Consumer Discretionary Sector

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Consumer Discretionary Sector

• Oren Bossin
• Michael Cooperman
• Howard Weiss

Student Managed Investment Portfolio ClassProf.
P.V. ViswanathSpring 2002
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Objective

• To find Consumer Discretionary stocks that are
  undervalued, but in a good position financially
  to capitalize in a recovery market.

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Research Methodology
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Research Methodology

• Debt Capacity Regression Analysis
• 1st Quartile
• FCF/MVA
• 1st Quartile
• FCF/Revenue
• 1st Quartile
• Total Liabilities/Total Assets
• 1st Quartile

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Research Methodology

• Add ROE rank to the four variables in leverage
  and profitability analysis and re-rank all the
  variables with each variable receiving a weight.
  This provided a roughly 60-40 split of
  profitability and debt. We chose the top five
  companies from this analysis.

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Initial Analysis
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And the Winners Are...
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WLS

• Anticipate Fed raising rates
• Result dampen housing market
• Housing market tends to lag economy
• showing signs of slowing
• Did not want to focus on industry directly
  impacted by Fed interest rate moves

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TOPP

• Strong financial position
• Not in a strategic position for growth
• Good debt capacity
• Excess cash reserves
• possibility of management not knowing how to
  manage excess cash
• Stock price has not moved in over 2 years

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KDE

• Good debt capacity
• Available free cash flow
• Growth opportunities
• Core product (Pokemon) fading
• Result Fad dies down earnings have substantially
  decreased
• Success relies too much on next big fad
• Risk outweighs benefit at this point in time
• Stock should be tracked for future investment

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SHFL and KSWS

• Good debt capacity
• Available free cash flows
• Opportunities for growth
• Low relative risk

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Model Value vs. Market Value
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Corporate Analysis

• Considerations
• Corporate Overview
• SWOT Analysis
• Damadoran 2-Stage Free Cash Flow Model
• Company to Index Comparison
• Insider activity
• Institutional activity

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Corporate Overview

• Shuffle Master Inc.
• Shuffle Master, Inc. develops, manufactures and
  markets automatic card shuffling equipment
  (shufflers) and gaming products such as table
  games, slot machine game software and slot
  machine operating system software for the gaming
  industry. The Company's card shuffler products,
  are automatic card shuffling machines designed to
  be used with table games in casinos and other
  legal gaming establishments. The Company's
  shufflers offer several benefits to its casino
  customers, including enhanced security and
  increased productivity.

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Corporate Overview
Products / M/A

• Continuous multi-deck shuffler marketed to casino
  customers (fiscal 2000)
• Featured a design that eliminated card counting
  and tracked productivity over the Company's
  multi-deck batch shuffler
• Acquired Gaming Products Pty Ltd. (fiscal 2001)
• Quick Draw shuffler product line
• Certain other assets related to the Gaming
  Products business
• Represents an alternate approach to continuous
  shuffler design Its long-term strategy is to
  develop a powerful, open-architecture game
  operating system that could run proprietary games
  on any slot machine.

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Corporate Overview
Strategy

• Develop or acquire gaming products and systems
• Productivity enhancing equipment
• New table and slot games
• Slot game technology
• Market these products worldwide
• Card shufflers and specialty-table game lines
  objectives
• Obtain licenses, patents, and other intellectual
  property
• Identify a business model to leverage and
  commercialize those assets
• Generate high-margin cash flow in line with the
  companys historical gross margins (70-80)
• Long-term strategy
• Develop a powerful, open-architecture game
  operating system that could run proprietary games
  on any slot machine

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Corporate Overview
Competitors

