Shoe Carnival Stock: Quietly Quality But Not A Buy (NASDAQ:SCVL)

Investment thesis

Our current investment thesis is:

• SCVL is a quality business, owing to a combination of commercial factors, such as a well-developed competitive position, as well as an efficient capital allocation strategy.
• While we do not believe returns will aggressively increase, the company appears to be a quiet compounder, particularly if margins can stabilize at a higher level than its historical average.
• Investors should continue to monitor the business, primarily looking out for when growth returns and at which point margins begin to slow. An increase in inventory turnover and bullish Management communications will be early signs of this.

Company description

Shoe Carnival (NASDAQ:SCVL) is a leading retailer of family footwear, offering a broad assortment of shoes for men, women, and children across various price points and brands.

Founded in 1978, Shoe Carnival operates over 400 stores in the United States, providing a unique shopping experience with a focus on value, convenience, and customer service.

Share price

SCVL’s share price performance has been respectable, broadly tracking the S&P500. This has been driven by quality leadership and efficiency capital allocation, maximizing returns from its weaker relative position in a highly competitive industry.

Commercial analysis

Presented above are SCVL’s financial results.

SCVL’s revenue has grown well during the last decade, with a CAGR of +3%. While this barely exceeds inflation during the period, its growth has shown a linearity of 0.7 and is softened by the current timing.

Business Model

SCVL operates as a value-oriented footwear retailer, offering a wide selection of brand-name and private-label shoes for men, women, and children at affordable prices. The company offers a diverse range of footwear styles, including athletic shoes, dress shoes, casual shoes, boots, sandals, and accessories.

This extensive product assortment caters to various customer preferences and occasions.

SCVL employs a discount pricing strategy, offering competitive prices on its footwear products. The company frequently runs promotions, sales, and clearance events to attract budget-conscious shoppers and drive foot traffic to its stores. When partnered with its considerable choice, SCVL provides a compelling value proposition to customers.

In addition to its brick-and-mortar stores, SCVL has an online e-commerce platform that allows customers to shop for footwear conveniently. The company’s omnichannel approach enables seamless integration between its physical and digital channels, which share capabilities such as marketing, with its e-commerce sales soaring in recent years.

SCVL focuses on providing an engaging and interactive in-store shopping experience for customers, remodeling a large number of stores in recent years in response to rapid growth in e-commerce. Features such as music, games, and promotional events create a fun and lively atmosphere, enhancing the overall shopping experience.

Competitive Positioning

SCVL’s industry has experienced considerable disruption during the last decade (discussed later), which is why we consider its growth trajectory to be fairly respectable. The key value drivers are the following we believe:

• Value Proposition – SCVL is price competitive within the market, regularly offering discounts and generally being on the lower-end. This value-oriented approach resonates with price-conscious consumers seeking affordable footwear options, as well as those looking for the cheapest retailer for a specific shoe.
• Responsive Merchandising – SCVL employs a responsive merchandising strategy, quickly adapting its product offerings to reflect changing fashion trends, seasonal demands, and customer preferences. This agility is increasingly important, as it allows the company to stay relevant and meet evolving needs at a time when trends are short-lived and ever-changing.
• Strong Vendor Relationships – SCVL maintains strong relationships with footwear vendors and manufacturers, allowing the company to secure favorable pricing, exclusive product offerings, and timely deliveries. Given its low-cost strategy, this is fundamentally important to its ability to outperform.
• Customer Loyalty Program – SCVL operates a customer loyalty program, known as Shoe Perks, which rewards members with points for every dollar spent. Members can redeem points for discounts on future purchases, special offers, and exclusive perks, fostering repeat business and customer retention. The company sees over 50% of its sales from its members, an impressive conversion ratio.
• Brand Reputation – Linking well with our first point, SCVL has built a strong brand reputation for offering quality footwear at affordable prices, earning the trust and loyalty of its customers over time. While its consumers inherently will go where prices take them, thus not loyalty from the traditional sense, the trust means SCVL is considered a reliable option to browse.

Footwear retail industry

The footwear industry is expected to generate mild growth in the coming years, with a CAGR of ~3.5%. The industry has experienced considerable disruption during the last decade, primarily due to the rise of e-commerce. This has contributed to a large increase in new entrants, who are able to price more aggressively due to limited overhead costs. Further, brands have used e-commerce to sell directly to customers, cutting out retailers.

