Saturday, September 8, 2007

Stock Analysis: HLYS

Heelys (HLYS)

The Heelys shoe is a very hot product for children spanning a broad age range. You have undoubtedly already seen children zooming around on them in the mall or on the street. The shoe is certainly “trendy,” which always poses a risk to the stock’s value as the fad becomes outdated and unfashionable. However, just as Crocs addressed the same concerns, I believe that Heelys will weather the storm and emerge a strong company.

My primary reason for confidence in the brand is the practicality of the product. Unlike most fashion hits, Heelys is not solely based on style (in Heelys’ case, the wheel that makes its shoes unique). First and foremost, a pair of Heelys IS a pair of shoes – the wearer can walk in the shoes just as easily as he can choose to glide. In fact, Heelys recently released a shoe without a wheel, asserting its position as a general footwear company.

Heelys had its initial public offering last year, with shares fetching around $30. By February 2007, shares topped $40. However, after that point, the value slowly declined, possibly as investors reassessed the true value of the niche brand. In the beginning of August 2007, Heelys was trading around $22 per share, when third quarter earnings projections were negatively adjusted to reflect a growing inventory at retailers. Shares were demolished, dipping to $12 that day, losing almost 50 percent of their value. Since then, shares have steadily declined, hitting an all-time low of $8.10 on Monday, September 10th.

Here's a picture of the chart over the last month and a half, and it isn't pretty:


http://3.bp.blogspot.com/_Qo-Z0Hm7P-Q/RuNq1aisu6I/AAAAAAAAAAM/5jGu4sgj2TI/s320/heelyschart.png

Chart courtesy of StockCharts.com


However, when I look at this chart, I see opportunity.

Heelys is a fundamentally solid company. Here are some of its noteworthy fundamentals, obtained at finance.yahoo.com:

VALUATION MEASURES



Market Cap (intraday)6:

226.78M

Enterprise Value (9-Sep-07)3:

173.71M

Trailing P/E (ttm, intraday):

5.05

Forward P/E (fye 31-Dec-08) 1:

6.60

PEG Ratio (5 yr expected):

0.55

Price/Sales (ttm):

0.88

Price/Book (mrq):

2.03

Profitability

Profit Margin (ttm):

16.65%

Operating Margin (ttm):

25.34%


Management Effectiveness

Return on Assets (ttm):

54.24%

Return on Equity (ttm):

70.06%

Balance Sheet

Total Cash (mrq):

53.07M

Total Cash Per Share (mrq):

1.961

Total Debt (mrq):

0




I italicized some important indicators, detailed here:

  • Very low PE: Whether analyzing this year’s numbers, or next year's weaker estimates, Heelys is still a very, very cheap company, especially considering its industry and type of business. Sales probably won't grow at the astronomical pace that has occurred over the past few years, but that shouldn't matter: Heelys is so beaten up now that even if sales simply level off, the shares could trade at double their current value, based on the current PE of 6.
  • Business Model: Heelys does not manufacture their own product; they outsource the production to another company. Therefore, Heelys has no long term obligation to pay off costs for factories, machines, or materials: their product goes straight from manufacturer to the retail distributor. They are able to avoid excessive risk because of this.
  • Clean books – Heelys has no long term debt. Even if they do have a few weak quarters while retailers are getting rid of excess inventory, the company will not go bankrupt paying off debts. The company is insulated from the dangers that many infant companies have to endure.


The famous heeled shoes represent over 90% of Heelys sales, which is obviously why investment is the company is risky. They are currently trying to launch an apparel line to diversify their product lineup. If successful, it will stabilize the company while adding revenue and profit.

Another interesting thought is the possibility that Heelys could be absorbed into a larger apparel company. Since it is a small company that currently has one unique and popular product, it wouldn't be unfathomable for a company like Nike or Adidas to acquire them. There is currently NO suggestion of this, but it's not a ridiculous statement. If bought out, shares would clearly fetch more than their current value.

I have a small personal position in Heelys; I entered the stock after the big declines, and am now marginally down on my investment. However, I am confident that even if Heelys shares slip further in the immediate, the company has a solid foundation, and is currently drastically undervalued.

In conclusion, Heelys is a fundamentally solid company that is going through a rough time. The product that they sell still has no direct competitor, and it is a great product: It is both practical (a fully-functioning shoe) and enjoyable (as the wheel provides entertainment value, like a toy). Since the product is a shoe, and growing children are the market, kids that wear Heelys will outgrow their shoes, and, seemingly satisfied, will ask for more. Overall, they have a tiny fraction of the shoe market, and have plenty of room to grow, especially as they expand traditional offerings and enter the apparel market.

I think the chance of Heelys completely ceasing to exist as a company, i.e. going bankrupt, is practically zero. It has no debt to pay off, and inventory is tied to retailers, not the company itself. Even if it stops selling shoes, it has no long-term obligations to fulfill.

It may continue to be a tough market for Heelys, especially as it reports third-quarter earnings, which were responsible for the 50% share price decline as the new guidance was announced.

However, I feel as though the company is undervalued, and in the long run, Heelys shares will be worth much more than they are today.



My short-term recommendation is
HOLD, my long-term recommendation is BUY.

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