I recommend initiating a long position in Wolverine World Wide ("WWW" or the "Company") at today's price of $58.88 (10/3/13). WWW shares present an opportunity to invest in a high-growth, diversified, branded footwear company with several iconic brands (e.g. Sperry, Merrell, Keds).
The market has given the Company credit for its near-term growth potential in North America but has failed to grasp the magnitude of the growth opportunity associated with the Company's Oct-12 acquisition of 4 additional footwear brands (Sperry, Saucony, Keds and Stride Rite, collectively "PLG"). The Company is very well managed, throws off consistent cash flow and has generated a 20%+ ROIC historically .
At $58.88/share, WWW shares today trade at 21x 2013 consensus EPS and 17x 2014 consensus EPS estimates. A long investment in WWW shares present an asymmetric risk/reward profile whereby I see an opportunity for compelling returns and minimal risk of capital over a 3 year holding period. I expect the Company's revenues and EPS to grow at CAGRs of 15% and 30%, respectively over the next 3 years. Based on this forecast and an exit in 3 years at a 1-year forward P/E of 17x, WWW shares would be worth $100+ and an investment today would generate a 100% return and a 25% IRR.
The current price does not reflect the tremendous growth that lies within the PLG brands on a stand-alone basis and the magnified and accelerated growth that PLG will realize under WWW. Furthermore, the current valuation does not reflect WWW's position as an innovative leader and market-share taker in a fragmented market with significant resources and a best-in-class management team capable of executing on future value-accretive acquisitions. Additionally, the PLG acquisition greatly increases the Company's exposure to children's footwear, which is a relatively acyclical market that is expected to grow at rates exceeding other footwear types. Lastly, the market is not adequately rewarding the diversification WWW enjoys (see Decker's UGG concentration).
I expect the Company's revenues and EPS to grow at CAGRs of 15% and 30%, respectively over the next 3 years. I forecast revenue from Legacy growing at a 7% CAGR, consistent with its 2001-2011 CAGR, and revenues from PLG growing at a 22% CAGR. Based on this forecast and an exit in 3 years at a 1-year forward P/E of 17x, WWW would generate a 100% return and a 25% IRR. In a downside case, I see revenues growing at 7%/year, consistent with Legacy's historical growth rate and less than half the growth rate PLG has enjoyed, and EPS growing at a 9% CAGR. Based on this downside forecast and an exit in 3 years at a 1-year forward P/E of 15x, WWW shares would trade in-line with where they are now. Even in this downside case, capital loss is very unlikely. This asymmetric risk/reward profile makes WWW a highly attractive long opportunity.
Risks and Mitigants
Risk: Legacy brands are dying and growth of PLG brands is decelerating in North America
• Mitigant: Management team that is generally conservative is highly confident that legacy brands will rebound from slow 1H 2013.
Risk: Labor inflation and costs associated with improving working conditions in emerging markets, namely China, to drive production cost increases
• Mitigant: WWW is less reliant on Chinese manufacturers than other US footwear companies and the Company has hedged its reliance on China by maintaining Company-operated manufacturing operations in the Dominican Republic and the US.
Risk: Above-average leverage (net debt/EBITDA) may limit the Company's ability to re-invest for growth and increases risk of equity investment
• Mitigant: More than enough free cash flow generated after debt-service to fund growth CapEx. Leverage is above-average relative to the Company's competitors but not at an unreasonable level for a company with its level of scale, margin stability, strong cash flow generation and relative resistance to cycles.
Risk: International expansion of PLG, especially in Asia, could increase risk of knock-offs. Unlike luxury brands, there is not a noticeable quality difference between real and knock-offs.
• Mitigant: Growth and popularity driven by brand, not functionality or uniqueness of physical product. Other western footwear brands face the same risk and still realize fantastic international growth.