As we step into the second half of 2023, it’s clear that Rocky Brands (NASDAQ: RCKY) has faced some challenges. I’ve been closely monitoring the company’s performance, and there are a few key observations that I’d like to share. While the stock’s value might seem tempting due to its low multiples, I remain cautious about its prospects moving forward. Here’s why.

**An Unsettling Quarter**

The company’s financial report for the second quarter of 2023 revealed a revenue drop of 38.4% compared to the previous year. Notably, the wholesale segment took a major hit with a staggering 46% decline in revenue, while the retail segment also faced a 3.6% drop. This shift in revenue composition is worth noting – the retail segment’s contribution has risen from 16.1% in Q2 2022 to 25.1% in Q2 2023, indicating a changing landscape.

**Challenges Ahead**

I see some formidable headwinds on the horizon. Pressure on revenue growth and operating margins appears to be an ongoing trend, and I anticipate this trend will persist in the coming quarters. This is primarily due to macroeconomic challenges and the burden of high inventory levels at the company’s partner firms.

**Wholesale Woes**

The significant decline in the wholesale segment’s revenue could potentially cast a shadow on the company’s overall operating profitability. The scale of the business is decreasing, and with a considerable portion of operating expenses being fixed – including logistics, rent, and wages – the ripple effects of this slump in the wholesale segment are concerning. Without substantial growth drivers or catalysts in sight, the outlook remains uncertain.

**Company Snapshot**

For those unfamiliar with Rocky Brands, the company specializes in designing, manufacturing, and selling clothing and footwear for both men and women. Its primary sales channels are wholesale, which constitutes 72% of revenue, and retail, accounting for 25% of revenue. The company is renowned for brands such as Muck, Servus, XTRATUF, Ranger, and Georgia Boot.

**Earnings Review**

The second quarter’s earnings report pointed to an increase in gross profit margin, from 33.2% in Q2 2022 to 37.6% in Q2 2023. This boost was driven by improved margins in the wholesale segment due to higher product prices. However, operating expenses as a percentage of revenue increased from 29.7% in Q2 2022 to 35.4% in Q2 2023, resulting in a decline in operating margin from 3.5% to 2.2%.

**Forecast and Concerns**

Management’s projections indicate a 23.6% YoY decline in revenue for 2023, with some anticipated improvement in the later quarters. However, I remain skeptical about the trading trends. The slow start in early orders did pick up momentum as the quarter progressed, but a full recovery in consumer spending seems distant. The potential delay in destocking at partner companies also raises concerns about future growth.

**A Balanced Perspective on Valuation**

While it might be tempting to base investment decisions solely on a relatively low valuation, it’s important to consider the broader context. Despite trading at 25% and 22% below sector medians on P/E and EV/EBITDA multiples, respectively, the company’s valuation isn’t exceptionally low. This is justified by the rapid revenue decline, the company’s size, and its relatively low profitability. Additionally, when comparing to the 5-year average, the company still trades above it by 1% on P/E and 3% on EV/EBITDA.

**In Conclusion: A Prudent Approach**

Taking everything into account, I don’t foresee a swift turnaround for Rocky Brands in the near future. With revenue challenges persisting and operating margins under strain, coupled with the absence of compelling growth catalysts, I am inclined to recommend a cautious stance. While management’s efforts to normalize partner companies’ inventory levels are commendable, it’s not yet convincing enough to overshadow the broader concerns. As the next quarters unfold, I believe it’s wise for investors to exercise patience before making any buy decisions. Given the current landscape, my recommendation leans toward a “Sell” position.