DSW Report

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells Equity Research | November 5, 2015 | NYSE: DSW

NASDAQ: DSW

Current Price: $21

Recommendation:

BUY Key Statistics 2015:

Intrinsic Value: $28.66

Market cap: 2.21B

Implied Return: 36%

Company Profile: Designer Shoe Warehouse (DSW) offers a range of branded and designer dress, casual and athletic footwear and accessories for women and men through DSW stores and dsw.com. It also offers kids' shoes exclusively on dsw.com.

Price Performance: One&Year&Price&Performance&

Sector: Consumer Discretionary Industry: Apparel Stores

Target Price: $35

DSW&

S&P&500&

30.00%& 25.00%& 20.00%&

52 week high: $39.58 52 week low: $23.61 PEG: 1.66 P/E: 13.25 P/S: .84 EV/EBITDA: 5.72 P/B: 2.1 Beta: 1.02 ROA: 11.25% ROE: 16.08%

15.00%& 10.00%& 5.00%& 0.00%& !5.00%& !10.00%& !15.00%& !20.00%& 10/30/14&

Risks:

12/30/14&

2/28/15&

4/30/15&

6/30/15&

8/31/15&

Investment Thesis:

• Unsuccessful execution of the omnichannel strategy • Fluctuations in prices of raw materials needed for shoes • Inability to maintain strong relationships with its vendors • Uncertain general economic conditions in the U.S. • Weather conditions

• Over reaction due to lower than expected retail sales in recent Retail Sales Reports and lower than expected quarterly results from big names in the shoe industry put downward pressure on industry players, with DSW’s fundamentals remaining the same • Expansion of DSW’s omni-channel strategy will increase top-line growth • Financial stability allows DSW to invest in systems that will enhance its operating efficiency

Catalysts:

Competitive Advantages:

• Online shopping trend • Improving disposable income • Positive outlook on athletic shoe category

• • • •

Loyalty program & marketing strategies that drive customer traffic Affiliate Business Group Vast brand offerings Strategic Positioning of Stores

Recommendation: BUY

Investment Thesis Breakdown Shoe Industry:

Omni-channel Expansion:

Disappointing retail sales in June and September due to slowing job growth and overseas turbulence that curbed discretionary spending created downward pressure on the overall retail industry. DSW's stock dropped among its peers because of the conditions.

DSW is expanding its omni-channel strategy, which will result in previously store-only products to be also available online and in the recently launched DSW mobile app. This will respond to the trending customer preference of shopping online by expanding the channels from which customers can purchase from DSW. The options to Buy Online, Pick-up InStore and Buy Online, Ship To Store will be implemented in the fourth quarter of 2015, which will expedite in-store pickup for online sales. Furthermore, DSW's has turned all of its 449 stores into mini-distribution centers capable of fulfilling demand that is originated elsewhere, which allows customers to purchase shoes from a shop other than from where the customer originally demanded the item.

Weather conditions also adversely affected sales of DSW and some of its industry peers in the third quarter of 2015. DSW’s stock dropped further than its competitors even though their revenues were missed for similar reasons. DSW’s fundamentals remain attractive relative to its competitors.

Total$Monthly$Retail$Sales$vs.$DSW$Stock$Price$$ $410,000$ $390,000$ $370,000$ $350,000$ $330,000$ $310,000$ $290,000$

Jul02015$

Jul02014$

Jan02015$

Jul02013$

Jan02014$

Jul02012$

Jan02013$

Jul02011$

Jan02012$

Jul02010$

Total&Monthly&Retail&Sales&

Jan02011$

Jul02009$

Jan02010$

Jul02008$

Jan02009$

Jul02007$

Jan02008$

Jul02006$

Jan02007$

Jul02005$

$250,000$

Jan02006$

$270,000$

$50.00$ $45.00$ $40.00$ $35.00$ $30.00$ $25.00$ $20.00$ $15.00$ $10.00$ $5.00$ $0.00$

DSW's omnichannel has been proven successful with it trending to well over $100 million in sales this year. Its omni-channel customers spend two to three times more than its single channel customers, with its mobile app playing an important role in converting single channel customers. Mobile traffic has grown rapidly over the last two years and now accounts for over 40% of online traffic.

