Do you remember back to the Crocs, Inc. (CROX) IPO when the quirky - yet super sensible - line of foam shoes was the biggest fad in fashion? That was in 2006, and the stock saw a precipitous rise during its first year of public trading - investors saw more than a 5x return in the first year alone. Then the company saw its business all but evaporate during the next six months - late 2007 to early 2008 - when it gave up over 98% of its market capitalization and analysts left it for dead. But the stock has rallied since, reaching highs of $31 in 2011 before settling into a trading range between $13-$20 during the past two years. The point of the story here, though, is that after all of the volatility during the past seven years, CROX hasn't in fact gone anywhere - its trading at roughly the same price as its IPO.
So where does the company go from here? In seven more years will investors be languishing at a stock that still hasn't budged? Or does CROX have some ideas in the pipeline to catalyze future growth?
It finally seems that CROX is ready to take the business to the next level. The fad is over and CROX are mainstream. Therefore, the company will have a hard time (as it has experienced during the past few years) driving growth with established product lines. How well it is able to scale horizontally will determine the future of this company. Positive news for investors: it seems that it has finally embraced that fact.
The Seasonality Problem
One of the top-selling qualities of CROX products has been that, by design, they fit a certain niche and consumers know exactly the quality and efficacy of the product they're purchasing. The company produces warm weather products. According to the 10K, nearly 96.5% of sales in FY 2012 came from footwear.
As noted in the two charts above, 43% of revenues in FY 2012 were derived from Q2, or the three spring months heading into the summer. Critics might argue that all businesses have seasonality factors - which is true - but the argument here is not at what point during the year consumers are purchasing CROX products. The argument, in fact, is that even the 57% of sales that are done during the other nine months of the year are for products that will predominately be used during the warm months. While some CROX products are year-round (the closed toe, no hole lines), much of the line is worn only during the warm months.
From the company's 10K: "Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather."
The Durability Problem
One of the most tightly held trade secrets in the CROX organization is the recipe behind the trademarked Croslite material. Also from the 10K: "Croslite material is manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formula by using exclusive supply agreements for key components, confidentiality agreements with our third party processors and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information."
From the consumer perspective, CROX are continually receiving accolades for comfort and durability. Earlier this week they were awarded Brand of the Year honors at the UK Footwear Industry Awards. With comfort and durability, though, comes a longer-than-average time for user consumption. In other words, the two ideals, which CROX was built upon, actually hinder repeat sales. In order to combat this the company couldn't - and wouldn't - decrease the comfort and durability. Instead, it found that increasing the product line is the answer to driving sales. Just like the bulk of footwear currently available is targeted toward the warm weather months, the company could create a line specifically designed for the colder or intermediate months. It has developed a terrific brand loyalty with the current customer base and could parlay that loyalty into future revenue growth. These customers continue to buy CROX products seasonally but are forced to buy substitute brands during the colder months. New product roll-outs would afford consumers the chance to do what they're already looking to do - wear Crocs all year round.
Business Segmentation & Growing International Potential
CROX's sales are segmented into three separate categories - wholesale distribution, retail and internet sales. In FY 2012 the company saw revenues of $1.12 billion, up over 12% year over year. Broken down, wholesale accounted for 57% of total revenues while retail drove 33%. The internet business channel is much smaller: 10%. All three categories were up on an individual year-over-year basis, but traditional brick and mortar retail sales saw the biggest gains of over 22%.
From an international perspective, the company was hurt by sales in Europe. While European retail sales grew a staggering 73%, wholesale and internet dropped, which drove the European sales figures to shrink from the previous year. Additionally, the company forecast weak European demand for the coming fiscal year, which was the catalyst behind the 10% drop in stock price after the earnings were released in mid-January.
While the European footwear market is struggling it seems that growth in Asia and the Americas seems to be well on track. Despite concerns over the economic stagnation in both China and India, CROX sustained most of its 2012 growth in the Asian market, overall 23% higher across all three market segments.
Finally on the international front, CROX has yet to go head first into the Latin American market. The company has fewer distribution centers in Latin America than it does in Asia, Europe, or North America. While there is a moderate focus on the Mexican market, as shown in the 10K, there is tremendous growth potential throughout the other Latin American countries - specifically emerging markets like Brazil, Venezuela, Colombia, Argentina, and Chile.