SCVL’s focus on the discount segment has insulated it to an extent, as its pricing is sufficient enough to encourage consumers to shop in store. This said, Management has rightly grown its online presence, as pressures progressively increase.

Growth progression

Whilst the company has a solid business model and a strong competitive position, its growth has been mediocre. The reason for this is a combination of the maturity of its industry, particularly the affordable segment, as well as growing competitive pressures. The issue for SCVL is increasingly visibility, with larger businesses outspending on marketing, limiting SCVL’s ability to get in front of customers.

Economic & External Consideration

Current economic conditions are the primary reason for the recent drawdown in sales. With inflation and elevated interest rates weighing on consumers, there has been a softening of discretionary spending. This is likely to continue dragging the company’s performance in 2024, until which time expansionary policy can return, which will likely be H2’24 / H1’25. Management recent flash trading for year end implies the company has hit its top-end guidance while being broadly flat with LTM.

Margins

Whilst SCVL’s margins are considerably below its FY22 peak, this period was likely a complete outlier and heavily influenced by the post-pandemic demand. Compared to its historically normalized level, SCVL remains comfortably above, albeit is currently on a downward trend.

We suspect SCVL can normalize at a level above an EBITDA-M of ~7%, although the visibility of this is somewhat limited.

Balance sheet & Cash Flows

One of the primary factors driving SCVL’s share price performance is Management’s capital allocation strategy, utilizing FCFs to repurchase shares. Since FY14, its share count has declined an impressive 33%.

The company will also be opportunistic with M&A, most recently acquiring Shoe Station’s assets for ~$70m.

This has maximized shareholder returns from, what is on paper, mediocre financial results. This illustrates the value that comes from efficient operations.

Outlook

Presented above is Wall Street’s consensus view on the coming years.

Analysts have forecast a continuation of its mild growth, with a CAGR of 4% into FY26, alongside margin improvement from its low in FY24. We broadly concur with these forecasts, as we expect its financial performance to improve in the second half of 2024 and may already have “bottomed” given the decline since FY23.

Beats and Misses

It is worth highlighting that SCVL has been underperforming forecasts in recent quarters, with analysts expecting better margin improvement.

Industry analysis

Presented above is a comparison of SCVL’s growth and profitability to the average of its industry, as defined by Seeking Alpha (27 companies).

SCVL performs moderately relative to its peers but is lacking following a decline in financial performance. Whilst its growth has underperformed, the company boasts superior margins.

The key to the attractiveness of SCVL is the ability to maintain a superior ROTC over time with higher margins, while broadly limiting the difference in growth. We believe SCVL can reach this level, although it appears unlikely.

Valuation

SCVL is currently trading at 8x LTM EBITDA and 8x NTM EBITDA. This is a premium to its historical average.

A premium to its historical average is reasonable in our view, owing to the company’s improvement in margins and sustainable growth trajectory. This translates to a slightly lower FCF yield of 7.5% vs. its decade average (-0.2ppts).

Further, SCVL is trading at a considerable discount to its peers, reflecting its weakness in growth primarily we believe, and its limited scope to close the gap. This discount appears reasonable in our view.

Finally, SCVL’s FCF and EBITDA per share have considerably declined, without a proportionate decline in share price. Shareholder value is enhanced when both are increasing (naturally) but the expectation is for the two to broadly track each other.

Overall, we believe SCVL is broadly valued correctly. Whilst the company is solid and performing moderately, its weakness in relative financial performance makes it less attractive compared to other opportunities.

Key risks with our thesis

The risks to our current thesis are:

• Near-term growth contributing to an improvement in investor sentiment.
• Normalized EBITDA-M outside of ~11-14%.

Final thoughts

SCVL is a solid business, underpinned by a strong business model and competitive position, alongside a slow-moving industry. The company’s share price performance is attributable to this, alongside a savvy Management team that has maximized its value.

This said, its near-term performance is underwhelming and its relative performance suggests it struggles to stand out. We believe this will act as a strain on shareholder value prior to 2025.

At a lower FCF yield with near-term risks to demand, we rate SCVL a hold.