Over the past six months, Designer Brands has been a great trade, beating the S&P 500 by 10.4%. Its stock price has climbed to $3.65, representing a healthy 37.7% increase. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
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Why Do We Think Designer Brands Will Underperform?
Despite the momentum, we don't have much confidence in Designer Brands. Here are three reasons we avoid DBI and a stock we'd rather own.
1. Shrinking Same-Store Sales Indicate Waning Demand
Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).
Designer Brands’s demand has been shrinking over the last two years as its same-store sales have averaged 4.5% annual declines.
2. EPS Trending Down
We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Sadly for Designer Brands, its EPS declined by 33.3% annually over the last six years, more than its revenue. This tells us the company struggled because its fixed cost base made it difficult to adjust to shrinking demand.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Designer Brands’s $1.32 billion of debt exceeds the $44.94 million of cash on its balance sheet. Furthermore, its 12× net-debt-to-EBITDA ratio (based on its EBITDA of $110.5 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Designer Brands could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Designer Brands can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We see the value of companies helping consumers, but in the case of Designer Brands, we’re out. With its shares beating the market recently, the stock trades at 5.7× forward EV-to-EBITDA (or $3.65 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are more exciting stocks to buy at the moment. We’d recommend looking at one of our top digital advertising picks.
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