Tuesday, November 5, 2013

Wolverine Growing Under a Pile of Debt

The following column was originally published by TheStreet on a company with a market cap of $3 billion

Earlier this month, the footwear company Wolverine World Wide (WWW_) released impressive quarterly results in which it managed to beat both top- and bottom-line estimates. Wolverine has a portfolio of footwear brands that includes Cat, Harley Davidson, Hush Puppies, Merrell and Sperry, and has reported phenomenal growth (on the back of a major acquisition I'll get to shortly).

As a result, the company is now sitting atop a massive pile of debt. Moreover, although its shares have underperformed this year against some of its key competitors, they are still trading more than 40 times its trailing earnings. Despite these stellar results, I believe investors should stay away from this stock. Let's dig deeper.
In October 2012, Wolverine acquired Collective Brands' Performance + Lifestyle Group, or PLG, for $1.25 billion. The impact was plainly apparent in its earnings release, as Wolverine reported a 103% revenue increase from the same quarter last year, to a record level of $716.6 million, while earnings rose by 64% to $1.08 a share. Excluding the acquisition-related costs and other one-off items, Wolverine managed to increase its earnings by 61% from the same quarter last year, to $1.16 a share.

Wolverine has also reported "pro forma" results for its revenues presented under the assumption that Wolverine had acquired PLG on January 2012. These results eliminate the unusual impact of the massive acquisition on the company's quarterly revenues and, therefore, provide a fair assessment of its performance.
Unlike the 103% increase in reported revenues, they are up a more-realistic 9% on pro forma basis. This is an impressive performance because not only it is around $4 million above expectations, but this growth has come on the back of a challenging business environment in the U.S and Europe, where both retailers and consumers have cut back on their spending.
In January 2013, Wolverine started reporting its results in three segments: Performance, Lifestyle and Heritage. Wolverine now owns more than a dozen different brands in these segments. Before the acquisition, Wolverine counted about 43% of its revenues from Performance Group, 40% from Heritage Group and just around 11% from Lifestyle Group. Now the company gets around 41% of its revenues from the Lifestyle Group, 36% from Performance Group and just 20% from Heritage Group.
This is a significant shift from last year. Growth in the previous quarter was led by these two segments that reported a double-digit year-over-year revenue increases. On the other hand, the Heritage segment could only manage an 0.8% increase in revenues. The stark contrast between the growth numbers of the new and improved segments and its Heritage business highlights a key point; nearly all of Wolverine's growth has come as a result of the PLG acquisition.
As mentioned earlier, PLG came with a price tag of $1.25 billion, equivalent to 60% of Wolverine's market cap in October last year. The acquisition was financed through long term debt, which now stands at a massive $1.1 billion, up from zero in the same quarter last year. The company's long-term-debt-to-equity ratio, or D/E ratio, has swelled to 144%, which means that Wolverine has considerably more debt than its equity.
This is far from ideal; the industry's average is just 6%. Although Wolverine's financial health has been improving as its D/E ratio has dropped from 190% in December 2012, which clearly shows that the business has been moving in the right direction, but it still has a long way to go.
The adverse impact of this debt came in the form of a significant increase in interest expense which rose from just $1 million for the nine months ending Sept. 8, 2012, to nearly $37 million for the corresponding period in 2013. Some of its refinancing measures will cause a meaningful reduction in the interest expense, by as much as $8 million in the next year, but unlike 2012, the interest expense will continue to drag the company's earnings in the coming years.
So far this year, Wolverine has generated free cash flow of $96 million but investors should note that Wolverine is currently focused on using its cash flow to deleverage. Therefore, I believe that the company's management is not going to indulge in any meaningful buyback activity.
Wolverine's shares have risen by 43% in 2013, which sounds great, but the company has underperformed some of its other rivals, such as Deckers Outdoor (DECK_) and Nike (NKE_).
Wolverine is currently trading 41 times its trailing earnings, considerably above the industry's average of 15 times. Even the athletic footwear and apparel giant Nike, whose stock is up 50% this year, is cheaper trading 26 times its trailing earnings.
Therefore, despite delivering strong results in its previous quarter, Wolverine World Wide is certainly not a buy at the moment.
At the time of publication, the author held no position in any of the stocks mentioned.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.