DSW&Stock&Price&

Financial Stability: With healthy cash flows, DSW has had and will continue to have the capability of investing in systems that will enhance its operating efficiency in areas such as its supply chain, merchandise planning and allocation, inventory management, distribution and labor management.

DSW has implemented an order routing fulfillment optimization for all its product categories. This proprietary technology is designed to reduce markdowns by fulfilling orders from the slowest turning locations. It has also completed investments in its supply chain to support size replenishment and size optimization. Size replenishment focuses on replenishing core styles at a size level; size optimization allows it to effectively allocate sizes by store. All categories will be planned using an enterprisewide assortment planning system that will allow it to build assortments based on local customer profiles rather than just based on store volume.

During fiscal 2014, DSW had invested in the installation of a new shipping sorter in its distribution center. This new shipping sorter improved productivity and increased shipping capacity within its fulfillment center. Its fulfillment center processes orders, which are shipped directly to customers using a logistics provider. Its ship from store program enables it to fulfill unmet demand originating from either dsw.com or DSW stores from inventory that is located in other stores rather than only from its inventory in the fulfillment center or the customer’s home store.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

2

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Recommendation: BUY

Risks Unsuccessful execution of the omni-channel strategy:

Uncertain general economic conditions in the U.S.:

DSW’s management is positioning the company as an omni-channel retailer and is expected to make significant capital investments and have significant expenses related to this strategy. The failure or inability to execute the omnichannel strategy would materially adverse the business, financial and operating results, and how customer expectations are met.

Decreases in disposable income and in the consumer confidence index, weak demand for apparel in the retail sales report and increasing unemployment rate can adversely affect sales and the financial performance of the company.

Inability to maintain strong relationships with its vendors: Weather conditions affecting seasonal sales: Changes in weather patterns affect consumer preferences, therefore if the store orders seasonal products in bulk that do not meet weather conditions, it could face inventory write downs that would adversely affect revenue and margins.

DSW relies on its strong relationships with vendors to purchase brand name and designer merchandise at favorable prices. If these relationships are damaged, DSW may not be able to obtain a significant merchandise at attractive prices, which would adversely affect the business and financial performance. However, since its beginnings DSW has been able to successfully maintain and create new strong relationships with its vendors, therefore we do not see this risk materializing.

Competitive Advantages Loyalty Program & Marketing Strategies: DSW Rewards is a customer loyalty program that the company relies on to drive customer traffic, sales and loyalty. DSW Rewards members earn reward certificates that offer discounts on future purchases. In both fiscal 2013 and 2014, shoppers in the loyalty program generated approximately 90% of DSW sales. As of January 31, 2015, approximately 23 million members were enrolled in DSW Rewards and have made at least one purchase over the course of the last two fiscal years, compared to approximately 22 million members as of February 1, 2014.The loyalty program gives Loyalty#program#customers# consumers an incentive to come back to DSW rather than competitors due to the fact they will be 25# earning loyalty points and receiving discounts.

23# DSW is able to use data from the loyalty program to 21# inform shopping behaviors and trends, and that allows the company to tailor its experience to how 19# Loyalty#program# customers are already behaving. customers# 17# DSW’s new digital marketing strategies drove sales 15# for the second quarter of 2015. It uses advanced analytics to deliver targeted messages throughout 13# the customer journey. It does so through on-site 2010# 2011# 2012# 2013# 2014# 2015# search technology, email strategy, and digital media targeting which results in increased customer engagement and incremental sales.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

3

Recommendation: BUY

Competitive Advantages Continued Affiliate Business Group: DSW has revenue sharing licensing agreements through its Affiliate Business Group (ABG) with Steinmart, Gordmans, Yellow Box and Frugal Fannie.

