2023-10-19 06:57:56 ET
Summary
- Crocs is a unique brand with strong brand power and potential for sustainable growth.
- Crocs is showing solid growth and boasts high returns on capital.
- The stock's current low price appears to compensate for the associated risks.
- If Crocs is not a trend, then a bargain is in front of us.
- As earnings are approaching, here's what you should be keeping an eye on.
My Thesis
We're all familiar with Crocs' (CROX) financials, and we've all been surprised by its price when we delve into it. Yet, I believe we've all been asking, "Why is it so cheap?"
I think it's because the market is concerned about its brand power. Is it sustainable, or will we see the past repeat itself? I don't believe that's the case nowadays, and I'll explain why through this article. We need to answer the question: Is it a trend, or is it sustainable and secular? Because if it's the latter, it's definitely a bargain.
The Brand
Crocs is all about uniqueness. It's different and may not be everyone's idea of fashion, but it's undeniably a social statement, something not frequently seen in the traditional market. Nowadays, people want to feel special, whether it's through customizing their shoes with Jibbitz or exploring the brand's special collaborations, which we'll discuss later.
In the past, Crocs made significant mistakes that cost them their brand relevance. They lost focus on their core product, and it had a negative impact that took years to recover from. However, I believe that since Andrew Rees took over in 2014, the company has been on a path to outperformance, thanks to several factors.
Smart marketing: Crocs is engaging in aggressive collaborations with other brands and celebrities, making their clogs even more unique and special. Teens love them, and public figures like MrBeast and Post Malone have embraced them. Recent examples include the "Cars" clogs and the "Shrek" clogs.
New products: While staying within their specialty, Crocs has introduced new products, like Crocs sandals, which are expected to contribute to a 30% revenue increase to $400 million in 2023. They are a significant factor in Crocs' double-digit growth in North America.
Global expansion: Crocs is rapidly growing in Asia, with a 47% increase in sales in the trailing twelve months before the last report.
However, I don't think Crocs should pursue more acquisitions like HeyDude. HeyDude is still too new to judge, and they've taken on a significant amount of debt to finance it. Its growth hasn't been very satisfying, with only 3% growth in the last quarter. Perhaps HeyDude's growth will improve in the long term, as direct-to-consumer sales tend to grow faster than wholesale, and the brand is very strong among comfort-seeking customers. It's ranked as the number one casual brand.
What I believe is crucial is diversifying the Crocs brand's product range. There's a concern that clogs may go out of fashion, and the sandals represent a great diversification. However, venturing into clothing or products outside their current landscape might not be the best idea.
Top Line Growth
Crocs is not a new brand; it was founded back in 2002. However, in recent years, it has experienced a resurgence in popularity, almost like a new startup. Over the past five years, they've achieved a remarkable 29% CAGR and a 39% cash flow CAGR, which is truly outstanding. But I'm not counting on this kind of rapid growth to continue as it did in the past. The initial breakout to the market was fast, and the hype was particularly high after the onset of the COVID-19 pandemic.
Now, I believe that future growth will be more in line with today's growth rate, which stands at a solid 12% . I have confidence that they can maintain this rate, especially with their international expansion gaining momentum, the strong performance of the sandals category, and a 20% growth in direct-to-consumer comparable sales. Furthermore, there's potential for the HeyDude brand to regain momentum. Analysts are projecting realistic top-line CAGR numbers of 9% for the next three years. If this growth rate materializes, Crocs still represents a substantial bargain.
Margins
Crocs is a highly profitable company; in fact, it's one of the most profitable, boasting a 15% free cash flow margin. This high margin is of great importance as it provides the management with a margin of safety in case of issues such as inventory mismanagement or an increase in labor costs. Moreover, I believe Crocs has some pricing power. Since the shoes are not expensive to begin with, increasing prices by a certain percentage can significantly improve the margin without adversely impacting demand. In 2022, Crocs raised its average price by 19%, and yet, the Crocs brand (excluding HeyDude) achieved a 15% growth in the last quarter.
Additionally, the combination of price increases, effective inventory management, and overall operational efficiency has led to visible margin growth, creating substantial operating leverage. While the top line has been growing in recent years, the management has successfully decreased inventory levels by 13% year-over-year.
ROC
In addition to revenue growth, in my opinion, one of the most critical factors is returns on capital, as this is ultimately what a company is here for - creating value. Value is truly generated when the returns on capital significantly surpass the cost of capital.
Crocs exhibits high returns on capital employed ((ROCE)) and return on invested capital ((ROIC)), both of which are pivotal metrics for predicting future outperformance. When these parameters appreciate, alongside solid FCF growth, it results in a substantial compounder. And this becomes even more compelling when paired with a low stock price.
