How Will Shoe Stocks Fare in 2014?

Can the bulls keep charging in 2014?

Many footwear stocks crossed the finish line last month at all-time highs as the broader S&P Retail Index ended 2013 up 44 percent. The strength came despite choppy store traffic and heavy promotional activity in the second half.

Looking at the year ahead, market watchers are generally bullish and expect athletic players to be the biggest winners on Wall Street, thanks to continued strength in the sector and an overall uptick in consumer confidence.

“Coming off a tough back half of fiscal 2014, we believe top-line [revenue] growth should benefit from continued macroeconomic improvement and recovering consumer demand,” said Randal Konik, an analyst at Jefferies & Co.

Konik said the promotional war zone during the holiday season resulted in many companies entering the new year with lean inventories, which should reduce the level of profit-eroding discounts in the first half. That will allow companies to focus on growing earnings, driving stock prices higher.

Still, one of the key risks for footwear stocks this year is the disconnect between lofty share price valuations and company fundamentals, said Jeff Van Sinderen, an analyst at B. Riley & Co.

He noted that most footwear stocks are trading above their five-year historical average on a price-to-earnings multiple and warned there could be a pullback if retailers fail to cycle easy comparable-store earnings this year.

“At some point, companies have to deliver stronger earnings growth to justify a higher multiple,” Van Sinderen said. “The fact that these stocks are trading where they are means you have to believe the overall environment is going to get better — maybe it’s the promotional environment, maybe it’s the weather, maybe it’s the consumer.”

Two factors remain central to the footwear sector’s performance this year, according to the analyst: foot traffic and the rise of online shopping. “We still will have volatile traffic this year. Then there’s the impact of the shift to online. How companies adapt to this transformation will impact how the year shapes up,” Van Sinderen said.

Steve Marotta, an analyst at CL King & Associates, predicted high-single-digit earnings growth across the sector for the coming year.

“Footwear has performed exceptionally well since the trough of the recession. From a valuation standpoint, companies are tending to trade well above their historical norms,” he said.

But Marotta cautioned investors to beware of stocks with high valuations and near-peak operating margins — such as Michael Kors Holdings Ltd. — which could slide if earnings disappoint.

So which stocks will lead the footwear sector in 2014? Most experts agree that athletic and performance-oriented firms have the most upside potential.

Sam Poser, an analyst at Sterne Agee, listed Foot Locker Inc., Deckers Outdoor Corp., Skechers USA Inc. and Under Armour Inc. as strong contenders.

“Athletic wins this battle. From a retail perspective, there is a big lack of trend in women’s fashion right now,” he said.

Innovation in product design and use of color will continue to drive athletic sales this year, Poser explained. Of his overall top pick for 2014, he said, “Foot Locker’s European business is turning and they have a new acquisition there. In the U.S., they are redoing their stores.”

Van Sinderen also touted companies in the sports segment. “We’ve seen a resurgence in the running space, so companies able to innovate will continue to do well, as will those operating in the basketball categories,” he said. In particular, “Nike Inc. is on fire and will continue to have strong business to the extent that they deliver fresh and exciting new products, while Deckers had a lot of momentum over the holidays, not just domestically but internationally.”

Shares of Nike closed 52.4 percent higher last year, while shares of Deckers were up 109.7 percent. (The latter’s stock has been on a roller coaster during the past few years.) Finish Line Inc. and Skechers are two other players expected to profit, Van Sinderen said. “Skechers has an excellent diversified portfolio and Finish Line has pushed to be an omnichannel leader and is playing off the strength of Nike,” he noted. Steven Madden Ltd. is positioned to have another strong year, according to the analyst.

But Poser said the broader fashion market could suffer due to the lack of fresh trends. “A lot of boots and booties have been hot for a year or two. We need to see some big ideas that are going to drive business,” he said

Given the recent success of Madden and other firms, Marotta suggested several private players could consider the IPO market in the coming months. “Companies are seeing what the value of being public is — [valuations] are so high that it presents a compelling case for private companies to go public,” he said.

Gil Harrison, founder and chairman of Financo, agreed that improved consumer sentiment should benefit the sector this year, listing DSW Inc., Nike and Adidas Inc. among his favored stocks, due in part to their strong growth stories and expansion strategies. “We’ve been at such a disadvantage over the past two years, and people are more optimistic about the outlook going forward,” he said.

Harrison also forecast that mergers-and-acquisitions activity will remain robust. He expects the deal pipeline to show no signs of slowing this year, noting that the anticipated breakup of recently acquired The Jones Group Inc. will be in the spotlight in the first half.

“The most interesting story is Jones and what will happen [if parts of it] are sold or replaced,” he said.

Also in the news is Fifth & Pacific Co., which spent more than a year trimming its brand portfolio to just two names: Kate Spade and the Adelington Design Group jewelry line. “The management team [at Kate Spade] has done a phenomenal job growing the company, and it will be a leader going forward as one of the fastest and best specialty retailers,” Harrison said.

He also highlighted VF Corp. as one of the companies that could make another acquisition this year following the successful integration of Timberland, which it purchased for $2 billion in 2011.

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