Stock Picks: DSW Up; WMG Down

Shares of discount shoe and accessories retailer DSW (DSW) were up 8% on Tuesday in the wake of better-than-expected third-quarter earnings and bargain-hungry consumers.

DSW earned $26.6 million, or 60 cents a share, up from $13.2 million, or 30 cents a share, a year ago. It far surpassed analysts’ expectations that on average were 46 cents a share, according to Thomson Reuters.

The company reported a 14% increase in revenue to $444.6 million, surpassing analysts’ expectations of $424.6 million, and same-store sales increased by 8.7% for the comparable period vs. a decrease of 4.1% last year.

Selling high-end footwear brands at a discounted price is a winning tactic in this environment, says R.J. Hottovy, an equity analyst who covers DSW at Morningstar. “This is continuation of what we’re seeing in retail space; if you offer brands at compelling value, consumers will shop there.”

In addition to higher sales, DSW is benefiting from cost control. During the company’s conference call today, Chief Financial Officer Douglas Probst said that DSW’s occupancy-expense rate decreased as a result of the chain negotiating rent concessions. He also said earnings were boosted by selling more items at the store’s full price rather than at a discount, and by trimmer inventory. By the end of the third quarter, Probst said, inventories were down approximately 10% on a cost-per-square-foot basis, with over half of the decrease coming out of the distribution center.

“We will continue to plan inventories conservatively throughout the fourth quarter and into 2010,” Probst said.

The bottom line: DSW’s earnings are looking bright at least for the short-term while consumers focus on finding value at a lower price. “If consumers are looking at fashion for value – which they’ll continue doing for a while – DSW will remain a compelling case,” says Hottovy. “More brands have consumer appeal and that’s a trend we’ll continue to see.”

Shares of the world’s third-largest music company, the Warner Music Group (WMG), dropped almost 15% on Tuesday as the company reported an unexpected quarterly loss tied to higher operating costs.

WMG, home to music moguls like Jay-Z and Madonna, posted a net loss of $18 million, or 12 cents a share, in its fourth quarter ending Sept. 30, compared with a profit of $6 million, or four cents a share, a year ago. The company’s total costs and expenses ballooned to $807 million during its last quarter, up from $788 million a year ago. In its earnings statement, the company noted that the shrinking demand for CDs and the weak economy hurt its revenue and are likely to affect future results.

“Looking ahead to fiscal year 2010, the volatile global economy and ongoing recorded music industry transition are likely to continue to affect our results,” says Steven Macri, WMG’s executive vice president and chief financial officer. “Given this backdrop, our conservative approach to managing costs and our balance sheet gives us the flexibility to optimize results.”

The company’s revenue grew 0.8% to $861 million from $854 million in the prior year quarter and was up 4.7% on constant-currency basis. This reflects WMG’s key release schedule in the quarter as well as the ongoing economic pressures and transition from physical sales to digital sales in the music industry. International revenue rose 8.8% (or 17.8% on a constant-currency basis), but it was offset by weakness in the U.S. where domestic revenue dropped 7.4%. Meanwhile, digital revenue grew 10.2% over the prior-year quarter to $184 million.

“WMG has made a conscious effort over the past year and a half to eliminate many of its fixed costs in order to mitigate the decline in sales of albums,” says Tuna Amobi, a media and entertainment analyst, who covers WMG at Standard & Poor’s equity research department. That included eliminating some of the marketing costs that related to album sales, and laying off staff that worked on physical album sales while hiring individuals with digital experience.

Going forward, WMG should be in better financial standing in fiscal year 2010, as it benefits from expanded rights deals and shifting to web site, merchandise and tour deals. It should also gain from its strategy of variable pricing of its songs on iTunes, and partnerships with social media outlets including MySpace and YouTube.

The bottom line: WMG remains one of the dominating forces in the music industry, and its ability to offset losses with digital revenue should help keep it afloat for the near term. “The company has been pretty aggressive more than any other major music company to shift its business model and make it more adaptable to the digital age,” says Amobi. “That will help mitigate the decline in CDs and core business that will continue this year.”