DSW is able to leverage the store space of 370 additional locations and E-commerce channels through ABG contributing 5.8% of revenue over the past three years while not having to add the fixed costs associated with these locations.

Shoe%sales%as%%%of%revenue%% Vast Brand Offerings:

91%$ 79%$ DSW$ TJX$$ 57%$

JCP$ ROST$ 38%$

M$ AMZN$ FL$

8%$

13%$ 6.30%$

DSW stores and dsw.com sell a large assortment of betterbranded and private label merchandise. Its products at each store are geared toward the particular demographics of the location. A typical DSW store carries approximately 24,000 pairs of shoes in approximately 2,000 styles compared to a significantly smaller product offering at typical department stores. A wide product portfolio enables DSW to cater to various customer needs and broaden its market coverage, which, in turn, increases the company's top-line growth.

Strategic Positioning of Stores:

DSW opens stores in high traffic areas, such as strip centers and malls that attract more consumers into the stores. It also plans to reposition existing stores as opportunities arise.

States&with&20+&Store&Count& 41# 37# 33#

California# Texas#

27# 22#

As shown on the graph to the right, DSW opens stores in the six states with the most popular cities such as New York, Houston, Austin, Tampa, Miami, and San Francisco to name a few.

Equity Research | November 5, 2015 | NYSE: DSW

21#

New#York# Florida# Illinois# Pennsylvania#

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

4

Recommendation: BUY

Suppliers & Demographics DSW purchases merchandise in bulk directly from approximately 430 domestic and foreign vendors that provide a discount for DSW that are passed onto the customers. Its vendors include suppliers who either manufacture its own merchandise, supply merchandise manufactured by others, or both. Most of its domestic vendors import a large portion of their Commodity"price"for"rubber"&"leather" merchandise from abroad.

300" 250" 200" 150"

Rubber" Leather"

100"

Jul*15"

Jan*15"

Apr*15"

Jul*14"

Oct*14"

Jan*14"

Apr*14"

Jul*13"

Oct*13"

Apr*13"

Jan*13"

Jul*12"

Oct*12"

Jan*12"

Apr*12"

Jul*11"

Oct*11"

Jan*11"

0"

Apr*11"

50" Oct*10"

If prices of raw materials increase, specifically leather and rubber, its suppliers will pass the increase onto DSW, which will in turn pass it onto its customers and could lose revenues due to price increases. However, according to the graph shown on the right rubber is increasing and leather is decreasing, therefore keeping cost constant. This is expected to remain constant in the successive years.

DSW’s customers include middle class consumers with 28% of customers having income ranging from $30,000-$60,000 and 31% having income above $60,000. With the economy continuing to show improvement, DSW’s growth will increase with consumers willing to spend more money on shoes.

Because DSW target customers are middle class consumers, it will perform better with an improving economy.

Industry Drivers Relying on consumer spending, the shoe industry will benefit from increased consumer spending over the next five years with consumers using multi-channel avenues such as online retail and mobile applications. A greater number of Americans returning to work, combined with improved home ownership conditions, will increase consumer confidence leading to increased discretionary spending. Shoe store sales are expected to grow by approximately 2.7% CAGR in the next five years as per capita disposable income growth is projected to peak in 2015 and then slow at a modest pace in successive years.

Per&capita&disposable&income& Per&capita&disposable&income& 3.00%& 2.00%& 1.00%& 0.00%& !1.00%& !2.00%& !3.00%& 2010&

2011&

2012&

2013&

2014&

2015&

2016&

2017&

2018&

2019&

2020&

One of the fastest growing trends in the apparel sector is athleisure, where additional growth in sales is expected. There is a growing proportion of the population participating in sports, thus athletic shoe wear is likely to be purchased for style and function to wear whether the consumer is exercising or relaxing.

