Looking Forward: Should Crocs Be Part Of Your Portfolio In 2014?

Nov.20.13 | About: Crocs, Inc. (CROX)

Every year around this mid-fourth-quarter timeframe I review a few companies for consideration as my investments for the year ahead. Today, I wanted to re-visit the beat-down designer and distributor of cell-resin footwear that has once been an exceptionally popular fad - Crocs, Inc. (NASDAQ:CROX). For the 2013 year-to-date the company has been down almost 15%, recovering to around just 9% in recent days, challenged by a number of external macro issues as well as problems specific to the company itself. With the company amidst its fourth quarter nearing the 2013 closeout, I looked at the performance year-to-date and most recent earnings conference call to assess whether Crocs is a buy, a sell or just a plain stay away for the year ahead.

YTD 2013:

So far in 2013 company revenues stand at $964 million up 7.3% from $898.3 in 2012, while adjusted net income of $90.3 million is a whopping 33% decline from the 2012 $135 million. And that is adjusted for ERP expenses, Brazilian tax credits and D&A, implying that declines are margin driven and hint at operational business issues rather than one-time unexpected expenses.

With just a single quarter remaining, the 'effective' midpoint guidance for the entire year stands at $1,186.5 million and $0.875 non-GAAP EPS (adjusted for expected ERP and currency impacts). That compares to $1,123.3 million and $1.40 per share in 2012 - a 5.6% growth on the topline and 37.5% decline at the (adjusted) bottom line respectively.

What drove this major divergence between the top and bottom lines? In the topline all major geographic segments reported growth even with the negative currency impact, aided by the 25% growth in global store count. But same store sales have deteriorated significantly with Americans and Japan markets down 5.1% and 16.1% respectively and in constant currency, yielding overall net comps decline of 2.4%. With the larger number of stores, SG&A expenses are up 18.4% YTD, while GPM is down to 54% from 55.8% for the comparable period in 2012.

The Goods:

While the results are really worrisome and concerning for investors, it is somewhat of a comforting note that the two major drivers - the cooler-than-expected summer in the U.S. and the monetary easing in Japan - are really one-time events that are outside of Crocs business model. Currency impacts will get "anniversaried" come 2014 and a reversal in Japan's stimulus will actually aid the company's bottom line. Weather is also a random factor, and a return to more normalized seasoning pattern is likely to aid Crocs with more consumer traffic.

Further yet, lack of ERP implementation costs in 2014 and the boosted share buyback programs are likely to improve earnings-per-share growth by just that much more.

The Bads:

Yet ultimately the question still remains - is the macro picture the driver in results tumble or is there something with the operational model that warrants further attention and assessment.

One warning sign is the 32% decline in Americas Internet business due to purchase traffic shifting to e-tailing partners. The shift is likely due to higher promotional activity and smaller "price respect" resulting in lower gross margins for the company. And that trend is likely to drive store sales down just as well - why buy from a Crocs retail store when you can order online from Amazon or similar wholesaler?

Another, is the physical decline of 3% in Japanese sales even when offset for currency impact. Although "[company] information shows that Japanese consumer traffic in malls was 10% to 15% lower in the quarter", whether the customer will come back to the malls in 2014 and will actually buy Crocs products is in question. That question is further fueled by declines in the U.S. and a struggle converting the product line to an all-season trademark - all clearly pointing to potential brand image decline among consumers and potentially continued sluggish sales that require promotional incentives.

Closeout:

Lastly, at $13.37 close price on Monday, Nov-18 shares trade at around 15.3-times 2014 EPS P/E ratio, something I would consider fairly expensive given the uncertainty regarding company's future market potential.

A significant boost to that number (up from $12/share, a 52-week low just a few days earlier after the earnings release) is given by the buyout talks - and am I glad I have not published this article earlier as in general - my conclusion on Crocs brand is of a negative and bearish tone.

I for the most part agree with B. Maurer in his assessment of buyout opportunity as highly unlikely at the price levels considered. Yet, ability of a bigger brand to leverage CROX balance sheet and brand intangible assets is much more intrinsic in nature and I in no way discount a takeover by a larger retailer who sees synergies, especially given company's success in Japan and Asia Pacific.

For now, I would remain on the sidelines. Certainly, in the $12/share range I would very much consider a long position in company shares, especially if company presents any new product lines that seem interesting and can potentially drive sales. But besides that, I think that pin-point trades on the sell-side if speculation drives shares back above $14-15 price range are much more likely to yield gains - and I would not hold a position for more than one or two days as buyout rumors can always factualize.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.