SKX - Skechers: Good Near-Term And Long-Term Growth Prospects

2023-09-08 07:12:26 ET

Summary

• Skechers' revenue growth is expected to benefit from increasing demand for comfortable footwear and the recovery of the Domestic Wholesale channel next year.
• The company's sales growth is supported by China's economic reopening, international expansion, and the growing Direct-to-Consumer channel.
• Skechers' margin is expected to grow due to the increasing mix of D2C sales, moderating logistics costs, and sales leverage from increasing volume.

Investment Thesis

Skechers U.S.A., Inc.'s (SKX) revenue growth should benefit from healthy demand for footwear across the globe with increasing mobility post-pandemic. This demand is also supported by the changing consumer preferences towards comfortable footwear and the company's affordable products. Further, the recovery of the Domestic Wholesale channel due to easing comps and good sell-through should also aid the overall revenue growth starting FY24. In addition, China's economic reopening, international expansion, and growing Direct-to-Consumer (D2C) channel should support medium to long-term sales growth.

On the margin front, SKX is expected to benefit from an increasing mix of D2C channels, moderating freight costs and volume leverage. So, I believe the company's near-term as well as long-term growth prospects are sound. This combined with a lower-than-historical valuation makes the company a good buy.

Revenue Analysis and Outlook

In my previous article , I discussed the company's good revenue growth prospects ahead due to healthy end market demand, China reopening, and footprint expansion. Since then, the company has reported its first and second-quarter earnings of 2023, where similar dynamics were seen and the stock price has seen a modest appreciation of ~8%.

In the most recent quarter, the company's revenue continued to benefit from healthy end-market demand for footwear as consumers across the world continued to increase their mobility and traveling. This led to good volume growth in the company's Direct-To-Consumer (D2C) channel. Further, this growth was also aided by an increase in demand in China, post its economic reopening. However, this good growth in the D2C channel was offset by the decline in the Wholesale segment especially the Domestic Wholesale channel due to excess inventory at retailers who are now destocking. This resulted in an overall revenue growth of 7.7% YoY to $2 billion, with a 4.4% YoY decline domestically and a 17.9% YoY increase internationally. On a constant currency basis, sales grew by 9% YoY.

Looking forward, I believe the company should be able to deliver revenue growth as the demand momentum for the company's products remains strong. In addition, China's reopening, and global expansion, should also help the company's sales growth moving forward.

The end market demand for the company's footwear products is good. This strong momentum in demand is well demonstrated by the growth in the Direct to Consumer (D2C) channel, which grew both domestically (up 28.7% Y/Y) and internationally (up 29.5% Y/Y). The demand should remain at healthy levels moving forward as well due to an increase in mobility and outdoor time spending, as daily routines are now slowly reverting to how they were before the pandemic. Moreover, the post-pandemic demand for footwear is showing trends of changing consumer preferences. While many people got used to comfort-centric footwear like sneakers and slippers during lockdowns, there's also a growing demand for more stylish and formal options as people return to offices, social gatherings, and travel.

This shift reflects the hybrid lifestyle emerging after the pandemic, where comfort remains important but style and versatility are also valued. This is an area where Skechers focuses - on stylish, high-quality, and comfortable footwear. Further, Skechers offers competitive pricing compared to its peers, which should sustain the demand for its products even if consumers start seeking more affordable options because of inflation. The company has also increased its advertising and marketing activities to boost brand awareness and capture this opportunity arising from changing consumer preferences. So, increasing mobility, changing consumer preferences, and affordable pricing should keep demand sustained and help sales growth moving forward.

In addition, I believe that the inventory congestion (excess inventory) in the domestic wholesale channel should start to decrease moving forward. In 1H22, domestic retailers, and wholesalers build excess inventory in response to supply chain challenges. This resulted in good order growth in 1H22. However, moving into 2H22, channel partners took action to rightsize their excess inventory through destocking. This continued in the first couple of quarters of 2023 as well. Management anticipates inventory congestion to remain a headwind in 2H23 as well. However, the rate of impact should decrease as compared to previous quarters due to good sell-through and consumer demand, which should give a boost to reorders and help the recovery of the channel.

Moreover, year-over-year comparisons in the second half of 2023 as compared to the first half are also easing for the domestic wholesale channel. This should also help in the recovery of domestic wholesale sales growth. So, as inventory congestion abates after a couple of quarters, I expect the domestic wholesale to resume its contribution to the overall sales growth of the company in 2024, given the good end-market demand.

Furthermore, the company has also started to see sales recovery in China after a three-year-long lockdown. China comprised ~15% of the company's sales in FY22, which was a decline of 500 bps from 2020 and 2021 sales levels due to the pandemic-related disruptions. Now, the country is slowly returning to normalcy and is seeing increasing mobility day by day. This resulted in sales growth of 18.6% YoY in China in the second quarter of 2023. I expect China's sales contribution to continue increasing in the coming quarters.

Lastly, as I mentioned in my previous article , the company's biggest advantage is its global presence, which is helping it protect against region-specific macroeconomic slowdowns. The company is focused on further expanding its global reach and increasing its market share. The company's total store count reached 4705 stores in Q2 2023, reflecting an 8% YoY growth. These new store openings are distributed in every region across the globe, demonstrating the company's growing global presence. The company is also entering new markets to further capture the demand and market share. In Q1 2023, the company opened its first-ever store in Tajikistan. SKX plans to open 90-100 company-owned stores for the balance of the year. This should further increase its global footprint and also help both the wholesale and DTC channels in delivering sales growth.

In line with expanding its international presence, the company also acquired Sports Connection Holdings ApS in the second quarter of 2023. Sports Connection is a distributor and retailer having a strong presence in the Scandinavian countries. This acquisition should help the company further broaden its reach in Europe and gain market share in the Nordic region. So, this growing presence in the international markets should help the company's sales growth in years to come.

In addition to growing its international presence, the company is also focused on growing its D2C channel in order to capture the healthy consumer demand in the channel and to serve the fastest-growing markets. The company is all set to open additional distribution centers in China, India, and Canada by the end of 2023. This should further help the company in serving its D2C channel, which should also support the company's sales growth in the coming years.

Hence, I remain optimistic about the company's near-term as well as long-term sales growth prospects.

Margin Analysis and Outlook

In the second quarter of 2023, the company's margin benefited from an increase in the mix of Direct-To-Consumer sales, which is a higher-margin channel for the company. In addition, price increases and easing supply chain challenges also helped the company's margin growth. This resulted in a 460 bps YoY increase in gross margin to 52.7% and a 250 bps YoY increase in the operating margin.

Looking forward, I expect the company to continue delivering margin growth moving forward. The company's D2C channel has higher margins as compared to the wholesale channel, given the elimination of middleman partners. So, increasing the mix of the D2C channel with growing D2C sales should continue to benefit margins moving forward as well. Moreover, the company is also experiencing meaningful easing of the supply chain challenges, and logistics costs including ocean freight and road freight have moderated as compared to the prior year, which should help the company's margin growth over the coming quarters. Furthermore, I also expect sales leverage from increasing volume and carryover pricing to support the company in growing its margins. Hence, SKX's margin outlook looks positive as well.

Valuation and Conclusion

The company is currently trading at 14.32x based on the FY23 consensus EPS estimate of $3.41 and 11.85x based on the FY24 consensus EPS estimate of $4.13, which is below its 5-year historical average forward P/E of 21.09x. I believe the company has good near-term and long-term revenue and margin growth prospects, benefiting from good consumer demand, international expansion, moderating logistics costs, and a growing D2C channel. So, I have a buy rating on the company given its favorable valuation and encouraging growth prospects.

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