2023-10-16 08:00:00 ET
Summary
- CROX stock is currently on sale at ~7x P/FCF, offering investors a chance to buy the global casual footwear giant at a deeply discounted price.
- In this note, we will analyze Crocs' financial performance and determine its fair value using the TQI Valuation Model.
- I rate Crocs stock a "Strong Buy" in the $80s.
Introduction
By definition, a fundamentally sound business trading below its intrinsic fair value [and/or is relatively cheaper than its peers] is termed a "value" stock.
As an investor, I am primarily focused on finding opportunities with market-beating, long-term risk/reward potential. While most of my published research work is focused on "growth" stocks, I do not consider growth and value investing to be any different from one another.
AzQuotes
For me, investing is all about finding proven businesses with consistent fundamental growth, solid financial strength, and strong future earnings power - trading "at or below" their intrinsic value.
In today's note, I will share research on one of our top "value" stock ideas -
Investment Brief For Crocs Inc ( CROX )
Riding high on the casualization theme, Crocs has turned into a global footwear giant over the last few years. While Crocs' clogs continue to remain divisive due to their appearance, consumers are clearly prioritizing comfort and utility in the post-pandemic world. Since the coronavirus pandemic hit in early 2020, Crocs' revenues have nearly 4x'ed, and the business has turned into an incredible free cash flow machine.
In recent quarters, Crocs' revenue growth has decelerated significantly (down to 11% y/y in Q2 2023, projection of 3-5% y/y growth in Q3 2023), raising fears of a 2008-like collapse at the footwear company, which saw Crocs lose $185M (in 2008) and CROX stock falling from ~$69 to ~$1 per share. Investors are fearful of Crocs being a passing fad, and this is what's being priced into the stock, which is trading at a lowly P/FCF multiple of ~7x [free cash flow yield of 14%+]:
While Crocs' history supports investor caution, I believe Crocs is a fundamentally different company today than it was fifteen years ago. Numerous collaborations with celebrities like Justin Bieber and big brands like Hershey ( HSY ) have enabled Crocs footwear to go from a utility/comfort-driven purchase to a fashionable one. Believe it or not, Crocs' limited-edition drops are a thing now, and there's a significant secondary market for these divisive shoes. And personalization through Crocs' Jibbitz is a unique attraction for Gen Z consumers, who don't really seem to care much about traditional fashion norms.
According to Google Trends data for "Crocs", consumer interest in 2023 looks on par with last year, and remains far higher than pre-COVID levels. Further, consensus Street estimates indicate positive sales growth at Crocs for years to come. When I was in Miami last month with my wife, we visited a Crocs store, and at the time, the store was brimming with customers. Given my personal experience with Crocs and the data in the charts below, I do not see any sort of demand cliff (negative revenue growth) for Crocs here [barring a deep, deep economic recession]. In my view, the fears of Crocs being a COVID fad are way overblown.
Google Trends
In a recent interview with CNN, Andrew Rees, Crocs' CEO, said:
We did absolutely benefit from the pandemic. People were at home, and in my view it accelerated that casualization trend we’ve seen for some time. We've continued that post-pandemic, and we’re seeing very strong growth in the Crocs brand.
This year the Crocs brand will be a little bit shy of $3 billion in annual sales. That is a scaled, global footwear brand, and what scale gives you [is] a large innovation engine. You can afford to innovate; you can afford to try new things and create new materials.
It gives you a large marketing budget so you can constantly engage with young consumers, and it gives you a strong share of shelf with your wholesale partners.
In addition to collaborative innovation and product diversification, Crocs is attempting to drive future growth via international expansion [especially in Asia (Q2 growth of +47% y/y in constant currency)] and improved brand awareness for HEYDUDE. While Crocs is unlikely to grow as rapidly as it has done over the last three years, I think it is more than fair to assume 5-10% CAGR sales growth for the rest of this decade.
Based on relative valuation metrics such as Price-to-Earnings (forward) and Price-to-Free Cash Flow, Crocs currently trades at a deep discount compared to its peers:
Naturally, one would assume that Crocs must be reporting inferior revenue growth and margin performance compared to its peers. However, the truth is starkly different - Crocs is growing faster (or at comparable rates) with best-in-class margin performance among its industry peers:
While Crocs' margin profile has come under pressure since the completion of the HEYDUDE acquisition, strong performance within the Crocs brand has enabled overall margins to improve in recent quarters. In Q2 2023, Crocs' gross margins rose +290 bps to 58.1%, with net income [profit] margin rising to 19.81%.
