Designer Brands has been treading water for the past six months, recording a small loss of 1.3% while holding steady at $3.71. The stock also fell short of the S&P 500’s 10.5% gain during that period.
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Why Do We Think Designer Brands Will Underperform?
We're sitting this one out for now. Here are three reasons you should be careful with 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 5% annual declines.
2. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
Designer Brands historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 1.7%, lower than the typical cost of capital (how much it costs to raise money) for consumer retail companies.
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 $1.33 billion of debt exceeds the $46.03 million of cash on its balance sheet. Furthermore, its 11× net-debt-to-EBITDA ratio (based on its EBITDA of $114.4 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
Designer Brands doesn’t pass our quality test. With its shares underperforming the market lately, the stock trades at 14.8× forward P/E (or $3.71 per share). At this valuation, there’s a lot of good news priced in - we think there are better stocks to buy right now. We’d suggest looking at the most dominant software business in the world.
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