Designer Label Stock: Still a Story to Show (NYSE: DBI)

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Designer brands‘ (NYSE: DBI) recently increased 2022 guide came as a welcome surprise – not only does it suggest that the recovery in dress shoe sales is gaining traction in the US, but also that inflation has been less significant impact on consumer spending than expected. While this is good news in the short term, DBI hasn’t quite addressed the age-old threat from Amazon (AMZN) and the off-price channel. Additionally, DBI may not yet be out of the macro wood, with rising interest rates, an economic downturn (reminder US GDP contracted in the first quarter of 2022), and global supply chain challenges loom. While management’s mid-term forecast of around $2.80/share on Investor Day shows they clearly disagree, I would wait for further evidence of sustainable growth/d stable margins before plunging – even with the stock at ~8x P/E.

P/E ratio of designer brands
Data by YCharts

Secular headwinds cloud medium-term financial outlook

DBI’s latest investor day targets hinge on its mid-term revenue growth outlook of around $4 billion by 2026 (implying a CAGR of around 4%). Most of the additional revenue is being guided to come from the doubling of DBI’s own brand revenue, with penetration expected to reach >30% (well above the current ~19%) while national brand revenue remains flat. Still, DBI faces age-old headwinds given its outsized exposure to fashion footwear at around 70% of revenue at a time when consumers are increasingly shifting to athletic categories. Additionally, DBI’s main banner, DSW (~75% of revenue), is under threat from e-commerce and must cover more than 10 square meters amid a century-long decline in foot traffic. Thus, I am reluctant to subscribe to a low double-digit revenue CAGR pending concrete signs of a successful mix shift towards online sales and sports products.

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Growth projections are accompanied by forecasts of gross margin expansion to ~35% by 2026 (from 33.4% in 2021). Most of the delta is due to the increased penetration of own brands, which typically come with around 18% higher gross margin compared to national brands. Meanwhile, SG&A is guided to remain relatively stable, with major investments already made and DBI on track to reduce square footage by around 14% (mainly by downsizing stores). Net, this implies an operating margin expansion of approximately 200 basis points through 2026, which translates to a double-digit EPS growth algorithm (assuming DBI meets its sales growth numbers). While that all sounds promising, executing on own brands and streamlining the store’s footprint won’t be an easy task, nor will it be navigating the age-old headwinds of high-end. Therefore, I would be hesitant to post these earnings numbers pending better visibility in the coming quarters.

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Hopes based on the Owned Brands Initiative

The importance of DBI’s own brands as a driver of the mid-term outlook cannot be underestimated: according to management, own brand customers spend approximately 43% more at DSW. Thus, the company aims to shift to a brand building strategy to double revenue from its own brand business by 2026. As this will involve replicating the Vince Camuto brand building playbook with seven other own brands, the execution will be a challenge. . If successful, however, the company’s investment in own brands and a focus on brand building should give it more control over its destiny and generate margin profits over time. In particular, the company’s ability to leverage its deep customer data will prove useful in better understanding customers at the brand level and delivering the product where the consumer wants it. While this should mean greater engagement with its ~30 million loyal members, it also means higher marketing spend, and therefore, I see a risk to the mid-term forecast (marketing spend at 4-5% of sales ).

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Positive supply chain and sourcing improvements, but margin pressure remains a concern

At a time when supply chain disruptions are hitting industry-wide logistics hard, it is positive to see DBI actively improving its supply chain and sourcing capabilities. For example, the company shortened its shoe manufacturing process by two months while reducing the testing time (now two weeks). As a result, DBI can now fully stock a product within 70-90 days of successful testing. While the timing benefits are clear, DBI’s decision to reduce its China sourcing exposure to 50% by 2024 (from around 80% today) could have negative cost implications. To offset the impact, DBI relies on higher sales enabling better operating leverage (i.e. fixed costs spread over more volume) and lower operating costs through more efficient processes. in place (for example, by partnering with a third-party logistics provider). That doesn’t strike me as a particularly conservative view from management, though I could be wrong – DBI’s efforts to leverage its physical footprint and customer data, as well as consolidate pools of inventory, are unique value propositions within footwear retail that could pay off. overtime. Still, it’s hard to look past greater gross margin pressure in 2022/23 amid product cost inflation and freight cost headwinds, as well as an increase clearance sales (coming back in line with historical post-COVID levels).

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Always a “show me” story

Overall, I consider DBI a classic “show me” story. While its medium-term targets are promising, the heavy reliance on own-brand growth via DSW (i.e. via private label strategy) leaves the current revenue forecast vulnerable to execution risk. 2026 EPS forecast of around $2.80 is positive, implying an undemanding forward P/E at current levels, but DBI still faces structural headwinds as a fashion footwear retailer in the middle of the online migration and trend shift to athletic and casual footwear. Thus, I am reluctant to fully subscribe to management’s core EPS scenario at this stage, pending a clear shift in industry-wide trends and a dissipation of ongoing macro headwinds. Other downside risks include execution missteps (e.g., on fashion merchandising) and pressure on labor margins, as well as increased markdowns and freight costs. .

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