The announcement that it's changing its name to Designer Brands couldn't mask the earnings shortfall that DSW Inc.'s (NYSE: DSW) 2018 acquisition of the Camuto Group brought to its fourth-quarter financial report.
According to DSW management, because Camuto Group has such high selling, general, and administrative expenses, and won't be contributing much to its acquirer for at least a year, it will drag down the retailer's overall results for the rest of 2019 and beyond.
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Falling far short of the mark
Although its U.S. retail business continues to perform as well as ever, DSW reported a $0.07-per-share loss for the period that ended in early February, surprising analysts who had anticipated a profit of around $0.05 per share. Overall revenue rose 16% year over year to $843 million, but the company's adjusted loss of $5.45 million was a far cry from Wall Street's expectations.
Guidance was also weak, and not just for the current fiscal year (2019), but through fiscal 2021, when management forecasts earnings per share of between $2.65 and $2.75. At the midpoint, that would require the company to put up compounded annual growth of about 17% from fiscal 2018's $1.66 per share, but that's less than what analysts were anticipating, and contrasts with the glowing growth opportunities the company laid out due to Camuto Group.
Management said during its Investor Day presentation last week that all it really needs from Camuto is for it to essentially continue operating as it is, but bring DSWs private label brands into the fold, then DSW should be able to do all the rest. For example, digital amounted to less than 1% of Camuto's sales, so adding DSW's wide-reaching expertise in that area to the well-known brands Camuto is bringing to the table ought to provide an enormous lift to both .
DSW bought Camuto Group for $375 million last October in partnership with Authentic Brands Group. DSW got a 40% stake in Camuto's private brands, including names such as Vince Camuto, Louise et Cie, and Sole Society, while ABG took a 60% position. DSW also assumed licensing rights for Jessica Simpson footwear; footwear and handbag licenses for Lucky Brand and Max Studio; and will participate in a joint venture for Camuto's ED Ellen DeGeneres and Mercedes Castillo brands.
The acquisition also gave the footwear retailer capabilities in product design, development, sourcing, production, and marketing.
Camuto goes kaput
Part of the problem is that DSW acquired a somewhat troubled business that was desperately seeking a buyer. In 2017, Camuto was on course for an acquisition by Canadian footwear giant Aldo Group, but that deal was called off three months after it was announced. Perhaps Aldo management saw something they didn't like.
The Camuto acquisition also altered DSW's business model. Where it had always been just a retailer, it now must figure out how to be a designer and manufacturer, a vertical in which it has no experience.
DSW acknowledged there were problems that need fixing at Camuto. Even when the deal was announced, DSW said it didn't expect the outfit to contribute to earnings anytime this coming year, and the issues it repaired won't start benefiting the business for at least three more quarters due to lead times in the shoe industry. So investors were already expecting the new unit to drag down profits -- what wasn't expected was the magnitude of decline.
DSW management pointed to a number of factors responsible for the recent shortfall, such as last year including an additional selling week, so sales in the just-closed year were lower as a result. Also, the calendar shifted a week heavy with clearance merchandise into the fourth quarter while eliminating from the quarter a week with more normalized pricing, causing gross profit rates in the quarter to decline.
On top of those complexities and apples-to-oranges period comparisons, the Camuto Group had a much-worse-than-anticipated quarter. It was experiencing consistently late deliveries, was behind on payments, and couldn't bring its factories up to capacity as a result. DSW had to rectify all that when it took over, which it did. And as a course of business, Camuto also typically carries higher SG&A expenses and lower profit margins than DSW.
Although DSW didn't break out any numbers about how difficult the quarter was for Camuto, it said it didn't buy the company because of whatever margins it has on its own, but rather the infrastructure it brought with it. When DSW makes product in-house, it reduces product costs and captures margin, executives said. Still, DSW expects Camuto to have half the operating margin of DSW.
New look, old problems
DSW (which stands for Designer Shoe Warehouse) changed its name to Designer Brands with the March 19 earnings report (and will change its ticker to DBI on April 2) to more aptly fit its new business model. The rebranding is intended to reflect broader opportunities ahead, but optimism should be tempered, since the company appears to have run into issues that were deeper than it previously recognized, and it will take longer than anticipated to correct. Meanwhile, Camuto Group won't be delivering the necessary uplift for some time, and DSW management will have to learn a whole new business.
There's a reason the markets sent DSW's stock careening 15% lower on the latest earnings report. The picture it paints doesn't bode well for a quick recovery.
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