The shoe store industry is in the mature stage of the business cycle described as having tight profit margins, growth in sales slower than GDP growth, and high competition placing downward pressure on prices. Increases in revenue will come from increasing store counts in underserved markets and opening up more shopping channels that are convenient for the customer, such as online stores.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

5

 

Recommendation: BUY

Competitors Finish Line (FINL):

Shoe Carnival (SCVL):

The Finish Line, Inc. is a mall-based specialty retailer of branded athletic footwear, apparel and accessories. Finish Line operates in the US and the District of Columbia.

Shoe Carnival is a family footwear retailer. The company's stores offer dress, casual shoes, sandals, boots and athletic footwear for men, women and children with a selection of both name brand and private label merchandise. Shoe Carnival primarily operates in the US, where it is headquartered in Evansville, Indiana.

Demographics: Middle to high level income athletic people who practice sports. High quality, known brand items.

Genesco Partners (GCO): Based in Nashville, Tennessee, is a specialty retailer of branded footwear, licensed and branded headwear, as well as a wholesaler of branded footwear. Genesco also designs, sources, markets and distributes footwear.

Genesco is represented by more than 2,225 retail stores in the United States, Canada, and Puerto Rico and is composed of five main business segments; Journeys Group, Hat World/Lids Group, Underground Stations Group, Johnston & Murphy, and the licensed brands, consisting mainly of the Dockers Brand.

Demographics: Relatively young consumers (20-35 years of age).

J.C. Penney Inc. (JCP):

J.C. Penney Company, Inc. is one of the leading retailers in the US. The company offers a range of family apparel and footwear, accessories, jewelry, beauty products, and home furnishings through a chain of department stores and the e-commerce website jcp.com. JC Penney is the holding company whose principal operating subsidiary is J. C. Penney Corporation. J.C. Penney primarily operates in the US.

Equity Research | November 5, 2015 | NYSE: DSW

Demographics: Moderate income, value conscious families.

Foot Locker Inc. (FL): Foot Locker, Inc. is a retailer of athletic footwear and apparel. The company operates 3,473 athletic stores under various brand names, including Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, Footaction and SIX:02. Foot Locker has presence in 23 countries. It is headquartered in New York City, New York.

Demographics: FootAction stores target urban customers who are more brand and trend-conscious while Champs Sports target sports enthusiasts with a broad array of footwear and sporting goods equipment.

Ross Stores Inc. (ROST): Ross Stores is an off-price retailer of apparel and home accessories. It sells products from other seasons at a marked down price. Ross Stores is an off-price retailer that purchases unwanted inventory from name-brand manufacturers, department stores, and other retailers at an opportunistically low price. ROST then sells them at heavy discounts off the regular retail price. Carries more popular brands.

Demographics: Price-conscious middle class consumers and consumers from the lower-income brackets.

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

6

Recommendation: BUY

Competitors Continued Competitor Analysis:

Market&Share&&

Throughout 2015, DSW’s and its competitors, such as Shoe Carnival, Finish Line, and Genesco stock prices declined because of missed expectations in revenue. Unfavorable weather was a common factor for less-thanexpected sales of winter shoes for fiscal 2015.

5.50%&

7.30%&

5.80%&

DSW& Finish&Line&

4.70%&

Shoe&Carnival& Genesco&

14.50%&

Foot&Locker&

2.66%&

Payless&& • Shoe Carnival missed on revenues in both 2.40%& first and second quarters and had its Brown&Shoe&Company& guidance revised downwards.

• Finish Line, on the other hand, beat revenues and earnings in the first quarter but missed on revenues in the second quarter due to a deceleration in same-store sales.

• Genesco missed on its revenues and earnings in the first quarter of the year and revised its full-year guidance downwards also due to a pressure from a stronger U.S. dollar that the company expects to negatively affect earnings by $0.08.

