Can Skechers Recover From Missteps?

NEW YORK ( TheStreet) -- Sometimes net/nets are able to turn things around.

Net/nets are stocks that trade for less than their net current asset values. Sometimes stocks end up in this predicament because of bad business moves, a rough economy, intense competition or even obsolescence.

Some of these companies never recover. But others are able to right the ship. If you can correctly identify the latter stocks, and have the stomach to endure the roller-coaster ride often involved with owning such names, you could be richly rewarded.

Footwear company Skechers ( SKX) is a great example, but it's still a work in progress.

Skechers was a victim of the insane markets we experienced in early 2009. It traded below net current asset value for a while before it embarked on an incredible run between April of 2009 and June of 2010 that saw shares soar from $6 to $44.

But following that amazing recovery, the company's missteps brought the stock crashing back to earth. By early January 2012, much of the earlier gain had vanished, and shares traded for less than $12. The fall from grace was primarily due to Skechers' "Shape-ups" line of sneakers, an unmitigated disaster that led to lawsuits and growing inventories.

Demand for the shoes, which promised health benefits to those wearing them, was weak, and the company was left with a boatload of unwanted product. Ultimately, Skechers dumped the inventory, while investors dumped their positions in Skechers.

Although the company has not yet returned to profitability, the markets have warmed up to the stock, and shares are now back near the $20 level -- up more than 60% year to date. Despite negative bottom lines for the first two quarters of 2012, the losses have been much lower than analysts' consensus estimates.

Inventories have fallen. Second-quarter inventory was down more than 20% vs. the same period last year. Consensus estimates for the third quarter are calling for revenue of $435.3 million, and earnings of 32 cents a share. We'll know more on Oct. 24, when the company is scheduled to report third-quarter earnings.

I continue to hold Skechers primarily because of the strength of its balance sheet. The company ended the second quarter with $374.2 million, or $7.60 per share in cash, and $142 million in debt. Shares currently trade for slightly more than tangible book value per share (1.14) and at a low multiple of net current asset value (2.16). The company has also generated significant free cash flow over the past 12 months, more than $2.50 per share.

Of course, one of the dangers with a company like Skechers is that it operates in a highly competitive business, highly subject to changing consumer tastes. If you misjudge what consumers desire, you can be stuck with inventory that no one wants. Let's hope Skechers has learned from the mistakes of the past.

Although I rarely view one quarterly earnings release as make or break, I am interested to see what type of progress the company has made, and whether it will live up expectations.

At the time of publication, Heller was long SKX.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.

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