Heelys Revisited - Analysis

I published an analysis of Heelys (HLYS) as my blog was in its infancy... about one month ago now.

Over the past month, Heelys' shares did little of anyting - they teetered around in the low $8's, trading up or down a dime every day.

However, on Friday, Heely's shares jumped after they released their Spring 2008 lineup of shoes.

The stock was up 16%, a huge jump compared to the basically-flat performance over the past two months. I don't expect the stock to hold all of it's gains from Friday simply because it was such a dramatic pop on non-major news.

However, I still find Heely's as attractive as I did a month ago. Heres are some data (provided by Yahoo! finance) that demonstrates some of the reasons why I still love Heelys:

Share Statistics
Average Volume (3 month)3:	606,689
Average Volume (10 day)3:	496,433
Shares Outstanding6:	27.06M
Float:	17.31M
% Held by Insiders4:	33.52%
% Held by Institutions4:	43.70%
Shares Short (as of 25-Sep-07)3:	2.35M
Short Ratio (as of 25-Sep-07)3:	9.6
Short % of Float (as of 25-Sep-07)3:	28.90%
Shares Short (prior month)3:	2.43M

The statistic that really screams "POSSIBLE BIG GAIN" to me is the percentage of short shares - a whopping 29% of the float. It would take 5 full trading days to completely cover the short positions.

That, in a nutshell, is why Heelys could be an explosive pick. It could very well do nothing for a long, long time, but when there is substantial positive news about Heelys, a major short squeeze will occur and the price will skyrocket.

After the terrible earnings in the summer that sent the stock plummeting, I think that virtually all bad news has been priced in. Lower orders and estimates are already incorporated into the share price; I think that the current quarter could turn out well since the estimates were revised lower.

All it will take to sent Heelys to $15 is good news and the subsequent short squeeze - say that they beat earnings, or Journeys doubles their order - a natural rise to $11 or $12 may occur, and at that point, many investors who shorted the stock on the way down may scramble to cover positions, increasing the price even further.

Will this happen tomorrow, next week, or next month? Don't count on it. I bought my Heelys position around $8.7, and I wouldn't be surprised if it stays priced between $8-$10 for a substantial period of time. However, since Heelys has virtually no long-term debt or obligations, I think the company will regain footing after the retailer's current inventory clears out, and then it will be all good things for the company.

Lastly, another thing to always consider is the possibility of a buyout. Heely's current market cap is about $250 million, which is very doable for Nike (market cap - $31 billion), Adidas, or even Crocs ($5+ billion). I'm not necessarily predicting a buyout, but for a big apparel company, acquiring a growing, popular niche brand like Heelys could be a very attractive investment.

Last Week Review

Last week was a very big week for me; my positions in my portfolio changed significantly.

I sold my long position in Hovnanian, as it was up 50% in three sessions, to a price that I felt was inflated. (So far, I was correct, as the price has fallen almost $2 from when I executed my sell order).

I was also long in some Hovnanian 12.5 September calls, which thankfully, I was able to sell for a nice little profit. I also had some Abercrombie 80 September calls, which I sold for a little more than break-even.

I'm looking to re-initiate a long position in a homebuilder at some point, once the market settles down a little bit - with earnings being reported from a couple builders this week, the potential volitility is a little more than I am comfortable with. I may or may not choose Hovnanian again; I might choose a safer play. as Hovnanian is probably one of more-endangered builders. However, I still do think HOV will not go bankrupt, and it will trade at two, three, or four times today's price, but I don't know if I want to reintroduce that risk to my porfolio now.

In other news, Syntax-Brillian (BRLC) finally bounced a little bit; I initiated long-term options position $2.50 calls, expiring January), increasing my exposure to the company with some deep-in-the-money, limited-risk calls.

Heelys (HLYS) also finally had a few positive sessions; once again, I reiterate that the company currently looks fundamentally cheap. It's a very long-term hold.

Now that I've pretty much eliminated all short-term plays from my portfolio... its time to get a new one! And for the first time in my life, I'm looking to go short and/or buy puts.

Look at the next post for what I'm thinking about.

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 10^th.

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

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.