Returns To Shareholders
Crocs does not pay dividends, but they engage in share buybacks. This strategy is highly beneficial when the stock is undervalued and beaten down, as it can effectively reduce the number of outstanding shares, thereby enhancing each share's ownership in the company. However, it can be destructive when the stock is overvalued and expensive.
In the case of Crocs, I believe the former situation holds true. The stock appears to be undervalued and experiencing a downturn, making share buybacks a wise and value-enhancing move for the company.
Solvency
Crocs financed the purchase of HEYDUDE with debt, which resulted in a leveraged company. While this isn't an ideal situation, it's worth noting that the management is aware of the situation and is actively allocating capital to reduce this leverage, all while ensuring that growth investments are not adversely affected.
Although the cash on hand ( $166 million ) may not be substantial in comparison to the debt ($2,007 million), Crocs is maintaining key financial ratios in a positive range. The debt-to-equity (D/E) ratio is below 1, the current ratio is above 1, and the Altman Z-score is above three (a score below three is considered risky). While the balance sheet may not be as robust as that of some other companies I've analyzed, I don't see a significant danger here, unless there is a massive drop in free cash flow, which appears unlikely given the company's current performance.
Valuation
Ultimately, investing comes down to the balance between risk and reward. I plan to evaluate this by employing a three-step valuation method: historical multiples, DCF analysis, and straightforward technical analysis. This comprehensive approach will help provide a well-rounded view of the investment opportunity.
An important point to bear in mind is that the historical average is influenced by the Zero Interest Rate Policy ((ZIRP)) era, and a contraction from that average is a likely scenario. However, the company is currently trading at remarkably low multiples, with some metrics down by over 50%. While I may not anticipate a full return to the past multiples given the company's projected future growth, I do expect some degree of multiple expansion.
A 14% free cash flow yield is quite extraordinary for a company with these financials, and a PEG (Price/Earnings to Growth) ratio under 1 is rare in today's market, particularly for a company with such high returns on capital. These metrics suggest that there may be significant value and potential for a favorable risk-reward balance in the investment.
Those low multiples are concerning to me, as they seem to be shouting that I'm overlooking something. Crocs appear to be priced very attractively for a seemingly obvious reason, yet I haven't been able to identify that reason.
DCF
I'll approach the DCF analysis conservatively, given my caution regarding Mr. Market's signals. I will use a 10% FCF growth rate, slightly below the EPS growth analysts project for the next few years. I'll also use a 12% discount rate, which is relatively high, to account for trend uncertainty, and a 2% terminal growth rate. These rather conservative inputs suggest a stock value of $142, indicating a 67% undervaluation!
To justify today's stock price with the discount rate I've applied, the FCF growth would need to be around 4%, which seems highly unlikely. This approach reduces risk and potentially increases rewards for investors.
From a technical analysis perspective, I prefer to invest in companies that are trading near their 200-day moving averages and have low RSI values. Crocs fits this criteria precisely.
Taking into account the three-step analysis process, I see a significant upside potential for Crocs. The current price, in my view, is low enough to offset any concerns or uncertainties surrounding the company.
Risks
Several risks merit consideration:
1. Crocs could be more of a trend than a long-term secular growth story.
2. There's uncertainty regarding whether HEYDUDE will maintain growth or become stagnant.
3. The challenge lies in identifying where future growth will come from as the Asian market matures.
4. The pace of innovation may not fully satisfy customer demands.
5. Solvency may face challenges due to rising interest rates.
6. There's a question about brand relevance in the next five years. Crocs is not in the same league as Nike ( NKE ), so it's hard to guarantee its relevance in the coming years.
Earnings Soon
Crocs is set to report its Q3 earnings on November 2nd. Here's what you should be looking for:
1. Keep an eye on HEYDUDE's growth. We'd like to see this brand showing significant growth, as a mere 3% increase won't suffice.
2. Ensure that Asian growth remains robust and that North America doesn't experience a decline.
3. Check if the sales of sandals continue to exhibit high double-digit growth.
4. Pay attention to the company's deleveraging strategy. Observe how the management is handling its balance sheet.
5. Look out for any announcements of collaborations. We hope to see more high-quality collaborations in the company's future.
Conclusions
Crocs is a well-managed company poised for solid growth and boasts high returns on capital. While there are inherent risks, I believe that the current price adequately compensates for these risks. I foresee potential margin expansion alongside the business's growth.
Consequently, I would rate Crocs as a STRONG BUY.
I do not currently hold any of the company's stocks, but I might consider initiating a position in the near future.
I'm eager to hear your comments and thoughts on this value play. What's your take on it
For further details see:
If It's Not A Trend, Crocs Is A Bargain