Ratios Against Competitors

Inventory)Turnover) 5" 4.5"

DSW)

4"

Finish)Line)

3.5"

Shoe)Carnival)

3"

Foot)Locker) Genesco)

2.5" 2"

2011"

2012"

2013"

2014"

2015"

Historical*P/E*Ra/os*0*Compe/tors* 30" 25" DSW"

20"

Finish"Line"

15"

Shoe"Carnival"

10"

Foot"Locker" Genesco"

5" 0" 2011"

2012"

2013"

2014"

2015"

Forward""

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

7

Recommendation: BUY

Business Model The DSW Business Model has recently switched to become customer-centric. All shoe inventory is strategically placed on the sales floor to invite customers to try each shoe at his or her own pace. With all the inventory on display, customers are welcomed to more tailored shopping experiences without sales pressure from employees and without prolonged waiting times. The store continues to deliver everyday low prices instead of fluctuating between regular and sales pricings.

Its stores are also mini-distribution centers capable of product deliveries. In cases where inventory is unavailable, orders are directed for fulfillment from nearby locations. What differentiates DSW from other retailers is its ability to understand meeting demand generated across the board, regardless of fulfilling orders from the same store.

Orders are taken from the mini-distribution channels and consolidated between stores and from dot.com, making DSW more flexible to gratify its customer needs.

Furthermore, DSW strives to place the correct shoes in their correspondingly labeled boxes to avoid confusion and inventory replenishment errors. DSW’s “size by store” model optimizes inventory along with SAS data analytics. SAS automatically recommends the most requested styles and sizes per individual location to optimize inventory to meet demands. The result is a reduction in obsolete inventory which would need to be sold at a discount at season end, thus preventing loss of sales from stock-outs.

Revenue growth this quarter and general comparable store sales as well as the omni-channel sales are benefitting from this switch in processes. The store is highly benefitting from the implementation of its omni-channel where customers can browse, compare, and order products from their smartphones in the DSW app, online from the website, and even from sales personnel at in-store locations with timeliness, ease, and organization. Plus, the opening of multiple small store concepts is improving from significantly smaller box sizes, thus presenting additional growth opportunity for markets where only small stores can be placed.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

8

 

Recommendation: BUY

Valuation EV/EBITDA Valuation:

Multiple valuation methods were used to arrive at a target price for 2020. The first model used is an EV/EBITDA multiple model. DSW currently trades at an EV/EBITDA multiple below its five-year historical average. Its five-year historical average EV/ EBITDA multiple is 7.81 times (see appendices page #17). We expanded the multiple over our investment horizon due to its improved omni-strategy that will increase revenues. At 7.6 times EBITDA, DSW will have a market cap of over $2.9 billion and an equity value per share of $35.83.

EV/EBITDA Sensitivity Analysis: We conducted a sensitivity analysis on the multiple to account for the improving efforts of its marketing strategy to help drive customer traffic to increase revenues.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

9

Recommendation: BUY

Price/Earnings Valuation:

A P/E model was also conducted to help obtain a price target for 2020. We modeled for P/E expansion. The historical P/E multiple for the last five years is 17.51 (see appendices page #17). During our investment horizon, DSW’s P/E will expand to a multiple of 17.42. DSW’s P/E multiple will continue to expand as the economy continues to improve and consumers spend more of their disposable income on shoes. DSW will take market share away from its competitors as it continues to improve its omni-channel and marketing strategies to obtain customers.