Crocs Investor Relations
With the business scaling up and margins in expansion mode, Crocs' TTM EBITDA and free cash flow have reached ~$1.1B and $0.75B, respectively.
In 2022, Crocs acquired HEYDUDE for $2.5B using debt , sending its annual interest expense soaring to ~$170M (in a rising interest rate environment). While the debt doesn't come due until 2028, Crocs' management has been utilizing Crocs' strong cash generation to deleverage quickly, and the business is now close to its long-term net leverage target of 1-1.5x.
As of Q2, 2023, Crocs had $166M in cash versus financial debt of $2.03B, i.e., a net debt of $1.86B. While Crocs' liquidity position isn't rock solid due to the lack of a sizeable cash cushion, I currently do not see any imminent liquidity problems as the business is producing tons of free cash flow every quarter.
In fact, Crocs is all set to resume its stock buyback program in Q3 2023, which still has $1B in authorized capital. At its current valuation, Crocs should be able to eliminate roughly 20% of its outstanding shares over the next 18–24 months if a large majority of free cash flow is returned to shareholders via share buybacks.
From a fundamental standpoint, Crocs is a growing, profitable business that shouldn't be trading at a deep discount to its peers. Now, let's determine Crocs' fair value and expected returns.
CROX Fair Value And Expected Return
Using conservative growth and margin assumptions under a 5-year model, we deduced that the intrinsic value of Crocs' stock is $205, i.e., +142% above the current share price.
TQI Valuation Model (TQIG.org)
Assuming a conservative exit multiple of ~15x P/FCF (lower than peers), I see CROX stock rising from ~$84 to ~$391 by 2028-29. And this 5-year price target implies a CAGR return of ~36% from current levels.
TQI Valuation Model (TQIG.org)
Considering our investment hurdle rate of 15%, I think Crocs' long-term risk/reward is truly asymmetric. While investing in the consumer discretionary sector has been a painful exercise in recent months, Crocs is getting too attractive to ignore. At ~7x P/FCF (~9.5x EV/FCF), Crocs is likely a no-brainer buy!
Risks
As with all equity investments, Crocs carries some risks. Here are some of the major risks associated with CROX:
- According to leading economic indicators, the US economy is headed for a hard landing (recession). In such an environment, consumer spending on discretionary items such as footwear will likely contract, hurting Crocs' sales (and profits) in the process.
- As we saw in this note, Crocs' financial positioning isn't rock solid, and soaring interest rates will lead to higher interest expenses and lower profitability.
- Crocs' future growth is heavily reliant on international expansion, and the company could fail to gain popularity in foreign markets as it has done in its domestic market here in the US.
- Although it's a very low probability, Crocs could turn out to be a COVID fad that loses prominence as the world normalizes further in upcoming years.
- Amid a broad equity market decline, the ongoing pullback in CROX stock could deepen in the near future, with the stock sitting well below its 50-day and 200-day moving averages (bearish technical setup).
Concluding Thoughts: Crocs is On Sale, Buy While Supplies Last
Crocs, Inc. is a global, digital-focused casual footwear company that houses growing, highly profitable brands - Crocs and HEYDUDE. While Crocs' comfortable clogs remain central to the story, Crocs has diversified its product offerings for men, women, and children, combining style and comfort with a value that consumers love about Crocs.
The post-pandemic normalization is hitting Crocs' sales growth rate, which is set to hit low single digits this quarter; however, the casualization theme is unlikely to fade away anytime soon as indicated by Crocs' financial performance and trend data.
At ~7x P/FCF (14%+ FCF yield), Crocs is trading at a deep, deep discount to its fair value of ~$205 per share. Despite reporting best-in-class revenue growth and margins, Crocs finds itself as an outlier among industry peers. In our view, CROX is an incredible value play!
Key Takeaway: I rate CROX a "Strong Buy" in the $80s
Thanks for reading, and happy investing! Please share your thoughts, questions, and/or concerns in the comments section below.
Editor's Note : This article was submitted as part of Seeking Alpha's Best Value Idea investment competition , which runs through October 25. With cash prizes, this competition -- open to all contributors -- is one you don't want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!
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Crocs Stock: A Textbook Value Play