Merrill sees Skechers gaining traction, finds convertible around 2.27% cheap

By Ronda Fears

Nashville, Dec. 13 - Although Skechers USA Inc. warned this week of a net loss rather than profits in fiscal fourth quarter, Merrill Lynch & Co. convertible analyst Robert Dia sees limited downside to the convertibles and actually finds the issue trading cheap.

On Monday, Skechers announced a shortfall in sales for fourth quarter, owing to soft consumer spending, pricing pressures and inventory issues. Thus the company said it expects a loss of 25-35c instead of its previous estimate of 3-8c profit.

"We believe that the Skechers 4.25% convertible bond represents an attractive total return alternative to the equity offering a 6% yield advantage, given the greater uncertainty surrounding future sales and earnings," Dia said in a report Friday.

For hedge funds, a heavy hedge was recommended to start a position, lightening as more data is released.

"Despite the negative [news], we believe that the company's solid balance sheet will limit the downside in the convertible bonds (only debt except for bank debt and mortgages)," Dia said.

In the last quarter, the company had over $100 million in cash and total debt of $130 million.

Using the Merrill Lynch convertible model, assuming a spread of 1097 basis points and a 40% volatility, Dia said theoretical value of the convert is 76.74, or 2.27% more than the currently trading level.

"We believe that using a spread of about 1100 bps is conservative given the company's financial ratios. In the LTM period ending 9/30/02, the company had a coverage ratio of 12.5x and a leverage ratio of 1.0x," Dia said.

"When the company is examined on a forward basis the ratios deteriorate, but not so severely as to warrant such a wide spread. Spread levels of other fashion-sensitive companies are much tighter despite somewhat weaker credit ratios, albeit these companies just did not pre-announce weak numbers.

"We would not be surprised over time, as more data is released, that the spread levels on the bonds will tighten to more comparable levels of other fashion-sensitive names."

The optimism is chiefly based on a belief that Skechers' hot brand has not lost customer appeal, but that the company is just starting the next phase in a growth cycle as it looks to expand its operations overseas.

"The biggest risk in this name currently is trying to determine if this sales and earnings miss is a one-time event and if it was just bad luck that this happened in the company's weakest quarter, or is competition stealing market share and dollars," Dia said.

"The data we are hearing has been average to slightly above average (depending on the product category) on the sell-through, as the company has been actively managing the process with price concessions."

No doubt, the past year has been incredibly difficult for companies like Skechers as consumer spending and the continuing fear of more job cuts impact shopping patterns, he noted.

But Skechers has reported solid earnings and free cash flow numbers over the past year, due to the fixed cost nature of its business. He expects sales to moderate but improve sequentially over the next few quarters.

Skechers 4.75% convertible due 2007

Price: 75

Stock price: $8.10

Parity: 31.19

Conversion premium: 140.45%

Current yield: 6%

Yield to maturity: 12.06%

Yield to next call: 4.45%

Conversion ratio: 38.5089

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.