Athleisure Shift Pressures Margins, Yet Strategic Growth And Analyst Optimism Prevail

Key Takeaways

• Shifting focus to athletic sales strains profitability and net margins due to lower mark-ups and gross margin pressure from prioritizing growth in low-margin categories.
  
• Increased promotional activities and strategic shifts may lead to revenue disruptions, operational challenges, and potential impacts on sales growth and profitability.
  
• Strategic initiatives aimed at growth and diversification into athletic offerings, alongside digital marketing efforts, are poised to enhance revenue and profitability.

Catalysts

Engages in the design, production, and retailing of footwear and accessories for women, men, and kids primarily in the United States and Canada.

• The shift towards athletic and athleisure sales, while contributing to market share gains, implies a lower initial mark-up (IMU) and gross margin pressure due to prioritizing growth in these categories over higher-margin segments like dress and seasonal footwear. This could negatively impact profitability and net margins.
  
• Increasing promotional activity to clear seasonal inventory, exacerbated by lower consumer discretionary spending, suggests potential for continued gross margin contraction and impacts on net income due to the need for price reductions to stimulate sales.
  
• Launching into adjacent categories like athletic socks with notable inventory increases may add risk to inventory management and cash flow if the anticipated sales growth does not materialize as expected, potentially affecting liquidity and operational flexibility.
  
• Strategic pivots in the product assortment toward athletic and athleisure while planning to reduce reliance on seasonal and dress categories may lead to near-term revenue disruption and operational challenges, impacting sales growth and profitability during the transition period.
  
• Investments in talent, IT, and marketing, particularly for back-to-school initiatives, might raise SG&A expenses, leading to potential deleverage if sales growth does not offset these increased costs, thus impacting operating margins and earnings.

Assumptions

• Analysts are assuming Designer Brands's revenue will grow by 2.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from -0.2% today to 5.2% in 3 years time.
• Analysts expect earnings to reach $170.6 million (and earnings per share of $2.97) by about October 2027, up from $-5.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 2.2x on those 2027 earnings, up from -76.8x today. This future PE is lower than the current PE for the US Specialty Retail industry at 14.8x.
• Analysts expect the number of shares outstanding to decline by 4.53% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 10.74%, as per the Simply Wall St company report.

Risks

• Continuing progress on plans to return to growth and the anticipation of positive comps supported by strategic initiatives could lead to increased revenue.
  
• Expansion in athletic and athleisure offerings driving outsized growth suggests potential for further revenue increase and improved net margins.
  
• Strong back-to-school performance indicating momentum into Q3 could result in higher sales and earnings.
  
• Focus on digital and social media marketing driving improvements in engagement and customer acquisition could enhance revenue growth.
  
• Efforts in brand portfolio optimization, evidenced by success with brands like Topo Athletic and Jessica Simpson, may lead to higher profitability and margins.

Valuation

• The analysts have a consensus price target of $5.75 for Designer Brands based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $3.3 billion, earnings will come to $170.6 million, and it would be trading on a PE ratio of 2.2x, assuming you use a discount rate of 10.7%.
• Given the current share price of $6.85, the analyst's price target of $5.75 is 19.1% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.