SHOO - Crocs: Undervalued With Strong Near-Term Catalysts

Summary

• CROX is undervalued compared to historical multiples and other publicly traded footwear companies.
• It has implemented an exceptional turnaround since 2018 and boasts of industry leading margins that have resulted in strong cash generation and record EPS.
• The HEYDUDE acquisition is showing signs of early success with plans to grow the brand in the US and internationally in 2023.
• Record spending on marketing for the Crocs brand, as well as a focus on the sandals category and international markets will boost sales.
• The resumption of share repurchases once debt levels come down to desirable levels in mid-2023 is a potent catalyst to watch out for.

Crocs Inc ( CROX ) is a compelling case study of what a successful business turnaround should look like. The footwear company’s revenues stagnated in the $1.0 - $1.1 billion range between 2013 and 2017 amid over diversified product lines, a high cost base and negative EPS. However, after the current CEO Andrew Rees took up the reins in 2017, CROX rationalized its product portfolio, grew its revenues, expanded its margins, and significantly improved its profitability.

The results speak for themselves. CROX’s revenues have steadily increased from $1.08 billion in 2018, to $1.23 billion in 2019, $1.38 billion in 2020 and $2.31 billion 2021. In 2022, it completed the largest merger in its history after paying $2.5 billion for HEYDUDE, a casual footwear brand with a growing presence in the US. This acquisition helped supercharge CROX’s 2022 results, with revenues coming in at a record $3.55 billion, EBITDA at $973 million and adjusted EPS at $10.92.

CROX’s gross margins and operating margins during the past year were 52.3% and 23.9% respectively. These industry leading margins have resulted in strong cash generation relative to peers. CROX’s category peers include the likes of Skechers U.S.A., Inc. ( SKX ), Steven Madden, Ltd. ( SHOO ), Deckers Outdoor Corporation ( DECK ) and On Holding AG ( ONON ). The comparison below shows how these peers stack against CROX on profitability, with CROX’s higher operating margins resulting in the highest cash from operations among the group.

CROX’s business turnaround has translated into juicy returns for its stockholders. Over the past five years, the stock is up a mouthwatering 778%. This is an incredible return in light of the events that have shaped this period, such as the coronavirus pandemic, significant freight and inflationary pressures, and CROX’s acquisition of HEYDUDE. Despite its bullish run, I believe CROX could rise significantly higher from current levels in light of its relative undervaluation and the fact that it will likely benefit from several near-term catalysts.

HEYDUDE’s expansion

The first notable catalyst is the company’s 2023 plans to expand HEYDUDE in the US and internationally, starting in Europe. In 2022, the legacy Crocs brand accounted for 75% of total revenues while HEYDUDE was 25%, as per the company’s Q4 earnings presentation .

The plan for 2023, according to management’s remarks at the latest earnings call, is to grow HEYDUDE’s contribution by building on the momentum the brand has garnered in recent years. It's worth pointing out that prior to the acquisition, HEYDUDE was already on an impressive growth trajectory. It booked sales of $191 million in 2020 and $580 million in 2021. In 2022 following the acquisition, revenues grew to $960 while its EBITDA margins were above 30%. Management is aiming for an annualized growth rate of 20% through 2026.

At the moment, brand awareness for HEYDUDE is at about 20% in the US, where more than 90% of its sales come from. This leaves room for significant future growth in the US. CROX disclosed in its 10-K that it is exploring new distribution opportunities in the West Coast in Las Vegas. “We have also entered into a lease not yet commenced for a new HEYDUDE distribution center in Las Vegas, Nevada, to expand our distribution capabilities of the HEYDUDE Brand.” reads the 10-K in part. The company also disclosed that as part of its efforts to increase HEYDUDE’s international presence, it will venture into Europe this year.

HEYDUDE’s expansion in the US and internationally will not only drive top line growth, but also help maintain healthy margins. In Q4, HEYDUDE’s adjusted gross margin was 47.2% while adjusted operating margin was 27.7%. These are well above industry averages, when you look at comparable metrics for peers like SKX, SHOO or DECK. HEYDUDE’s success could therefore help push CROX stock higher as investors price in the impact that the brand’s revenue growth will have on EPS and cash.

Record marketing investments for legacy brand

Another near-term catalyst for CROX is the record marketing investments for Crocs, its legacy brand. “We will invest a record amount of marketing dollars over $200 million to drive the Crocs brand relevance, amplifying our products and engaging new and existing consumers. This will be achieved by maintaining our digitally led and social first approach to engage consumers through digital first drops, social innovation and brand ambassadors,” noted CEO Andrew Rees on the latest earnings call.

Assuming these plans are well executed, the return could be well worth it in terms of creating shareholder value. CROX’s high margins will work in investors favor if the marketing investments pays off as it will be able to generate strong cash on the back of continued sales growth.

Importantly, CROX is approaching the growth of Crocs’ brand in multiple ways. It's not only looking at increasing marketing spend, but also expanding fast growing product lines and doubling down on its international markets, particularly Asia where economics and demographics provide powerful tailwinds. Presently, the largest category for the Crocs brand is clogs, accounting for 57% of the product portfolio. The company is, however, looking at growing the Crocs brand in the sandals category, which is presently a $310 million business. The aim is to grow this to approximately $400 million in sales in 2023.

Resumption of share repurchases

The final near-term catalyst is the possible resumption of share repurchases in mid-2023. Share repurchases were put on hold after the HEYDUDE acquisition, which was partly funded by debt. CROX’s long-term debt has as a result increased from $180 million in 2020, to $771.4 million in 2021 and $2.29 billion in 2022.

The management team has been categorical that when it comes to capital allocation paying down this debt using cash from operations (and not stock issuances) is its top priority. The objective is to get gross debt to adjusted EBITDA to below 2x, with plans to resume buybacks at around 1.5x. The timing for the attainment of this goal that has been previously shared by the management team is mid-2023. Buybacks reduce outstanding shares and therefore boost EPS, meaning CROX could see accelerated EPS growth in the next 2 - 4 years assuming it resumes share repurchases within the timeline it committed to.

Undervalued buy

CROX could continue on its multi-year bullish uptrend in view of its relative undervaluation and the possibility of strong EPS growth fueled by buybacks, revenue growth and high margins.

CROX has a P/E (fwd) of 12.32x compared with 14.58x for SKX, 98.96x for ONON and 21.92x for DECK. Its EV/EBITDA (fwd) of 9.20x is also the lowest in its peer set. Historically, its 5 year average P/E is 17.83x and its 5 year average EV/EBITDA is 13.69x, indicating that it has gotten cheaper despite significant earnings growth. The stock is still an undervalued buy despite strong gains in recent years and I am firmly in the bullish camp on this one.

The risks to the bullish thesis in the short-term is weaker consumer spending as a result of high interest rates and possible recession slowing revenue growth in 2023. Longer-term, competition could be more intense than anticipated, particularly for HEYDUDE which in my view has a less defensible position than the legacy Crocs brand. The cyclical nature of fashion could also explain the seemingly low valuation as investors may be discounting risks associated with unpredictable consumer preferences. Delays in bringing down debt or resuming buybacks could also sour investor sentiment. Despite these concerns, I continue to add to my long-term position as I believe the current valuation caps the downside risk.

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