4/16/2008

Crox Warning Takes Further Bite Out Of Retail Sector
By Brian Sozzi

A recent 1Q '08 earnings warning from plastic shoe manufacturer Crox Inc. (ticker: CROX) sheds light on the extremely difficult situation plaguing the retail sector.  While there is a component to the Crox earnings warning that stems from management's inability to control costs and elongate the business model, in our view demand at primary points of distribution (department stores) has dried up given current economic circumstances.  In turn, this is leading many retailers to cancel orders for upcoming selling seasons as they work to mitigate product markdown risk.  It's our position that the shortfall at Crox portends soft 1Q'08 financial results and disappointing FY'08 guidance from apparel and footwear manufacturers, in this case Columbia Sportswear Co. (ticker: COLM) and Timberland Co. (ticker: TBL).  Both of these companies have struggled in recent quarters in sparking demand and controlling inventories, two key necessities in navigating a down cycle in the retail sector.  We have lowered our 1Q'08 and FY'08 financial estimates once again for each firm citing sales and margin risks; our underweight recommendations on the stocks remain unchanged.

WSS Financial Revisions

Columbia Sportswear Co.

•  1Q'08: $0.50 per share from $0.53 per share
•  FY'08: $3.48 per share from $3.52 per share

Timberland Co.

• 1Q'08: $0.17 per share from $0.18 per share
• FY'08: $0.87 per share from $0.90 per share

Core Thesis: Columbia Sportswear Co.

No other purchases are more discretionary than apparel and footwear, two vital components to Columbia's business.  Given the macroeconomic factors, our primary concerns as it pertains to Columbia's inventory at 4Q'07 end (+25.0% year over year), order cancellation risk for the spring, and increased operating expenses associated with outlet and retail store openings, we view the shares as a high risk proposition.  Additionally, we would like to point out that the shares are not valued at particularly compelling levels and that there is significant uncertainty heading into Columbia's 1Q'08 earnings release when management will provide its fall backlog total.

Core Thesis: Timberland Co.

The Company sells a material amount of goods to department store operators, and inventory/margin concerns in this channel of distribution raises the probability for sluggish 1H'08 financial results.  We would also note that as of December 31, 2007, Timberland's backlog was down by 18.0% year over year and was well shy of management's projected FY'08 sales growth guidance according to the 10-K filing.  Although the backlog total only reflects wholesale accounts, it is a good indicator of demand trends throughout the aggregate business in our view.

Trading at a PE multiple of 16.0 times estimated FY'08 earnings, and a 1.33 PEG ratio, investors may be pricing in too much optimism from recent cost cutting measures and from a potential takeover.  On the latter topic, which we believe is not as feasible as it appears, it's important to note the Company's voting power is 72.0% controlled by the founding Schwartz family, and there is a poison pill in place (can issue preferred stock without shareholder approval).