Price/Earnings Sensitivity Analysis:

A sensitivity analysis was also conducted to reflect what the firm’s price target could be at different multiples during 2020. The bear case assumes the P/E expands to only 16.42 and DSW’s 2020 EPS is $1.69. Yielding a 5.78% annualized return. The bull case assumes the P/E expands to 18.42 and DSW’s 2020 EPS is $2.19. Yielding a 13.99% annualized return. According to all of our multiples, there is still strong upside with very little downside risks at DSW’s current price. This supports our recommendation of a strong buy on DSW.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

10

Recommendation: BUY

Free Cash Flow to Equity Valuation:

We used a free cash flow to equity model to value what DSW is worth today. Our model implies that the stock is 36.47% undervalued on our base case scenario. The model has implied assumptions based on our expectations of the firm, its competitors, and the industry landscape.

* Top line growth will increase with higher number of members joining the customer loyalty program and by improvements in the omni-channel strategy * Capital expenditures will increase at a moderate rate due to the firm’s plan on increasing its store count in future years to come * Using a 60-month regression, we arrived to a beta of 1.3 that was used in calculating the discount rate. Since shoes are relativity inelastic, we believe this to be in line with our assumption.

Free Cash Flow to Equity Sensitivity Analysis:

We also conducted a scenario analysis by changing the discount rate and terminal price to account for the possibility of unsuccessful execution of the omni-channel strategy, fluctuations in prices of raw materials needed for shoes, and uncertain general economic conditions.

The bear case implies that DSW is 27.97% undervalued, whereas our bull case implies that DSW is 45.26% undervalued.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

11

 

Recommendation: BUY

Appendices

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

12

 

Recommendation: BUY

Appendices Continued

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

13

 

Recommendation: BUY

Appendices Continued

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

14

 

Recommendation: BUY

Appendices Continued

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

15

Recommendation: BUY

Appendices Continued Management:

Chief Executive Officer- Michael R. MacDonald Mike MacDonald’s annual compensation has been consistent with company performance over the past year. He has been the CEO and President of DSW Inc. since April 27, 2009.

Mr. MacDonald has over 30 years of business experience in all phases of retail, including managing merchandising, marketing, stores, operations and finance functions. He has served as a CEO, CFO, President and COO, CAO, as well as a Senior VP and Chairman of varying retail and department stores such as Sacks, Marshall Field & co, Northern Department Stores Group and ShopKo Stores Operating Co in addition to Carson Pirie Scott & Co, Dayton Hudson Department Stores, and Boston Store and Younkers.

Additionally, he has been an Independent Director of Ulta Salon, Cosmetics & Fragrance, Inc. The average tenure of the DSW management team is approximately 4.6 years in length, which is about average. The average tenure of the DSW board of directors is roughly 8.3 years long. The length of tenure is also average. In the past month, more shares have been bought than sold by DSW management and board of directors with only one seller in the past three months while 501,750 shares were bought. Currently the company Insiders own 18.8% of DSW Inc.

Executive Vice President and Chief Executive Officer Successor- Roger Rawlins Mr. Rawlins has extensive retail leadership experience including nearly a decade of experience with DSW. Prior to his current role, Mr. Rawlins served as Executive Vice President, Omni Channel, Senior Vice President and General Manager of DSW.com and Vice President, Finance and Controller. Prior to joining DSW in 2006, Mr. Rawlins served in leadership positions at HER Real Living and L Brands Inc.

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

16

Recommendation: BUY

Appendices Continued

Historical#PE#Mul7ple# 35.00# 30.00# 25.00#

Historical#PE#Mul7ple#

20.00# 15.00#

Linear#(Historical#PE# Mul7ple)#

10.00# 5.00# 0.00# 2/1/10#

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Historial#EV/EBITDA#Mul;ple# 15.00# 10.00#

Historial#EV/EBITDA#Mul;ple#

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Linear#(Historial#EV/EBITDA# Mul;ple)#

2/ 1/ 10 # 2/ 1/ 11 # 2/ 1/ 12 # 2/ 1/ 13 # 2/ 1/ 14 # 2/ 1/ 15 #

0.00#

Equity Research | November 5, 2015 | NYSE: DSW

Analysts: Hailey Davis, Isabella Duarte, Brandon Moore, Bridget Parsells

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