K-Swiss (KSWS) by The Buffett Way
March 30th, 2008 by 
CA Editors
Mike Price sends: Following my analysis of Netflix (NFLX), I’ve decided to use the same test and try to find if K-Swiss (KSWS) still deserves a spot in my portfolio.
Business
Simple, Understandable
K-Swiss makes extremely comfortable and long-lasting leather shoes. More than two-thirds of their sales come from their classic brand, which has changed little in design over the past forty years.
They also are starting to focus more on tennis and hired Anna Kournikova to promote their shoe.
Consistent History
Though earnings have dropped lately, the margins and returns on capital have stayed around the industry average.
Long-Term Prospects
Very favorable, they are just starting to expand internationally and management has confessed it made some bad moves domestically which are partially responsible for the earnings drop of late and will not make these same moves internationally, which spells huge growth continuing into the future.
Also, new advertising, including commercials that will debut during March Madness, looks great and I think will be a big boost to earnings in the coming quarters.
Management
Rational
Management realizes they are in turnaround mode right now and know how to get back into growing smoothly mode - as they have gone threw three down cycles like this so far.
Candid
In the three years I’ve owned them I’ve never felt they were keeping anything from the shareholders.
Resist Institutional Imperative
K-Swiss does not try to impress Wall St. in the short-term, as proved by their discipline in not reducing prices to help their ST earnings.
Financials
Return on Equity
K-Swiss has no debt and rapidly falling earnings yet it still returned 11% on capital last year. This is a deceptive number, it seems low but it would be a lot lower had management reduced prices to get a short-term boost.
Look for K-Swiss’s ROE to rise to above the shoe industry average again once it regains earnings growth.
Owner’s Earnings
Net Income $39,073
+ D&A $ 2,303
- CapEx $10,489
= Owner’s Earnings $30,887
Net Margin
K-Swiss had a 10% net profit margin, down from their industry leading numbers of the past.
Valuation
PE + Excess capital
Using Pabrai’s method, 16x owner’s earnings plus excess capital gives a value of $21.31 per share, which is a 24% discount, the company’s cash hoard compared with no debt is the reason behind the high value.
DCF
Using Pabrai’s DCF method, this does ten years of earnings, starting with negative growth going to no growth before growing at 2% in year five, eventually 4% by year ten discounted back to the present at a rate of 10% then assuming it is sold for the current excess capital in ten years K-Swiss is currently worth $29.50 per share - which a little over a week ago was double the share price.
Conclusion
Right now, K-Swiss is essentially a turn-around bet. It’s earnings have been almost halved in the past year, and it has paid the price dropping from as high as $33 in the last year. But, the company has 52% of its market cap in cash with no long-term debt to pay. Wall St. clearly believes K-Swiss won’t turn-around or it will take a long time to do it, I believe it could start growing earnings this year, and I know I have the margin of safety to make that bet.
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March 30th, 2008 at 1:13 pm
I’ve looked into K-Swiss over the past two years and I have decided to pass on it for the following reason:
Who buys K-Swiss shoes ?
Over 30 ? No.
Over 20 ? No. “K-Swiss ? Oh yeah! I used to wear those in high school”
Teens ? Yes, but K-swiss was a 2-5 year fad that simply did not last. The Adidas, Nike shox and Puma shoes have clearly taken their market share as everyday shoes. If you visit any sport shoe retailer, they barely carry K-swiss anymore. If they do carry them, they mostly carry last year’s model selling at a very big discount.
I see this company as more of a fad then anything that can keep producing growth in income and above average margins.
March 30th, 2008 at 5:57 pm
I concur with anon, who buys K-swiss anymore??? It’s going the way of the dodo bird.
March 30th, 2008 at 11:29 pm
I hate to pile on as well, but value or value trap? I feel it is much more likely to be the latter. The huge net cash position is appealing, but it isn’t large enough to make me want to buy a business that was declining (by most metrics) during a huge consumer expansion in 2004-2006.
April 1st, 2008 at 8:36 pm
Mike, check out FINL and HLYS
April 1st, 2008 at 8:49 pm
I don’t know what the obsession with Heely’s is - it was a crappy, overpriced IPO from a company that was taken public at the high of its popularity/fad-y-ness. Good job by the I-bankers getting that fee, although they had to be choking back laughter as they pitched HLYS to potential investors.
FINL looks like a simple bet that the company will have to liquidate inventory - i.e. why it’s trading at a fraction of book. Having gone into one lately, the sneakers are about 25% more expensive than at a Dick’s or something similar… not a huge fan of the niche specialty stores right now, especially for a mainstream product. Also, the Finish Line by me (in Boston) has a huge stock of Coco Crisp jerseys marked down from $80 to $20… perhaps another reason why the stock is at a fraction of book.
April 2nd, 2008 at 12:25 am
K-Swiss shoes are still pretty popular among high school students.
But, they are also popular among tennis players, and K-Swiss is making a push to gain more share in this market with marketing and more focus.
They are also focusing more on marketing towards teens, with new ads debuting during the Final Four this weekend.
Also, their popularity may be dimming in the US, but they have exploding growth in Asia and Europe, and management admits they screwed up during the last 5 years in the US which is why they have had negative growth over the last year, and will change their strategy in international operations to create more staying power.
Right now K-Swiss is a turn-around, the huge cash reserves serve as a margin of safety (in combination with the cash flow, though its growth is dwindling it still spits out a bunch of cash and doesn’t borrow) while investors wait for it to turn-around.
April 3rd, 2008 at 8:16 pm
Popular with tennis players!? Where are on Earth are you from? I’m a club pro in SFO and have yet to see one of my students and/or tourney players wear K-Swiss.
Compare the technology of say an Adidas with anything that K-Swiss produces and you will understand why they are not used on the tennis court by serious players. That the company signs a top name pro to wear the product doesn’t hurt the exposure factor but the bottom line is if the product performs. There are serious footwear product and then there is K-Swiss and other posers.
K-swiss should stick to what they are good at … fashion, inner-city footwear.
April 7th, 2008 at 1:43 pm
Not sure what SFO means, but K-Swiss has some serious Tennis shoes and they get excellent reviews in Tennis magazines. They are very popular tennis shoes in Europe.
For K-Swiss to succeed, they need to become a different kind of company. The management is excellent operationally but likely do not have the marketing savy to take them where they need to go. They should sell to Nike.
KSWS will likely do OK but might take longer and spend more cash getting there than many investors think. I like them but at a lower price.
April 7th, 2008 at 3:18 pm
I’m the same Anon as above…
In terms of FINL, I don’t believe this situation has a margin of safety anymore. I remember taking a look at this when it was under $2.50 a share and wanting to make a move after a preliminary analysis, but got distracted with school work.
The reason I don’t think there is a margin of safety anymore is because you cannot count there inventory at full price. In a situation of liquidation, this inventory would probably sell for 25 cents on the dollars, if not less.
This opportunity was definitely mispriced when it was trading below $3 or so, but I can’t justify it anymore. The stock might keep climbing, but I’m not confident the margin of safety is wide enough to risk my investment dollar.