• Primary Competitor is WMS Gaming

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SWOT Analysis

• Shuffle Masters Inc.
• Strengths
• Core business of card shuffler and
  specialty-table game lines are growing and
  providing gross margins of between 70-80
• No outstanding debt, an unused 15 million line
  of credit, and 23 million in cash
• Partnered with International Game Technology
  (IGT), the largest U.S. slot machine manufacturer
  to generate revenues using its brands and
  licenses
• Regulatory approval was given to Shuffle Masters
  slot machine operating system
• Strong pipeline of game titles, both by
  themselves (15 new game titles submitted for
  regulatory approval) and with IGT (538 games have
  been installed as of January 31, 2002)
• Company one of the few leaders in gaming software
  technology
• Weaknesses
• High RD costs associated to keeping up with the
  accelerating rate at which games are being
  advanced and changed
• Success is largely dependant on approval of
  gaming technology by state gaming agencies
• Gaming industry has been hurt by September 11,
  which has caused a slow down in vacations (to
  casinos). Recovery will take some time
• Opportunities
• Gaming system approval will allow Shuffle Master
  to develop proprietary games using its own titles
  and brands for casinos rather than partner with
  other manufacturers and share revenues
• Will soon be introducing new single- and
  double-deck shuffler into the previously untapped
  poker market sometime this summer
• WMS Gamings (WMS) (Shuffle Masters main
  competitor) difficulties with its game operating
  system have created 1) a delay in its
  introduction of new titles and 2) a game base of
  roughly 50,000 faulty WMS video slots machines in
  the domestic market

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Shuffle Master Analysis
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Shuffle Master Analysis
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Shuffle Master Ratio Comparison
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Shuffle Master Insider Transactions
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Shuffle Master Insider Activity
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Shuffle Master Institutional Ownership
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Corporate Overview

• K-Swiss Inc.
• K-Swiss Inc. designs, develops and markets a
  growing array of athletic footwear for high
  performance sports use, fitness activities and
  casual wear. The Company was founded in 1966, by
  two Swiss brothers, who introduced one of the
  first leather tennis shoes in the United States.
  The shoe, the K-Swiss "Classic," has remained
  relatively unchanged from its original design,
  and accounts for a significant portion of the
  Company's sales. The Company sells its products
  in the United States through independent sales
  representatives, primarily to specialty athletic
  footwear stores, pro shops, sporting good stores
  and department stores. K-Swiss also sells its
  products to a number of foreign distributors. The
  Company now has sales offices or distributors
  throughout the world. K-Swisss goal is to
  become retailings most profitable vendor.

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Corporate Overview
Footwear

• The Classic Category - High Performance Tennis
  Shoes (1966)
• Classic Originals
• K-S Collection
• Limited Edition
• High-End Performance
• 7.0 System
• launched in 1997
• Sold in tennis specialty and pro-shops
• Training - To differentiate lines from
  competitors (2000)
• Speed
• moderately priced running shoes
• Strength
• moderately priced cross-training shoes
• Endurance
• trail running shoes

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Corporate Overview
Apparel and Accessories

• K-Swiss branded apparel and accessories
• Designed with the same classic strategies used in
  the footwear line
• Appeal to a variety of new markets from an urban
  distribution to an upscale suburban consumer
• New 7.0 line of high tech tennis apparel (1999)
• Complement its performance 7.0 footwear (Men
  Women)
• The product line consists of
• skirts
• shorts
• tops
• dresses
• warm-ups
• Collection for the casual athletic consumer
• tee shirts
• caps
• socks
• bags

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Corporate Overview
Competitors

• Domestic
• Nike
• Adidas
• International
• Nike
• Adidas
• Reebok

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SWOT Analysis

• K-Swiss
• Strengths
• Focused distribution and allocation strategy
• Senior management team has almost 16 years of
  experience in the industry
• President, Mr. Nichols, has been at the helm
  since he led the company's buyout in December
  1986
• Significant operating leverage from a low fixed -
  cost structure, resulting from efficient
  distribution and administrative operations
• Strong financial position - at the end of 4Q01,
  K-Swiss had 61.6 million in cash on its balance
  sheet with essentially no debt
• Weaknesses
• International revenue only comprised 15 of 2001
  total revenue
• Potential income loss due to a delay in starting
  the 2002 advertising campaign compared with that
  of 2001
• Expected decrease in gross margins and increase
  in expenses due to investments in National
  Geographic and Royal Elastic Brands
• Opportunities
• International markets present an attractive
  opportunity, and are performing well -
  international revenue increased 55.5 to 6.5
  million
• Beginning to see increased sales in some key
  markets - Asia, Europe (Classic 1 shoe in Japan)
• Joint venture with Rugged Shark to license,
  produce and market a men's, women's and
  children's collection of National Geographic
  casual footwear
• Acquired the rights and business of Australian
  designer and manufacturer, Royal Elastics
  (elasticated footwear)

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K-Swiss Analysis
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K-Swiss Analysis
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K-Swiss Ratio Comparison
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K-Swiss Insider Transactions
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K-Swiss Insider Activity
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K-Swiss Institutional Ownership
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Re-Cap

• Recommend buy SHFL and KSWS
• Watch KDE for future investment