everything is powering ahead.
When I look at retail stocks in particular, I get very nervous. I think a lot of these stocks are getting way ahead of themselves, and we are starting to see signs of this at some of these companies.
Specifically, I’m concerned about developments at DSW (NYSE:DSW) and Nike (NYSE:NKE).
These are both fine operations, and of course Nike is an 800-pound gorilla. Both are solid brands with brand loyalty and solid financials. I’m not suggesting they’re on the brink of bankruptcy, only that their stocks are trading at lofty multiples that leave no room for error.
DSW has 300 stores across the country and sells footwear across all price points, but usually for less than the cost of the same shoes in department stores. DSW had a great quarter, to be sure. Profits were up 24% on a 10% sales increase. Same-store sales, the number that really tells the story at a retail business, were up 5.6%.
But DSW guided slightly below analyst estimates and expects same-store sales to rise 2% to 4%. The company aims to open as many as 40 new stores this year and has some operational-efficiency plans in the works as well, so that may boost capital expenditure and impact free cash flow.
The problem I have with DSW is its valuation. The company forecasts 9% earnings growth this year, and analysts are looking for 10% annualized growth. Even backing out the $7 in net cash, giving the stock an effective price of $48, fair value is pegged at 10x this year’s earnings of $3.28, or $33. No way do I buy DSW at 50% over fair value. In fact, I sell it if I hold it.
I may not be the only one thinking like this. Jay Schottenstein, a DSW director, sold his entire stake of almost 2 million shares last week, netting $110 million. Why?
Over at Nike, things looked really good as well in the fourth quarter: a 7% increase in net income on a 15% increase in revenue and an 18% increase in book orders. Again, we have a company with $7 in net cash that generates more than a billion dollars annually in free cash flow.
That’s all well and good. However, inventories popped up by 32%. That’s a terrible sign. A company should see inventories increase at only about the same rate as sales. If sales increased only 15%, then Nike is sitting on a lot of shoes that weren’t selling. The good news is that 18% order increase may work off the inventory, but that’s not a done deal.
Again, however, it’s about valuation. Even if you accept analysts’ estimates of 13% annualized growth, bump it to 14.3% when you include the dividend, and assign the company a 15% premium because it’s Nike, you get a 16x multiple at best.
On FY 2012 earnings of $4.93, that’s fair value of $79. The stock is at $107. No way do I pay a 40% premium for this stock. In fact, I sell it.
When you hear what these retailers are saying and look at similar news out of Tiffany (NYSE:TIF), you have to be concerned that retail at the very least is getting way ahead of itself. My advice to investors: Get out of the way.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
