DSW Looks for a Brighter Future

Image source: DSW.

For footwear and accessories retailer DSW (NYSE: DSW), the recent slump in the retail industry has had a negative impact on its business. Yet with some of its competitors having seen better times recently, DSW investors came into Tuesday's second-quarter financial report with hopes that the shoe company would have succeeded in finding a way to rebound and point toward better times ahead. DSW's results weren't unequivocally strong, and some shareholders reacted poorly to the short-term challenges that the company continues to face. In the longer run, DSW gave investors glimmers of hope that the retailer is making progress that will pay off eventually. Let's take a closer look at DSW to see what's happening with the business.

DSW can't make the shoe fit

DSW's fiscal second-quarter results had some positives for investors. Revenue climbed more than 5% to $659 million, and that roughly matched what most investors had expected to see from the shoe retailer. Net income fell by a third to $25 million, but after making allowances for certain extraordinary items, adjusted earnings of $0.35 per share were a nickel higher than the consensus forecast among those following the stock.

Looking more closely at DSW's business, the most disappointing aspect of the report was that the retailer once again suffered a decline in comparable sales. DSW reported a 1.2% decline in comps, reversing a year-ago gain of nearly 2% and only modestly improving from the first quarter's drop. The Ebuys acquisition once again produced a substantial bump to revenue of almost $20 million, which accounted for about three percentage points of DSW's overall sales growth.

As we've seen in past quarters, margin performance was a tough spot for DSW. Gross profit margin fell by more than two percentage points, with DSW citing lower initial markups, larger markdowns for clearance purposes, and the general downward pressure on margin figures that the Ebuys acquisition has caused. At the same time, operating expenses climbed by a percentage point, further weighing on profit margin numbers as the retailer spent more on marketing and technology. A higher tax rate also hit the bottom line. Inventory climbed about 10%, with roughly half of that stemming from the inclusion of Ebuys on the DSW balance sheet.

DSW's different divisions had similar challenges. Both the DSW retail segment and the Affiliated Business Group segments saw revenue rise about 2%, and both had similar declines in comps in the 1% to 1.2% range. Gross profit margin at DSW remained higher, but the Affiliated Business Group narrowed the gap to less than 10 percentage points.

CEO Roger Rawlins pointed toward a promising future. "We've made progress on a number of initiatives to drive sales and improve our financial trajectory," Rawlins said, and he correctly sought a balance between short-term financial improvement and "planting the seeds for long-term success."

Can DSW bounce back?

In particular, DSW sees potential on a couple of major fronts. First, the company expects to meet its outlook for the full year, in part because of its conservative positioning with fall inventories in order to take advantage of the most favorable trends in the business right now. In addition, cost-cutting measures could help save the company $25 million next year, and that would have a clear impact on bottom-line growth. Yet only about $7 million of that savings will be available this year.

Because of that, DSW didn't make an upward revision to its guidance. The company still expects to earn $1.32 to $1.42 per share this year on an adjusted basis, and it didn't make any changes to its belief that the retailer will suffer a decline in comps for the full year.

Given how other retailers have pointed toward quicker turnarounds, DSW investors seemed disappointed with the results, and the stock fell nearly 9% in early trading following the announcement. In order to move higher, DSW needs to take full advantage of any upturn in the general retail industry. Without that, it will be hard for the stock to make meaningful progress in the near term.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends DSW. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.