Ticker: Skechers (NYSE:SKX)
Rating: Upgrade from Hold to Buy
New Price Target
Old Price Target
New Buy/Sell Range
Skechers is looking like a great Buy after recent weakness and move into our Buy range. The company, we believe, is worth $20 at this time, and the stock is not properly pricing growth potential. Skechers had a rough past two years after the company saw its Shape Ups line lose popularity, and the company was forced to liquidate a lot of inventory at low margins or even a loss. The company, though, has come back in 2012 with a solid new lineup of shoes. One of the main issues for the company during their Shape Ups popularity was that the company saw a very high % of profits/revenue coming from just one line of business.
The trend that we are currently seeing for the company is that they are seeing a better mix of % of sales coming from different parts of their business, and we believe that they will see a solid level of growth resume as they have worked off their toning line. The company has been putting effort on new lines and improving margins. The company's ability to increase margins and increase popularity of new lines is the key to success, and we believe SKX has some definite potential in these areas. Yet, the company has some definite risks that we still need to keep in mind.
The company has set forth a strong plan to increase margins, and they seem to be on the right track. Operating and gross margins have both improved in the TTM over 2011. The company was at -8% operating margin and 29% gross margin. They are operating in the trailing twelve months at -0.6% operating margin and gross margin came in at 44% in the latest quarter. If this trend continues, it will be very solid for SKX.
Additionally, we believe that the company's international expansion will be key to the company's ability to rekindle their 2008-2010 growth. In the company's latest quarter, the company saw international distribution sales increase 11% with strong growth in Asia and the Middle East. International sales, as a whole, rose 18%. The company continues to see solid growth overseas, and we do not believe that the company will see a slowdown there. Finally, the company's growth prospects are definitely solid in the e-commerce arena. The company saw a 20%+ rise in the company's e-commerce division. Without Shape Ups, though, what divisions will be able to cause such strong growth. The promising lines appear to be the "Go" line, which has a longer chance of survival than Shape Ups, as the shoes are less about fashionable dieting and more about fitness in general. Additionally, the company's kids line seems to be another source of growth especially in international markets.
Let's dig further into our price target and what we can expect from this company.
The following price target was configured through a 5-year projected discounted cash flow analysis. The model projects operating income, taxes, depreciation, capital expenditures, and changes in working capital. Using that information, we can project what the company is worth. We can then use that projection and compare it to current prices.
Here is how to calculate price targets using discounted cash flow analysis:
(all figures in millions)
Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.
Available Cash Flow
For Skechers, we have projected the company to around 10-15% growth in sales in 2013, 8-10% growth in 2014, and 4-5% growth in 2015-2016. We believe the next two years will see strong growth over average levels due to low comparisons from 2011-2012. The company is seeing right now around these growth levels in combined domestic and international sales right now, and we believe that will continue in 2012-2013. At the same time, we do not expect explosive sales seen in 2008-2010 as the company does not seem to have a Shape Up product in their lineup. We believe that margins will continue to improve as well as it's a major initiative for the company currently.
Tax rates should continue to increase, and we have configured them to be around 25-30% by 2016.
Depreciation should continue to increase as the company builds more factories and stores over the next several years to support their international expansion.
Capital expenditures should increase in the next five years as the company continues to expand e-commerce, international stores and distribution, and continue to expand domestic sales as well.
Taking ten-year averages configures working capital changes.
Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012).
WACC for SKX: 6.5%
PV Factor of WACC
PV of Available Cash Flow
For 2016, we are going to calculate a residual calculation, as we believe that the market tends to value companies with around a five-year projection of where business will be. This is the common projection for discounted cash flow analyses.
For the fifth year, we calculate a residual calculation. This number is calculated by taking the fifth year available cash flow and dividing by the cap rate, which is calculated by taking WACC and subtracting out residual growth rate. Residual growth rate is typically between 2-6%. 4% is average growth for industry. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. This is why higher growth companies tend to have higher PE ratios. We will give you cap rate.
Cap Rate for SKX: 2.5%
Available Cash Flow
Divided by Cap Rate
Multiply by 2016 PV Factor
PV of Residual Value
Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:
Sum of Available Cash Flows
PV of Residual Value
Interest Bearing Debt
We have added in current cash/cash equivalents as of the latest fiscal quarter along with debt levels.
Divide equity value by shares outstanding:
In the end, we have found that Skechers stock should be worth around $20. We can compare that level to current prices, and we find that there is some solid value in the company.
The Oxen Group