K-Swiss in the Buffett Way

Following the Netflix re-examination, I've decided to use the same test and try to find if K-Swiss still deserves a spot in my portfolio.

Business

Simple, Understandable

K-Swiss makes extremely comfortable and long-lasting leather shoes. more than 2/3rds 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.