CROXC opened roughly 75 new stores in FY 2012, all of which were in Asia and Europe. In FY 2013 the company plans to open 70-95 new stores in all three geographical markets, with one-third of them coming in the Americas. The build-out of American stores is more expensive than Asia, but the retail environment in both markets has proven extremely profitable.
Finally, Some Great New Products
The growth picture in Asia and America is right on track, and after Europe navigates through the economic uncertainty with which it is currently faced, it too will be on track for growth. But, as noted, the current product line is not enough to justify investors building new equity positions in CROX. There needs to be a catalyst for a ramped-up growth project, not just the sustained growth the company has shown over the past few years (we've seen where that has gotten the stock price). The answer, as discussed above, is a new line of products. The new line adequately addresses the seasonality and durability issues that the company has faced. It allows for the loyal customer base to ramp up buying efforts with new complimentary products. According to Consumer Reports, the average woman in the United States owns 17 pairs of shoes. Currently, CROX consumers only have the capability to own a few pairs based on diversification of the product line (unless they own several colors of one line). Product line expansion to colder month products will allow customers to more than double their CROX consumption.
The new product lines are all focused around the same two core concepts that the company has always lived by - comfort and durability. All footwear will still have some component of the trademarked Croslite material - the aforementioned foam composite, which provides maximum comfort. Additionally, there is a new push toward fashion-forward footwear. Past product lines have become fads because of variables other than fashion. Current and future lines will capitalize on a combination of comfort, durability and fashion; this could be the spark that ignites the CROX fuse.
Late in 2012 the company introduced its new line of winter footwear, but the new products didn't have enough time to catch on. The colder months of 2013 should be prime for a product reintroduction. In addition to the late-2012 launches, the company will begin selling its new fuzz boots in November and December of this year - a product launch that will look to immediately and significantly challenge key competitor Deckers Outdoor (DECK), maker of UGGs. Additionally, the company will launch a new line of sneakers known as the Evercourt along with new flip flop, flat and boat shoe lines. Aside from the winter lines, the Evercourt is the most differentiated from the traditional product line and offers the company a chance to break into a new footwear segment of everyday users.
The Financial Picture
Long-term investors in CROX who got in at the company's IPO have seen no return if they held their shares for the past seven years. It's unfortunate that a company that was once the biggest fads in the footwear world fell from such graces. The chart below details the stock's performance relative to the broader market as well as the Dow Jones U.S. Footwear Index (DJUSFT).
It seems on many levels that the leadership at CROX has the pieces in place and is ready to take the company to the next level to finally reward investors for their patience. The logical next question is how long that transformation will take and if the company will be able to survive until these new investments return profit.
CROX has financed very little of its growth and operations with debt. Instead, the company has focused on building equity to finance the asset growth; the results of that decision are reflected in an industry-leading Current Ratio. Assets (cash and inflows) significantly outnumber FY 2013 projected outflows; solvency is strong.
As shown in the chart below, CROX has done a fine job of maintaining profit and operating margins. Their profitability is in line with industry standards.
Because the company has used equity to finance the overwhelming majority of its operations, the key indicator of management effectiveness is Return on Equity. While CROX also maintains an industry leading Return on Assets, the company has exceeded industry standards with regard to ROE. Major competitors DECK and Nike (NKE) have ROE levels of 16.5% and 22%, respectively.
Many of the leading footwear companies do not issue a dividend. Conglomerate NKE is an exception with a 1.39% yield.
From a valuation perspective, CROX is trading at a trailing P/E of 10.28x, nearly a 60% discount to the industry average of 25x. Perhaps more impressive, though, is the company's ability to bolster its cash account. With $3.32 of cash on hand per share and a Price/Cash Flow of 7.77x, liquidity should not be a concern. The company transformation can be given time to materialize without worry.
Finally, in 2007 there was a share repurchase authorization for 5.4 million shares. As of the end of FY 2012 the company had repurchased 1.9 million of those shares, with 3.4 million remaining. The company's reinvestment is encouraging given the fact that there are only 88.1 million shares outstanding, nearly 4% of which will be repurchased by CROX.
*All graphics courtesy of Crocs, Inc. 10K, Investor Presentation, and Reuters Investment Analysis.